The Worth of War (18 page)

French government finances understandably remained in disarray throughout the revolutionary period. Napoleon Bonaparte, however, sought to build a financial system with the ability to finance his military goals. To this end, in 1803 Bonaparte authorized the creation of a Bank of France, which, it was hoped, would enable the French government to match England's ability to obtain long-term credit on favorable terms. This bank, however, was very cautious in extending credit, perhaps recalling the experience of its predecessor in 1720. Thus, under both the Napoleonic regime and the soon-restored Bourbon monarchy, the government relied mainly on private banks to fund its debt. This practice had costs and benefits. The cost was a higher rate of interest, but the benefit was the growth of private banking. From the 1830s onward, particularly under the urging of Napoleon III, major private
banking houses including Comptoir, Credit Mobilier, and Credit Foncier offered long-term financing not only for the government, but also for industrial corporations and railroad construction. These banks and their peers financed France's industrial revolution.

As in the British case, France's industrial revolution was, at least in part, driven by military spending. For example, during the 1840s, France took a position of world leadership in the design and manufacture of steam-powered vessels—an innovation with major military and commercial applications. France's opportunity to take such a leadership position came about because of the conservatism of the Royal Navy, which had a vested interest in wooden-hulled, sail-powered vessels and worked actively to discourage the development of other technologies. Seizing the opportunity, the French designed ships protected by armor plate and carrying guns that fired explosive shells. These vessels were extremely heavy and required powerful steam engines to propel them.
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These military innovations encouraged an expansion of French iron foundries and engineering works. And, of course, determined to prevent the French from attaining a position of naval superiority, the British were forced to drop their own opposition to the development of new types of ships and to match French advances. In this way, military competition contributed to industrial development in both nations.

GERMANY

Many subsequent industrializers were also driven by military goals or necessities. Take the case of Germany. During the 1850s and 1860s, Prussia fought a series of wars against Denmark, Austria, and France. To finance these military efforts, the Prussian government turned to private bankers like Gerson Bleichroeder. In the 1850s, Bleichroeder had formed a consortium of German banks that financed the expansion of the German rail network. This brought him to the attention of Otto von Bismarck, who paved the way for Bleichroeder to organize a consortium of banks that financed Prussian mobilization during the
1859 Franco–Austrian war. Bleichroeder subsequently arranged the loans that financed the Austro–Prussian war and Franco–Prussian war that paved the way for German unification under Prussian auspices.

After German unification, the government made a major effort to spur the sort of industrial development that would increase German military power. One important step was the creation of a central bank, the
Reichsbank
, which would finance the government's needs as well as provide credit for foreign trade and German industrialization. For the new German government, rapid industrial development was essential to supporting Germany's military and political ambitions. The Reichsbank provided credit, set interest rates, and issued a new unified currency to replace the currencies of the formerly independent German states. New rules and regulations were designed to encourage the development of a host of other credit institutions at the regional and local levels to ensure an ample supply of credit for commercial and industrial borrowers.
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Germany's financial revolution played a major role in making Germany a major industrial and military power, with banks providing the long-term financing that facilitated German industrialization and the growth of German military capabilities. The latter two developments reinforced one another. With the help of the banks and spurred by military expenditures, German coal and steel production soon outstripped that of any other European nation. Germany also became the world's leader in such fields as electronics, optics, and chemicals. A great deal of this development was driven by the German government's desire to build a fleet able to do battle with the British. And, indeed, by the close of the nineteenth century, Germany boasted the world's second largest fleet and posed a serious threat to British naval supremacy in the North Atlantic.
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German nationalists declared, with some justification, that Germany brought, “an army, a navy, money, and power to the world.”
²³

THE UNITED STATES

America's nineteenth-century financial and industrial development was driven by military necessity more than military ambition. Necessity, of course, took the form of America's bloody Civil War. Prior to the Civil War, America's national government had few responsibilities and was able to finance its limited expenditures through tariffs and customs duties, occasionally supplemented by small-scale borrowing in national and international credit markets. During the Civil War, however, the government's need for revenues increased so dramatically that the government could not secure sufficient funds from the traditional sources—domestic banks and financiers. European investors, for their part, had no confidence that the Union would prevail on the battlefield and were reluctant to purchase US securities.
²⁴

The federal government therefore turned to new forms of revenue extraction, including excise taxes on manufactured goods, a tax on incomes, bond sales to small investors, and the issue of a variety of legal tender notes, some interest-bearing and some not, in small denominations. All these revenue devices depended upon a measure of popular acceptance and, as we saw above, left the government financially dependent upon popular confidence to meet the Union's military expenses, which ultimately totaled more than $4 billion. By the end of the war, excise and income taxes had produced more than $1.2 billion in revenues. A moderately progressive income tax was enacted in 1862. A levy of 3 percent was imposed on all incomes below $10,000, with the rate rising to 5 percent on incomes above that level. In 1864 and 1865, the income tax act was amended, eventually providing for rates of 5 percent on incomes below $5,000 and 10 percent for those earning more than that amount.
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As mentioned in
chapter 3
, a third major revenue instrument introduced during the Civil War was the sale of government bonds to small investors. In 1862, Treasury Secretary Salmon P. Chase invited Ohio Republican banker Jay Cooke to attempt to place $500 million in government bonds that could not be sold to domestic banks or foreign
investors. Cooke developed a plan to market these securities to ordinary citizens who had never before purchased government bonds.
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He thought he could appeal to the patriotism of ordinary Americans, and he believed that widespread ownership of government bonds would give large numbers of ordinary citizens a greater concern for their nation's welfare.
²⁷

Cooke pushed the idea that purchasing government securities was both a wise investment and a patriotic duty. His network of 2,500 sales agents throughout the North sold these bonds to an eager public. Knowing the difficulty of retaining popular support and the regime's finances over four long years of war, Republican Party organizations worked with Cooke's sales agents in every community to provide what historian Eric McKitrick calls a “continual affirmation of purpose.”
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By 1863, all the bonds had been sold and most were in the hands of private citizens rather than financial institutions.

A final revenue instrument introduced during the war was the issue of $450 million in legal tender notes. Some of these so-called “greenbacks” bore interest, and others could be redeemed for twenty-year government bonds. The bulk of the greenbacks, however, were unredeemable “fiat money.” Issued in the form of payment on existing government debt, the greenbacks constituted an interest-free loan from the general public to the government. After the war, the constitutionality of federally issued paper money was challenged and, eventually, upheld by the Supreme Court.
²⁹

The revenue instruments devised during the Civil War became important parts of the national government's revenue collection efforts during the ensuing decades. The income tax was declared unconstitutional by the Supreme Court in 1895 and then reinstated by the Sixteenth Amendment in 1913. During the late nineteenth and early twentieth centuries, business and financial interests, along with the Republican Party that spoke for them, opposed the income tax and advocated financing the federal government through the sale of large-denomination bonds. Bondholders, unlike taxpayers, derived private profit from financing the operations of the federal government, and a
government sustained by bonds tended to be attentive to the institutions and people who bought bonds.

Their participation in the primary and secondary markets for Civil War–era debt provided financiers based in the United States with a great deal of marketing experience and a much stronger financial base than they had previously possessed.
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Such financiers as Jay Cooke, Daniel Drew, James Fisk, Jay Gould, Edward Harriman, J. P. Morgan, and Joseph Seligman not only traded in government bonds but also used the capital acquired in this way to deal in commodities and undertake lucrative military contracts. Fisk, for example, made millions selling textiles and other commodities to the government. In Europe, where war seemed unremitting, such financiers had an ongoing role in sustaining the state revenue needs and selling supplies to the military. In the United States, by contrast, during the period after the Civil War the army was largely disbanded and direct governmental spending declined sharply.

Nevertheless, the federal government was compelled to deal with the matter of the enormous debt it had acquired to prosecute the war. Between 1860 and 1866, the national debt had increased from a mere $65 million to nearly $3 billion, a sum amounting to nearly 30 percent of the gross national product of the Union states. This mountain of debt curtailed private investment by absorbing capital that might otherwise have been used to finance private endeavors. At the same time, much of this debt had been acquired when the fate of the Union was still in doubt and, hence, was obtained at rates of interest well above current market levels.
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The Treasury Department realized that it needed to move expeditiously to repay or refund its outstanding obligations. This was accomplished through the issuance of new US government securities bearing considerably lower rates of interest than those marketed during the war. Some of the proceeds from the sale of the new bonds were used to retire the old debt. A strong effort was also made to sell these new securities in Europe in order to bring new capital into the country that would be available for industrial and commercial development. Many
of the same financiers who had made millions during the war, like Joseph Seligman, were now involved in refinancing the government's accumulated wartime debt.

The profits that Seligman, Fisk, and the others had made during the war and postwar periods financing the government's debts were, in turn, used to finance America's postwar industrial development. The single most important element of industrial development was railroad construction, which provided the nation with a unified continental market and promoted general economic and industrial expansion. The government worked to promote railroad construction by giving land grants to firms in exchange for their agreement to build rail lines. Such land grants were an important subsidy but did not provide the capital actually needed to lay track and purchase equipment. This is where the role of private financiers was critical. Financiers like Seligman or Drew would arrange to loan a railroad corporation the funds needed for construction and to begin operation in exchange for bonds secured by the value of the land grant that the railroad received from the federal government. In this way, private financiers were responsible for the government's success in promoting railroad construction—the key to America's subsequent industrial development.

Thus, as was the case in Europe, military needs set into motion a financial revolution that, in turn, paved the way for industrial development in the United States. For all its horrors, war served as the great engine of development.

LATER INDUSTRIALIZERS

It is worth noting that many, if not all, of the nations that subsequently worked to develop their economies were driven, to a greater or lesser extent, by a desire to compete militarily with the developed world. Thus, after seeing the heavily armed steam warships of the 1853 American squadron commanded by Commodore Matthew Perry, the Japanese government recognized that it would be unable to defend itself
against a Western power unless it developed its own economy and military capabilities. Japan began by establishing modern financial institutions including the Bank of Japan, networks of commercial banks, property rights, stock exchanges, and corporate law.
³²
These institutions were designed to integrate Japan into the international financial system and to give the government and private entrepreneurs access to the foreign capital and equipment Japan would need to develop its economy. Initially, Japan raised capital in the London financial markets, purchased machinery in England and Germany, and worked to build a fleet along British lines, purchasing warships in England and securing the services of British naval experts.

Tsarist Russia worked to modernize its economy after the military debacle of the Crimean War demonstrated that the developed nations had far outstripped Russia militarily. Subsequently, the Soviet Union, convinced that it would eventually be attacked by the capitalist world, sought to develop an industrial base that would support a powerful Red Army that would defend the state. And, of course, for the Chinese Communist regime, military modernization has been at the forefront of the “Four Modernizations” called for by Zhou Enlai and Deng Xiaoping. As was true in the eighteenth century, war and the threat of war have continued to provide an enormous incentive for economic development.