Appendix B2: The Capital of Capital
Lord of Slower-than-real-time
- Dec 13, 2005
Appendix B2: The Capital of Capital.
The City of London was, and still is, often referred to as a single entity, particularly amongst those keen to ascribe cunning scheming or malevolent intent to the nebulous forces of finance it represented. This is of course untrue, the shear variety of services offered and trades carried out by up the firms that worked in the City made a degree of internal disagreement inevitable and the various 'tribes' would regularly find themselves on opposite sides of the policy argument. That said there was some common ground and on a few select issues they could manage to speak with one voice, or at least as a mostly coherent choir. The most commonly held views were on trade, where the vast majority of the City's denizens were enthusiastic free traders for the simple reason that trade was the lifeblood of the City; the more the world traded, the more opportunities for profit there were. This was not just the trade of Britain, or even that of the Empire, from the perspective of the City any increase in world trade was an opportunity and something that would somehow end up benefiting them. An example from the summer of 1937 will perhaps demonstrate why this believe was so widely held.
The question of German-Japanese trade had been bothering both governments for quite some time; Japan was running a large deficit it could ill afford, while Germany worried about it's exposure to the risk of another devaluation of the Yen and the lack of any way to use the large Yen balances it was piling up. In theory the new Japanese policy for Manchukuo seemed to offer a way out of this; Manchurian agricultural exports could be used to pay for the German machinery imports the ambitious industrialisation plans required. Japan could therefore reduce it's own industrial imports (many of which had been earmarked for being sent onto Manchuria) while Germany would remove the Yen foreign exchange risk as it was being paid in raw materials, mostly high energy soy beans which became the fats and margarines that German farming could not produce. There was of course a problem and it was naturally political; the German government had not recognised Manchuria so could not officially trade with them. The Reich was trying to walk a careful path between China and Japan, hoping to keep both on side as trading partners and perhaps future Allies or distractions, so had not wished to enrage Nanjing by recognising Japan's puppet state. The solution was to forgo the preferred government to government treaty and instead use the German trading house of Otto Wolff to broker a theoretically commercial deal. Otto Wolff would take large scale industrial orders from the Manchukuo government and undertake to deliver them up front, then being repaid partly in cash but mostly in twice yearly agricultural shipments deal. The directors of Otto Wolff being reassured by a secret Reichsbank guarantee that the exports could be sold on in Germany and they weren't actually taking any risk. The relevance of this to the City was the credit facility was denominated in Sterling, the first batch of orders having a value of £2million (for scale total German exports to Japan were barely £30 million in 1936), and the 'cash' part of the repayment was also specified to be Sterling.
The monumentally vast Bush House in Central London shortly before the final finishing works. The dream of the American industrialist Irving T. Bush the building, and it's sister tower block in New York, were intended as temples of trade and visible symbols of Anglo-American friendship. After Bush's bankruptcy in the Great Depression the new owners were rather more concerned with just getting tenants into what had been dubbed 'the most expensive building in the world' (due to it's lavish use of Portland Stone and extravagantly decorated interior) and so departed somewhat from that vision. One of the new tenants was Arcos (the All Russian Co-Operative Society), the Soviet import/export guarantee body and occasional espionage front. Arcos was one of the many Soviet financial institutions based in London and it operated along side the older Russian banks and merchant organisations that the Soviets had claimed and nationalised. Not only was London a nexus for trade, even Soviet trade, it was the home of the London Gold Fix which was the benchmark sterling price for the precious metal. The London price was the reference rate used for all bullion transactions outside of the 'Gold Bloc' nations and, as a leading Gold exporter, the Soviet Union deemed it valuable to keep a close eye on the bullion market.
Aside from a certain amusement in seeing two proudly autarkic governments deciding to use Sterling the benefits to Britain do not appear immediately obvious, and in a direct sense that is somewhat true. It is from the consequences of the deal that the benefits flowed to the City, starting with the need for Japan to acquire moderately large amounts of Sterling to make the 'hard currency' element of the repayments. This implied increased Anglo-Japanese trade as Tokyo sought to earn the required foreign exchange with obvious benefits to the merchant banks who would facilitate the trade. While the goods covered by the deal would be carried on German and Japanese shipping, neither nation possessed enough tonnage to even carry their existing trade let alone any extra, so ships had to diverted from existing trade and were replaced by tonnage chartered from British lines. With that came the whole trail of ship brokers, insurance, merchant banking, bunkering and all the other professions who made their living facilitating trade. Finally when Japan made it's repayments those funds would not go into the Reichsbanks reserves but be used to pay for yet more German imports from either Britain or the wider Sterling Area. The government, to the limited extent it was aware of this transaction and the many like it, were somewhat less enthused about the Sterling Area being used to help Germany and Japan strengthen their economies. But just as the ubiquity of Sterling had many advantages for Britain it was recognised there were costs, not least of which was that people would use the currency for purposes you would rather they didn't. With enough effort from the Bank of England and Treasury the deal could have been scuppered, or at least forced to use a different currency and made to take longer to arrange and settle. However this minor benefit would have come at the very high cost of discouraging the countless other overseas parties transacting in Sterling and driving trade towards the ever-eager arms of New York or Paris. Sterling was pre-eminent because it was available, widely accepted and useful, if it became apparent the British government would intervene to stop it being used for certain purpose that would undercut that utility. Thus, like the Soviet banking presence in London and many other annoyances, the trade was monitored but tolerated as a price that had to be paid. It should also be noted that the many disparate intelligence groups scattered across the government had long since become accustomed to using this 'commercial intelligence' to supplement the information that came from more official sources.
If trade was the subject of widespread agreement within the City then loans and credits were a point of tension, though as any good banker should admit new and existing loans are always a point of tension for a financial institution as they require various contradictory concerns to be balanced. This remained a truism whether the loan was for a domestic mortgage or a new mineral export harbour in Peru, even if the number of factors that had to be balanced increased considerably for the latter. Taken as a whole Britain had a very large stock of investments, offered trade credits, and outstanding debtors, all of which generated a substantial portion of the 'invisible export' income that the overall balance of trade depended upon. This stock had to be added to by issuing new credits and offering new loans as old ones were paid off, because if not that income would shrink. Indeed ideally the stock of outstanding instruments should grow, so that the income generated and returned back to London and thence the country would also grow. Furthermore, just because the City was pre-eminent did not mean British capital had a monopoly, far from it, so the terms had to be keen as most would-be debtors had options beyond the City. The source of the tension should therefore be clear, debtors only had so much money they could use to make payments and if too much new debt was added then they may not have enough to pay the new debts and their existing old debts, particularly if any new investment would take time to generate an income (if indeed it ever did).
A balancing act was therefore required and for much of the 1920s the creditors had been in ascendance and the British government had prioritised collection of old debts. Trade deals had emphasised how a portion of any Sterling generated for the foreign power had to be used for debt servicing, these deals and measures like them had seen British creditors achieve repayments far in excess of their peers in Paris and New York. As the Depression struck minds in London started to change, it became apparent that the previous approach was having unanticipated costs, or at least unanticipated in terms of scale and consequence. Money spent on debt servicing could not be spent on British exports and the demands for surety of repayment where making British investments less attractive. The merchant banking sector of the City was also making the argument that if the debtors economies could be helped to grow they would find their existing commitments a lighter burden. The tipping point was the appointment of Walter Runciman to the Board of Trade in 1931, appointed to balance the pro-tariff Neville Chamberlain in the Treasury he would oversee a change in trade policy. Instead of chasing old debts Britain used it's leverage to promote British exports and new overseas investment. This change did indeed produce results as exports increased considerably and, significantly, they rose far faster than imports. Whether this success was being achieved at the cost of storing up problems for later as the creditors claimed, was of course, a different question.
A new narrow gauge diesel rail car from the Birmingham Carriage & Wagon Company undergoing final inspection, and photo opportunity, prior to being shipped to Argentina for service on the British owned Buenos Aries Western Railway line in early 1937. Out of the roughly £500million of British capital invested in Argentina by the mid 1930s some 60% of it, almost £300million, was invested in railway companies. Railway schemes had long been considered the ideal overseas investment; they required plenty of British engineers and exports to build, the locomotives and major replacements were often sourced from Britain, they did not compete with any existing British industry (indeed they often opened new markets for exports) and they were profitable so the creditors got repaid (provided one ignored the occasional over-budget disasters and failures of planning). However by the mid 1930s there were few places that had not already had their own 'railway mania' at some point, so British capital had to look for new projects and to the regret of the government these were often more controversial. It must be said that with hindsight this was probably for the best, with the rise of the cheap passenger car and the affordable lorry, railways were no longer the profitable venture they had once been.
The new projects themselves were, in the absence of the traditional railway investment schemes, generally 'Grand Projects'; the large scale and occasionally quixotic industrial works programmes that proliferated as countries either sought to escape the Depression or elevate their nation up the ranks of power. Due to their size (and often questionable business case) the schemes were generally led by the foreign government in question and could struggle to attract conventional investors. The City's solution was to enlist the help of the Export Credit Guarantee Department (ECGD) of the British government to assist in getting the projects financed. Setup in the aftermath of the Great War to restore British exports in markets that had been lost during the war, the ECGD had broad powers to guarantee debts, underwrite loans and even raise it's own funds as required. Yet those powers were rarely exercised as ECGD involvement was something of a self fulfilling prophecy; the presence of the guarantees meant the guarantees were rarely called upon. A foreign government defaulting on commercial loans was one thing, to a certain extent the Treasury and Bank of England encouraged the idea that investors must face the consequences of their decisions, but to default on a loan backed by the British government would have diplomatic consequences. In a typical ECGD scheme the 'price' for the guarantee was the understanding that British firms be used for the design and engineering and that British suppliers would provide all the necessary equipment. It must be stated this was not a British innovation but very much par for the course, any nation with pretentious for an export industry had an organisation like the ECGD with similar aims and powers.
Typically 'Grand Project' schemes were deemed 'strategic' by the foreign government promoting them and in some cases this was not just a euphemism for 'loss making bad idea' but a correct description (and of course often it was both). The largest and most lucrative of these strategic projects in the 1930s and 40s were Iron and Steel works; the thought process in the promoting nations tended to be that great powers had their own steel industry, the country in question wanted to be a great power, so therefore it needed a steel works. This was to the great annoyance of the British government as Steel was one of the more sensitive industrial questions in the country; Britain was the 3rd largest steel exporter in the world, but also the 1st largest importer. This is not quite as mad as it seems because 'steel' covered everything from girders, to cutlery, to car bodies to armour plate and no nation could make every type, even the Americans and Soviets imported certain specialist grades of steel. It did however mean that any new overseas mill was seen as a threat to British exports and a 'waste' of capital that should be spent building a new mill in the UK so Britain imported less. Then of course there was the Imperial dimension as the Dominions were all net importers of steel and could be relied upon to agitate for further investment in their own pet schemes. That the British government persisted was for reasons both commercial and strategic.
The Karabuk Iron and Steel Works, north Turkey, just after full opening in 1940. Turkey had been attempting to build a modern steel works since before Turkey had existed, it had been a dream of the Ottoman state going back to the mid 19th century. There were many reasons for the failure but a key one was that, economically, the entire scheme made very little sense; Turkey lacked any iron ore mines, her coal was low grade and poor quality, and the domestic Turkish iron and steel market was not large. To support the new works it also proved necessary to build almost all the supporting infrastructure; power stations, sintering works, coking works and so on, then to connect them up with new railways and provide new ports to handle the imported iron ore. Unsurprisingly the Karabuk works proved to need heavy subsidy and steep protective tariffs in order to survive, while the idea of 'profits' was a distant dream, a depressingly regular outcome for such schemes regardless of who initiated them.
On the commercial level the schemes were lucrative, not perhaps for those who planned them but certainly for those who designed and built them. To take the example of the Karabuk works, total fees came in at £2.5 million and the supply of plant and equipment provided 30,000 man-years of work for the supply chain in Britain. Moreover it was work that went to those parts of the British economy most in need, the heavy industry areas that had struggled to escape the Depression. The technical success of the works was also valuable, Karabuk did not make money but it did make steel in the required quantities and to the specified standard. Where Krupp had previously dominated, future British consortia had a success outside of the Empire to use as a selling point. The most important motivation though was grand strategy, Germany had ambitions in Turkey and had funded railways and wider works as part of their plan to woo the Turkish government. The Karabuk contract broke that run of success and inserted British interests into the most strategic project in Turkey and made Ankara dependent on Britain to finally achieve their decades long dream. It is hardly surprising that the Foreign Office had lobbied hard for a relaxation on the usual ECGD limits to push the project through, nor that the Imperial General Staff and Board of Trade had joined them. A secondary strategic benefit came from the payment and this returns us to the original view of the City; any increase in trade was always a benefit to the City. Under the pretence that it would take time for Karabuk to become profitable (it being un-diplomatic to doubt it would ever actually turn a profit) the British consortia, the ECGD and the Turkish government agreed that repayments were linked to a claim on Turkish mineral exports of chrome, molybdenum and manganese amongst other strategic materials. This was to prove highly satisfactory and a pattern that would be repeated on future schemes were there were concerns about repayment, not least the vast works contracted for in Brazil and China near the end of the decade. From a British government perspective the arrangement restricted Germany's access to such materials, at no cost to the British taxpayer, and brought Turkey further into the British sphere of influence. Viewed from that perspective a guarantee on a loan and further complaints from the Steel lobby doubtless seemed a small price to pay.
These issues would all surface during the Imperial Economic Conference and none of them would be easily resolved. The ECGD proved to be a surprisingly controversial subject, mainly due to Dominion complaints that it did not apply to investment within the Empire. As such investments were not see as 'exports', just moving capital around the Empire, this is perhaps understandable but the problem remained. There were schemes to promote investment within Britain (the Special Area Scheme) and for investment elsewhere (the ECGD) but nothing for intra-Empire projects, making them comparatively less attractive. With the aero-industrialisation schemes discussed in earlier chapters starting to ramp up in Australia and Canada this was becoming an issue, the main factories were getting funded but the supply chain was struggling for financing. More precisely they weren't so much struggling as upset at paying commercial rates and wanted to get ECGD under-written funding instead (government backed debts being less risky and so lower interest). The Dominions could have provide incentives that matched ECGD, but naturally wanted London to bear the risk and costs instead as it would be British firms that mostly benefitted. London believed that as the Dominions wanted the factories, they could pay for them. At heart it was a mismatch between politics and economics; the Dominions had their own budget, debt and policies so were naturally treated as separate countries by bankers assessing risk, but politically they saw themselves as part of the Empire and wanted to see benefits from this, such as being seen as low risk debts. The Sterling issue somehow managed to be more explosive, even if it was more tightly focused on Canada. While the rest of the Empire, and much of the world, pegged to Sterling, Canada had linked to the US Dollar due to proximity as much as anything else. The US adherence to Gold when Britain devalued had been painful and it had only got more painful, her exports were over-priced and the US tariff wall caused even cross-border trade to collapse. Canada had always been an oddity, inside Imperial Free Trade but outside the Sterling Area, but the contradictions were becoming impossible to bear. The Conference would see a choice finally made.
Well that is the 'short update' idea truly dead, killed by this monster. But are you now not better informed about the balance of trade, the Sterling Area and the wonderful world of overseas foreign investment?
From the top, the German-Japan-Manchukuo trade deal is OTL as is the use of Sterling. I find the idea of the two main Axis powers having to use Pounds to trade with each other a fascinating detail, so naturally had to include it. The currency aside it was a fairly standard German 'barter' deal, machine tools being essentially swapped for Soy beans, the sort of deal you have to do when none of the countries involved has useable currencies or 'normal' economies. You can see why the British were so confident the German economy would implode under blockade, because it was a Frankenstein's monster of a mess pre-war.
British readers and/or fans of the BBC may recognise Bush House as home of the World Service in OTL, though they did not move in until during WW2 when their main studio was bombed. There is no link to the recent Presidential Bush family as Irving T. Bush was from an unrelated Dutch family. He did go bankrupt OTL and lose control, but I think he got it back briefly. Here the Depression in the US is worse, so it is gone for good. Arcos is OTL, as was their spying in the 1920s, and they did end up in Bush House which I find mildly funny given it's original intent.
British investments in Argentina were that huge and were heavily railway focused, most of said railways did pay nice fat dividends until the late 1920s. For once the Depression was not the problem, it was the rise of taxis and cheap lorries under-cutting them and the government restrictions on fares and rates. There were tensions pre-war about this, but then everyone got distracted by the war and things drifted. Post-war Peron nationalised the lot at a cheap price, though in fairness the train lines weren't worth much once the country was flooded with war surplus vehicles that finally destroyed their chance of ever making a profit.
The Turkish Steel Mill is OTL as is the repayment scheme, the Foreign Office, IGS and everyone else did have a view and it went through with an ECGD guarantee. The war cut off Iron Ore imports to Turkey so they developed a domestic supply and kept going. It was famous for always losing money and terrible management, but it meant Turkey had a domestic iron and steel supply during WW2. Post-war it became a mill-stone of losses and debt, but by then it was definitely un-closeable due to Cold War grand strategy and a desire for a steel supply that could not be cut off. OTL the Brazilian mill (Vargas works) got built by the US during the war on dodgy terms as a "please don't join the Axis" bribe, while the Chinese mill in the Canton valley was being designed and finance discussed with a British consortium, then the Japanese rudely interrupted with the Marco Polo Bridge incident. With that not happening and China in the Sterling Area the scheme is going ahead.
The ECGD did exist as discussed and everyone had their own equivalent. The US had the Export-Import Bank that FDR setup in 1934 and I'm assuming something similar happens in Butterfly because it is so damn obvious and everyone else is doing it.
Finally Canada did peg to the USD but did sign up to the Ottawa agreement on British Empire tariffs. It did get a bit rough when the UK devalued before the US, but it was a short gap so manageable. Here the US is still on Gold so maintaining the CA$-USD peg is hurting. Something has to give and the Imperial Economic Conference is when it does.