During World War I, both sides had been reluctant to finance the war by raising taxes. Consequently, the only option for financing was to sell government debt. In France, for example, no new taxes were imposed until 1916, and the war debt reached astronomical proportions. As early as December 1914, the French government had an outstanding floating debt of over US $750 million. In November 1915, the French government floated its first long term debt — in the amount of US $3 billion.
|Lloyd George: Hang the Kaiser, stick Germany, and partition Ireland.|
In spite of the huge burden of debt, the currencies on either side could have recovered, given the chance. The problem was that they were not given the chance. The most serious problem with recovery was that an easy solution seemed ready to hand: Why should the “victorious” Allies trouble themselves with the pain and austerity of restoring their currencies and retiring their respective war debts, when Germany and Austria-Hungary could be charged with indemnities that would pay for the whole cost of the war? This attitude was epitomized in the British “Khaki Election” of December 14, 1918. Lloyd George’s campaign theme was, “Hang the Kaiser and let Germany pay the cost of the war.” This appealed to the people of Britain, France, Belgium and Italy. Tired of war, they wanted to lay the blame on someone, and were out for revenge. If any politicians saw the danger, they remained silent.
|J.M. Keynes: ignored the one time he was right.|
To his credit, the economist John Maynard Keynes saw the danger, and warned against it. In his book, The Economic Consequences of the Peace (1919), he detailed the problems with the reparations program as proposed. For once exercising common sense, he pointed out that it was economic nonsense to require huge reparations payments, while, at the same time, removing the means that would make payment possible. The fact that the amount of the reparations could not be paid in the time given even with a fully functional peace time economy was also emphasized. Ironically, Keynes, whose programs and policies were to be taken as gospel by later generations of politicians when they could do the most damage, was ignored when he could have done the most good.
Making the reparations payments would have required annual installments by Germany and Austria-Hungary totaling about six times the annual debt burden of the relatively untouched United States. Economists who pointed out the impossibility of making the required payments were regarded as “defeatists.” The politicians had promised their constituents huge payments and a free ride, and were reluctant to reverse themselves, even in the face of reality. This created a national "entitlement mentality," which resulted in people not rebuilding out of their own resources, but expecting the reparations to do the trick. When the demanded payments could not be generated, the restoration of the Allied currencies, which had been tied to the anticipated stream of wealth, faltered. Depreciation set in, and proceeded to such a point that recovery to pre-war levels was impossible even if the proper measures had finally been put into place.
It was not until the late 1920s that the Allies faced reality. The members of the Latin Monetary Union were particularly hard hit. The Union was forced to dissolve, as was, for similar reasons, the Scandinavian Monetary Union. France was forced to create a new currency, based on a Franc of 3.9 cents. Belgium put a new currency, the “Belga” of five Belgian Francs into place, worth 13 cents (making the revalued Belgian Franc worth 2.6 cents). Italy’s new Lira was worth 5.2 cents. All of these were down from their pre-war Union valuation of 19.3 cents.