Norma Cohen is an Honorary Research Fellow at Queen Mary University of London, and a former FT journalist. Her AHRC-funded PhD thesis, on the finance of the first world war, is entitled ‘How Britain Paid for War: bondholders in the Great War 1914-1932’. In this post she argues that Russia’s access to capital will ultimately determine whether it emerges a winner from the war in Ukraine.
The scale and speed with which Ukraine’s allies have moved to support its efforts to defend itself has been stunning. And while the inflow of arms and supplies — particularly from a previously reluctant Germany — have hardened the stance of some wavering European allies, perhaps the most significant support of all has come in the form of economic and financial sanctions on Russia.
Measures that range from targeting Russian’s foreign investment to freezing roughly $630 billion in foreign exchange reserves have put the Eurasian economy under serious economic duress, perhaps best signified by the rouble’s crash over the past week.
A long-term conflict similar to that of the first world war is conceivable. Ukraine shows no sign of being willing to surrender and Russia may have to occupy it for years at great financial cost. While Russian nationalism may buoy support for the invasion, maintaining that in the face of want won’t be easy. Access to financial capital is what is needed.
Financial warfare should be of no surprise to military historians. Perhaps no nation has more experience of that than Britain.
At the outbreak of the first world war in August 1914, Britain was the wealthiest of all combatants. But that didn’t ensure it would be able to harness the capital of its own citizens, nor could it guarantee that its enemies wouldn’t try to obtain some of that money for themselves.
However, what Britain did have in August 1914 was the institutional architecture to raise capital for war; it had a deep and liquid securities market, a system for collecting taxes to service debt, a legal structure protecting property rights and the Bank of England to act as agent in fundraising. No other combatant in 1914 could match these structures. As a result, Britain became war financier not only for itself and its poorer allies such as Romania and Italy, but also for wealthy France.
Indeed, in the first-ever truly global war Britain’s military and industrial battlefront was accompanied by what was effectively a ‘battle for capital’.
Access to capital became key after the war settled into a stalemate following Germany’s failure to secure a quick victory in northern France at the Battle of the Marne. This war was to be a ‘war of attrition’ and that required capital on a vast scale, not just for armaments but for basics from food to soldiers’ boots. Germany’s central government did not even have the power to raise taxes. It had a history that required it to win wars quickly and extract the costs from its enemies. Ultimately, German’s inability to supply soldiers and civilians with basic necessities led to a population that simply got tired of hunger and war.
But Britain’s own battle for capital was complex. It had three ‘fronts’, the first of which was to keep capital out of German hands. On the day war was declared, Britain immediately banned the transfer of sterling to German citizens, including interest and dividends or proceeds of sales from securities. It also seized the assets of the three largest German banks operating in the UK. This caused some pain to the UK’s business and banking communities as trade between the two nations was extensive.
Next, Britain sought to bar competition for capital within its own borders; whatever capital was available should be harnessed for war. It first barred any non-UK entity from raising capital on London and later, barred UK businesses from raising capital in the UK without Treasury permission.
Moreover, history suggests that even if nationalist sentiment supports war, that alone cannot ensure that it’s financed. By autumn 1914, over 500,000 Britons signed up to fight. Yet, the first effort to raise capital for war in November — via the issue of £350 million in 3-1/2% War Loans maturing between 1925-28 — was a dismal failure, raising only a fraction of the sums sought. By 1915, it became apparent the war would last longer and cost far more than expected. It increased taxes by previously unimaginable amounts and put in place a special tax to clamp down on war profiteering.
The second front in the ‘battle for capital’ was defence of sterling’s value against primarily the US dollar. The US was Britain’s main supplier of food and war materials. To the extent that Russia needs supplies from abroad, this, too, will be a war front. To defend sterling, Britain had to persuade its citizens — then the world’s biggest capital exporters — to sell or lend dollar-denominated securities to it.
But to raise war finance, Britain mostly resorted to borrowing it, effectively the ‘third front’ in the battle for capital. Of the £7.28 billion in war loans, 80 per cent was raised at home. To attract investors capital, Britain needed to do more than just limit competition; it had to offer terms so generous they weighed on the nation for a generation. So desperate was Britain by the end of 1916 — without more finance, its ally, France, appeared on the verge of surrender — that its finance minister threatened the nation’s banks and insurers that it would confiscate assets and deposits unless these could deliver their customers’ capital.
Contrast this with the experience of the Central Powers. By March 1918, Germany had defeated Russia in the east and General Hindenburg’s forces were driving Allied troops towards the English Channel. But that was not enough. It had no sources of financial capital within its own borders to draw upon. With its own currency collapsing, Germany was falling woefully short of food and supplies for soldiers, as well as for its civilians. A year before, Germans endured the ‘turnip winter’ in which the only food widely available was that usually fed to cattle.
As Hindenburg’s troops pressed on in France, they stopped their pursuit of Allied forces to eat the food and don the woolly jumpers they found in abandoned French trenches. They were hungry, cold and demoralised. By autumn, German forces were in retreat. Civilians were, too. By 1918, German labourers, who needed roughly 2,500 calories per day, were rationed down to under half that. More than 250,000 Germans had died of malnutrition alone in 1918. Austria-Hungary was in equally poor shape; the sixth army reported that average weight for its soldiers was 120lbs and only one in three had an overcoat for winter.
And while Britons endured some deprivations and high inflation during wartime, it did not need to even begin rationing food until January 1918.
It was the fact that Britain had access to capital, allowing it to buy what its military and civilians needed, that allowed it to outlast its enemies and declare itself the victor.
The question is whether Russia will be able to do the same in its war against Ukraine.
The century-old tax that could help pay for the pandemic — FT Alphaville