Political Risk and the International Bond Market between the 1848 Revolution and the Outbreak of the First World War

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Before 1914 it was widely believed that a major European war would have drastic consequences for financial markets. To the editors of The Economist magazine, this seemed ?obvious?:

... To begin with, [war] must necessitate Government borrowings on a large scale, and these heavy demands upon the supplies of floating capital must tend to raise the rate of discount. Nor is it only our own requirements that will have to be provided for. ... From other quarters demands are likely to be pressed upon us. There is a very general conviction that if war is entered upon ? Other Powers ? will almost inevitably be, in some way or other, drawn into the contest. The desire, therefore, in all European financial centres, will be to gather strength, so as to be prepared for contingencies. Thus the continental national banks will all be anxious to fortify their position, and as they can always draw gold from hence by unloading here the English bills they habitually hold, the probability is that gold will be taken. And the desire on the part of the continental banks to be strong will, of course, be greatly intensified by the precarious condition of the Berlin and Paris bourses. At both of these centres it would take little to produce a stock exchange crisis of the severest type; and ... it is to the Bank of England, as the one place whence gold can promptly be drawn, that recourse must be had. The outbreak of war, therefore, would in all probability send a sharp spasm of stringency through our money market ... [that] would pretty certainly leave rates at a higher level than that at which it found them. ... There is, of course, one [other] way, apart from the depressing influence of dearer money in which war, should it break out will prejudicially affect all classes of securities. It will ... necessitate Government borrowing on a great scale, and the issue of masses of new stock will lessen the pressure of money upon existing channels of investment. ... And as it is to the volume of British ? securities that the additions would be made, these would naturally be specially affected. ... With European Government stocks ... a more or less heavy depreciation, according as war circumscribed or extended its sphere, would have to be looked for. ? For Russia ... war can mean little else than bankruptcy, possibly accompanied by revolution, and those who ... have become her creditors, have a sufficiently black outlook.

The most striking thing about this prescient analysis is that it was published in 1885, nearly thirty years before just such a war – and just such a crisis – broke out. In the intervening years, only a minority of commentators dissented from the view that a war between the European powers would lead to steep falls in bond prices. In 1899 the Warsaw financier Ivan Bloch estimated that ?the immediate consequence of war would be to send securities all round down from 25 to 50 per cent?. If a battleship belonging to a foreign power were to sail up the Thames, the journalist Norman Angell asserted in his best–seller The Great Illusion, it would be the foreign economy that would suffer, not the British, as investors dumped the aggressor?s bonds. Diplomats used similar arguments during the July Crisis itself. On 22 July 1914, to give just one example, the Russian charg? d?affaires in Berlin warned a German diplomat that German investors would ?pay the price with their own securities with the methods of the Austrian politicians?.


Last updated on 07/13/2016