Chapter 8
Before the war our foreign trade was growing fast. England and France, in particular, were good customers for our wheat and other foodstuffs, iron and cotton manufactures, oil and automobiles. In exchange we imported the product of many European factories.
Business relations between nations are not settled like transactions between individuals and firms, that is, with checks or cash. They are settled by balances. England's imports from the United States, for example, are paid by her exports to us. Usually exports and imports so nearly balance that the difference is paid by gold or with the temporary use of bank credit. Therefore it is not a question of actual money but of exchange and this foreign exchange is a commodity whose value fluctuates with supply and demand.
Along came the war. Millions of artisans in France and England were withdrawn from lathe and loom to fight in the battle line. What workers remained at their posts had to produce war supplies. Yet civilian and soldier needed food, clothing and arms. The demand for our products increased and the United States suddenly became the work-shop and the granary of the world.
The Allies, in control of the seas, became our principal foreign customers. American exports soared: those of France and England declined correspondingly. A huge balance of trade--the biggest in our history--swung to our favour.
This balance of trade had to be settled, but on an abnormal basis. What was ordinarily a comparatively trivial matter of a few millions suddenly became an item of many millions and it was all owed on one side. The demand for exchange on New York greatly exceeded the supply and the inevitable dislocation happened. England and France had to pay a drastic premium on the American dollar. The English pound, normally rated $4.86, dropped to $4.50; the franc, ordinarily worth 19.29 cents, fell to 16.94 cents. This shrinkage in values was not due to any impairment of the resource or wealth of the Allies but because the machinery of international payment works automatically and unsentimentally.
Here was a crisis that without aid from us might have eventually cost us dear. Rather than submit to the terrific drain on the exchange value of the pound and franc, England and France could have set about emulating the example of Germany and become self-sufficient. It was not a month's work or even a year's work, but ultimately it would have made these countries more independent of the United States after the war is over.
Of course England and France could have met the situation by shipping gold. Each had a large reserve but the United States had all the gold it wanted, and still has. Besides, in such an emergency gold is an inert and unproductive commodity.
Again, the Allies might have "dumped" their American securities representing an investment of over three billions of dollars, which would have upset the American stock market and sent prices down. Either one of these performances would have done us no good.
It was important, therefore, for the benefit of all interest involved, that the Allies establish a credit in the United States that would enable them to buy freely and remove the costly handicap on American exchange. In a word, instead of having to pay their bills through an intricate mechanism that rose and fell with the tides of trade and put a premium on trading with us, a medium was needed that would restore the whole economic trade balance. It was as essential to us as to our customers.
Hence the Anglo-French Five Hundred Million Dollar Loan was floated and Uncle Sam became a war banker. This loan, however, was nothing more or less than the setting up of a credit of half a billion dollars for England and France in the United States. To put it in another way, it is just as if the two Allies had deposited this sum in an American bank and then drew checks against it for goods and raw materials made or mined in America. In a word, we lent to ourselves.
Put out at a time when money was scarce, the loan would have been unpatriotic and uneconomic. But our banks were filled with idle cash: everywhere capital sought safe and profitable employment. Now you begin to see why these allied loans are really good business in more ways than one.
What is our financial stake in the cost of the war: what does it yield: how is it safeguarded?
Clearly to understand this whole situation you must know just how these foreign bonds are put out. There are two kinds. One is the internal loan issued in the money of the country whose name it bears. This means that if it is a French bond it is in terms of francs: if English it calls for payment in pounds sterling: if Russian, in roubles: if German, in marks. An external loan, on the other hand, is issued in the money of the country in which it is floated. The Anglo-French loan is an example of this kind because both principal and interest are to be paid in United States gold coin. These internal and external loans may be direct obligations of the issuing governments or may be secured by collateral.
There is still a third medium for the employment of American money in the war. Technically it is known as bank credit. Through this agency, foreign firms make deposits of money or collateral in the national banks of their respective countries and purchase goods in America through credits thus established for them in a group of New York banks or trust companies. The acceptances for the goods thus bought become negotiable documents and are bought and sold by institutions and investors at a discount.
This evidence of debt is not the kind of foreign investment suitable for the man or woman with savings to employ because it is more or less a banking transaction. These credits usually net about 6½ per cent.
With the exception of a comparatively small amount of German and Austrian Bonds bought in the main by natives of these two countries for purely sentimental and patriotic reasons, the entire bulk of European loans placed in America is for the Allied countries, principally England and France who are our heaviest customers in trade.
The largest foreign loan brought out here so far is the Anglo-French 5 per cent External Loan which was negotiated through J. P. Morgan & Company--Fiscal Agents for the Allies over here--by the Commission headed by Lord Reading and Sir Edward Holden. It is the Joint and Several Obligation of the Governments of the United Kingdom of Great Britain and Ireland and the French Republic, is dated October 15, 1915, and is due five years after that date. It ranks first amongst the foreign war obligations of these countries.
This was the first big credit arranged by England or France in the United States and the proceeds were used, in the manner that I have already described, for the purchase of American goods and to stabilize the foreign exchange. These bonds which have had a very wide sale in America were brought out at 98 and interest and at the time of issue represented an investment that paid nearly 5½ per cent.
These bonds, I might add, are convertible at the option of the holder on any date not later than April 15, 1920, or provided that notice is given not later than this date, par for par, into 15-25 Year Joint and Several 4½ per cent bonds of the Governments of the United Kingdom of Great Britain and Ireland and the French Republic. Such 4½ per cent bonds, payable, principal and interest, in United States gold coin, in New York City, and free from deduction for any present or future British or French taxes, will mature October 15, 1940, but will be redeemable, at par and accrued interest, in whole or in part, on any interest date not earlier than October 15, 1930, upon three months' notice.
The equity behind these bonds is the good name, wealth and taxing power of the issuing countries. The interest on this loan equals only one-fifth of one per cent of the total estimated income of the British people in 1914. It is slightly more than one-third of one per cent of the French Republic in 1914.
Between this loan and the next large borrowing by England or France in the United States occurred an event of significance to the American investor interested in the securities of foreign nations. The Anglo-French loan, as you know, was simply the promise to pay of two great countries whose Government Bonds at home represented the last word in unshakable security.
But when England and France stepped up to our money counters again, Uncle Sam put sentiment aside and became a pawn broker. "I think you are all right," he said, "but you are in a war that may last a very long time and I must have collateral."
To English pride this was a terrific jolt. I happened to be in England at the time and I recall the astonishment of no less a distinguished individual than the Chancellor of the British Exchequer. It was unbelievable that any nation could demand greater security than the good name of the Empire. "If the elder J. P. Morgan were alive this would never have happened," said the London bankers. They knew that the Grizzled Old Lion of American Finance always held that character was the best collateral. In the war emergency, however, many American bankers thought to the contrary and the net result was that with all external loans thereafter England and France have been forced to dig into their strong boxes and do what any individual does when he borrows money--put up a good margin of security.
An illustration of this secured obligation of the British Government is the issue of $300,000,000 Five and a Half Per Cent Gold Notes dated November 1, 1916. Principal and interest are payable without deduction of any English tax in New York and in United States gold coin. The holder of these notes, however, has the option to get his money in London but at a fixed rate of $4.86 per pound sterling, the normal value of the pound in peace time. Since the pound sterling at the time this article is written is quoted at $4.76, this is a decided advantage.
The new English loan is secured by stocks and bonds whose total market value is not less than $360,000,000. One group of this collateral consists of stocks, bonds and other obligations of American corporations and the obligation, either as maker or guarantor, of the Government of the Dominion of Canada, the Colony of Newfoundland and Canadian Provinces and Municipalities. The second group included obligations of Australia, Union of South Africa, New Zealand, Argentina, Chili, Cuba, Japan, Egypt, India and a group of English Railway Companies. I enumerate this collateral to show the inroads upon British securities that increasing war cost is making. This collateral must always show a market value margin of twenty per cent above the amount of the loan. It means that should there be any slump the English Government must supply additional security.
This issue was brought out in two forms. Half of the loan is in Three Year Notes due November 1, 1919, which were issued at 99¼ and interest and yielding over 5.75 per cent: the other half is in Five¼ Year Notes due November 1, 1921, brought out at 98½ and interest and yielding about 5.85 per cent. These Notes are redeemable at the option of the Government at various interest dates between 1917 and 1920 at prices ranging from 101 to 105 and interest.
Having established the precedent of a secured loan, all succeeding English issues in this country have been backed up with ample collateral. These bonds have a ready market, an important detail that the investor must not overlook in purchasing foreign securities.
Now turn to the borrowings of France in the United States. With this great nation, whose middle name is Thrift, Uncle Sam was no respecter of past performance. For the one separate French external loan he exacted his pound of collateral. As a matter of fact it amounted to nearly a ton.
I refer to the issue of $100,000,000 Three Year Five Per Cent Gold Notes bearing the date of August 1, 1916. To float this loan the American Foreign Securities Company was formed which arranged to lend the French Government $100,000,000. As security the Company--it was merely a group of American bankers, required France to deposit stocks and bonds having a value at prevailing market and exchange rate of $120,000,000. Should the value of these securities fall below this sum they must be replenished until there is a margin of twenty per cent in excess of the principal of the loan.
These securities throw an interesting sidelight upon the resource of the French Republic and its ability to borrow desirable collateral from patriotic citizens. They include obligations of the Government of Argentine, Sweden, Norway, Denmark, Switzerland, Holland, Uruguay, Egypt, Brazil, Spain, and Quebec. The most picturesque parcel in the lot is $11,000,000 in Suez Canal shares. This stock is one of the corporate heirlooms of France and is very closely held. It not only pays a large dividend but shares in the profits of the company which in peace times are big. The fact that France should put these prize securities in "hock" is evidence of her determination to keep her credit absolutely above reproach.
The Three Year French Notes were brought out at 98 and interest and at the time of issue yielded about 5.73 per cent.
But all direct French borrowing in America has not been on the pound of flesh basis. For now we come to what might well be called The Loan of Sentiment. It is the $50,000,000 City of Paris Five Year Six Per Cent Gold Bond Issue dated October 15, 1916. It gave Americans the opportunity to pay a substantial tribute of affectionate gratitude for happy hours spent in the Queen City of Europe and have the prospect of a desirable dividend at the same time. Here is a piece of foreign financing with a distinction and a background all its own. Aside from its purely sentimental phase it is perhaps the only loan floated in America since the war which is dedicated to construction instead of destruction. The proceeds are to be used to reimburse the City of Paris for expenditures in building hospitals and making other necessary humanitarian improvements and to provide a sinking fund to meet similar disbursements. Amid the incessant hate and passion of war it is pleasant to find this back water of cooling relief.
Like most of the foreign issues made during the war it follows the highly intelligent European practice of putting out loans in small denominations so as to be within the reach of the great mass of the people. These bonds may be had in multiples of $100 and upward. The Government of France has agreed to permit the exportation of sufficient gold to permit the payment of principal and interest in the yellow metal in New York. The loan--the only external one of the City of Paris--was brought out at 98¾ and interest, which would make an investment of 6.30 per cent. In addition to this yield as an investment there is the possibility of profit in exchange in view of the option to collect principal and interest at the rate of 5.50 francs per dollar instead of the normal rate of exchange before the war.
This statement of possible exchange profits leads us to one of the conspicuous features of the latest National French Loan, which although internal in form has been put within the ken of the American investor.
Fully to comprehend it you must know that in ordinary times a dollar in American money is worth 5.18 francs. On account of the dislocation in foreign exchange the value of a dollar in French money has risen to approximately 5.85 francs. Therefore when you buy a French security in terms of francs for American dollars you get a great deal more for your money than you would have received before the war. Hence the possibility of profit when francs return to normal is large.
The National French Loan was sold to American investors at an exchange rate of 5.90, which means that every dollar you employ gives you a principal of 5.90 francs. On this basis the price for the security issued at a par of 100 would be 87½, which would make the direct yield over 5.70 per cent. Should exchange return to normal, the subscription price would be equivalent to 75½, which would make the direct yield over 6-5/8 per cent.
Translating this loan into terms of money, you find that for every $14.83 you invest you get 100 francs capital: for every $148.30 you get 1000 francs capital: for $741.52 you receive 5000 francs capital. If French exchange should return to normal and the securities sell at the issue price--87½--the investor would receive $16.89 for every 100 francs of capital: $168.88 for every 1000 francs: $844.39 for every 5000 francs. On this basis without regard to income return the holder of 5000 francs capital would receive a profit of $103.94 or over 13.75 per cent on his investment.
Should the market price of the issue advance to 100 and exchange return to normal the investor would get $19.30 for every 100 francs capital; $193.00 for every 1000 francs capital; $965.00 for every 5000 francs capital. In this case and again without regard to income return, the holder of 5000 francs capital would receive a net profit of $223.50 or approximately 30 per cent.
This loan is issued in _Rentes_ and in denominations of 100 francs and multiples. _Rentes_ is the form in which all French Government issues are brought out at home. The word means interest or income. The French always refer to their Government Bonds in terms of interest without any mention of principal. This is because _rentes_ are supposed to be perpetual. The new French loan just explained is not redeemable or convertible before 1931.
Usually there is no limit to these National French loans. To be in France during the war and see the popular response to the appeal for funds is to have a thrilling experience in the practical side of patriotism.
I chanced to be in Paris when one of these loans was launched. Throughout a day of driving rain thousands of people stood in line at the post offices and private institutions waiting for a chance to put their money out to work for their country. The French wage worker, be he artisan or street cleaner, needed no coaching in the art of employing his funds safely and profitably. Just as saving is instinct with him, so is the putting of these savings out to work in a Government bond second nature. He is the thriftiest and most cautious investor in the world. He has established a close and confidential relation with his banker such as exists in no other nation. Therefore when the French financier offers him Government Bonds or "Loans of Victory" as the war issues are emotionally termed, he does not hesitate. He knows it is all right.
Alluring as is the possibility of profit in the new French Rente at the present abnormal exchange basis, it fades before the prospects for similar profit that lie in some of the Russian Government Bonds available in the United States. The Imperial Russian Internal Five and a Half Per Cent Loan of 1916 amounting to 2,000,000,000 roubles will illustrate.
Ordinarily the Russian rouble is worth 51.45 cents in American money. It has gone down to 32 cents. At this rate of exchange a thousand rouble bond bearing interest at 5½ per cent would only cost $320.00. Based on the normal value of the rouble this bond would be worth $514.60 or $194.60 above the present price of the bond--an increase of about 60.8 per cent on the investment. Figuring roubles at the normal rate of exchange the yearly yield would be $28.28 or 8.8 per cent on the investment.
The fact that roubles are down so low is evidence that Russian credit at the moment is not as high as it might be. The principal equity behind this bond, as well as most other Russian securities available in America, is the fact that Russia has immense post-war possibilities. She will emerge from the conflict like a giant awakened and with the first realisation of her enormous undeveloped resources. To offset this, however, is the lack of stability of Russian Government as compared with the other Allies which makes all Russian Bonds speculative.
On account of the difficulty in shipping bonds and the preponderance of pro-Ally sentiment here, there has been a comparatively small market for German and Austrian war issues in the United States. Yet, in the face of these handicaps, a considerable market has developed. It is due to two definite reasons. One is the desire of the native born and transplanted Teuton to help his country. Many of them appear at the German banks with their savings books eager and ready to make financial sacrifice for the Fatherland. The other reason is that the German mark has so greatly depreciated (it has gone down from 23.82 cents to 17.65 cents) that should it ever come back to anything like normal and the Government does not repudiate its issues the investment will be very profitable.
Here is the way it works out: in ordinary times a 4000 mark bond which would be the equivalent of a $1000 American piece, costs about $960. At the present low rate of exchange the same German bond costs $690.00 in American money and therefore shows a profit on the exchange basis alone of $270.00 or over 28 per cent. Austrian Bonds show even a larger profit.
Summarise our war lending and you get a total of all loans to belligerent Governments since the outbreak of the war that aggregate $1,828,600,000, which is nearly one-third of the whole cost of the Civil War. Add to this our loans of $185,000,000 to Canadian Provinces and Cities and $8,200,000 to the City of Dublin and to the City of London for water works improvements, a grand total of $2,075,800,000 is rolled up. Of this sum $156,400,000 in obligations have matured and been paid off, which leaves a net debt to us of $1,919,400,000. It divides up as follows:
Great Britain $858,400,000 France 656,200,000 Russia 167,200,000 Italy 25,000,000 Dominion of Canada 120,000,000 Canadian Provinces and Municipalities 185,000,000 Germany 20,000,000
Having taken this financial plunge into European financial waters, Uncle Sam has got the foreign lending habit and has loaned $117,000,000 to Latin-America, mainly to Argentina and Chili: $39,000,000 to neutral European nations, including Switzerland, Norway, Greece and Sweden. Not desiring to play any race favourites, he has speeded China on her way to enlightenment to the extent of $4,000,000.
In buying foreign war bonds--a procedure which in war time naturally involves sentiment--it is wise for the investor to watch his step. Patriotism is all right in its place but unless you can afford to contribute money for purely emotional reasons, a cold business estimate of the situation is advisable. This applies especially to the man or woman with savings who cannot afford to take chances. He or she will find it a good rule to stick to external bonds except under exceptional conditions.