Patrick Armshaw

War and the Nation-State

Final Paper

Coal, Gold, and Nationalism: An Evaluation of Keynes' “The

Economic Consequences of the Peace”

The hand that signed the treaty bred a fever,

And famine grew, and locusts came;
Great is the hand that holds dominion over
Man by a scribbled name.

-Dylan Thomas1

The early part of the Twentieth Century must surely rank as one of the more exciting, and

dangerous, eras in the history of the West. From an expansionist (and not coincidentally imperialist)

sense of optimism in the seeming ability of “Freedom, Equality, Property, and Bentham” to procure,

from all corners of the earth, the requirements and accouterments of daily life, Europe tilted wildly

towards a massive, and economically devastating war, leaving tens of millions dead, several Empires

defunct, and a great power in the throes of revolution and civil war. In many ways, it was the end of an

era, perhaps of an entire world. Keynes' description of this world, although heavily reliant on the

experience of the middle- and upper classes, expresses this optimism (not to say complacency)

admirably:

The inhabitant of London could order by telephone, sipping his morning tea in bed, the various

products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery

upon his doorstep; he he could at the same moment and by the same means adventure his wealth in the

natural resources and new enterprises of any quarter of the world, and share, without exertion or even

1 “The Hand that Signed the Paper” from the anthology “Twenty-Five Poems” (1936)

1
 trouble, in their prospective fruits and advantages.”

This ideal situation reflects an ease of movement of goods and capital to be admired, even in our own

situation of advancing globalization. It was in fact hoped that the advance of trade would help to quiet

the militaristic urge, or at least push the arena of conflict out of Europe permanently. The last major

European conflict had been the Franco-Prussian War in 1871, a period whose aftermath saw the

incredible advance of industrialism throughout western Europe, the United States, and Japan. Such

conflicts as did occur, such as the Fashoda Incident or the Mahdi Rebellion, were by and large colonial

affairs: sited on colonial (or prospective colonial) territory, involving the defense of 'interests' rather

than the nation, and to be fought mainly by colonial manpower. Even more difficult disputes between

the colonial powers, such as the Moroccan Crises, had been no match for the combined sagacity of the

Entente powers. War, in the old dangerous sense, could almost be assumed away in such a situation,

for war, along with the militarism, nationalism, and racism which legitimized it, seemed antithetical to

the business of business - “little more than the amusements of [the inhabitant of London's] daily

newspaper.”2

Yet war did come, in many ways spurred by the very imperialistic capitalism that had seemed

to augur peace. And this war was to have a profound effect on its participants, revealing paradoxes in

the ideologies of the States that fought it, necessitating drastic changes in the ways that States

interacted with their economies, and ultimately unraveling the dense web of international trade that had

been painstakingly built up over the preceding forty years. But it was the actions and choices of these

States in the inter-war period that were to have the profoundest effects on the course of history. For

while an economic downturn was almost certain in the post-war era, given the massive losses of human

life, the destruction of physical capital by occupying armies, and the interruption of normal trade

networks, it was by no means certain that the downturn would be as prolonged, and as destructive to

2 Keynes, pp. 41 - 42

2
civil society, as the Great Depression turned out to have been. Keynes in particular was quite clear on

this in his prescient work published in 1919 “The Economic Consequences of the Peace.” Keynes'

critique of the Treaty of Versailles is founded on several basic elements, aside from simple questions of

justice for the defeated. His focus can be divided up into three main points: the effects of the

disruption of the coal industry on production, the maldistribution of gold in the global market (and

particularly the lack of sufficient gold holdings by the German state to pay off the demanded

reparations), and the political-economic effects of privation on the conquered German peoples. It will

be the purpose of this paper to examine the actual history of the inter-war period, and particularly the

effects of the Treaty on the global economy, in order to examine the linkages between the end of

imperial capitalism, the rise of political instability (resulting in the challenges of Fascism and

Communism), and the ultimate entrenchment of command-influenced economies in western Europe. I

argue that Keynes' choice of variables (energy supplies, money supplies, and the political consequences

of economic decisions) are ideal for these purposes, and that there is an interesting story to tell,

regarding the collapse of the 'free-trade' system and the rise of domestic protectionism and autarky

among the industrialized nations.

Coal

We begin by noting the fundamental importance of coal to the European economy. All

economies are driven by some source of power, in the physical sense. The Roman economy was

dependent upon slave labor, and the ceaseless demand for more slaves (along with the lack of a racial

caste-system) lead eventually to imperial overstretch, stagnation, and downfall. The middle ages saw

the institution of serfdom, providing for a class of labor whose movements could be circumscribed. By

the 1800s, however, this dependence on human labor was being transformed into a reliance on

machinery – capital itself came alive, providing a massive expansion in the productive capabilities of

3
those nations and capitalists able to afford it. And coal was the preferred food of this mechanical

Golem. In fact, coal was not simply a good, to be bought and sold, but was the underpinning of the

national economy, whose movements in price affected the cost of manufacturing, and the brute fact

that made trans-global trade (and the navy that protected it) possible. The introduction of coal-burning

ships allowed maritime powers vastly to increase their effectiveness in combat, expand their reach, and

shorten the length of time (as well as reduce the cost) of moving goods from one corner of the earth to

another. This last point is of considerable importance for the internationalization of trade in the late

Victorian era. While the early and mid 1900s saw the beginning of the switch from coal to petroleum

as a primary energy source, even as late as World War II coal was still of no small importance. In

1914 coal-driven ships accounted for 44 million tons, or around 97% of the total world tonnage, and by

1937 coal still maintained a sizable 49% share, or 32 million tons.3

During the war, the overarching importance of coal became apparent as the belligerents rushed

to ensure a steady stream of fossil fuels to the military machine. The coal industry however, especially

in the United Kingdom, seemed unable to meet the challenges. The UK, France, Germany, Austria,

and Russia all faced decreases in coal production from 1913 to 1917, some of them quite serious.

France's production dropped form around 41 million tons to 29 million, Austria from 60 million to 19

million, and the Russian Empire from 36 million to just 13 million. 4 The shortage itself was due to two

major factors: disruptions in the labor market due to popular mobilization, and a disruption in the

railroad systems that lead to bottlenecks in distribution. The disruption in labor was a direct result of

the war: many nations drafted coal miners directly into the army at the outset of the war,5 a policy that

was walked back as the disruption in the coal industry became clear. Furthermore, a not insignificant

portion of miners volunteered for duty, or left to gain higher wages in other industries (notably the

3 Voskuil (1942), p. 252

4 Notz (1918), p. 568
5 As much as a third of Germany's coal miners were tapped for military service. (Notz, 1918)

4
munitions industry), leaving behind mining positions that were filled by less experienced hands,

reducing productivity. The transportation situation was no better, and was to have profound effects on

coal workers' ability to profit from their indispensability. While the shortage of coal and it's

importance to the war effort did lead to higher wages, as governments, desperate to maintain

production, inserted themselves into labor disputes (sometimes even on the side of labor), workers

incomes were reduced through lost hours, as the rail- and waterways were taxed beyond their abilities

by the demands of total war. This, combined with harsher discipline and relaxed safety standards led

to considerable labor trouble, and made the job of keeping skilled workers in the mines more difficult.

[T]here has been much unrest and numerous strikes have occurred among the coal miners of Great Britain,

the United States, and Germany. The main causes for these labor troubles have been shutdowns at the

mines on account of shortage of cars, thus decreasing the number of work days, and a heavy increase in

mine fatalities, due partly to inexperienced labor and partly to less rigid enforcement of mine safety

regulations in order to speed production.6

Eventually, the situation became so desperate that the government was forced to play an

increasingly strong hand in regulating the coal industry: the British government, owing to labor unrest

in South Wales, seized control of the mines there on November 19th, 1916, and extended their control

over the entire industry by February 22nd, 1917. Furthermore, high taxes were set on super-profits,

prices set by government announcement, and elaborate zoning plans implemented to prevent

transportation bottlenecks, by decreeing that coal produced locally was to be consumed locally. We

see a major expansion of the public sphere to encompass what had previously been areas firmly

considered private. We also see a powerful argument for the centralization of such crucial industries.

One predictor of the level of disruption in a state's coal trade is the level of fragmentation before the

war. Germany's highly centralized industry suffered from less disruption than the more fragmentary

industry in the United Kingdom, and this lesson was not lost on the allies. The reliance on cheap

6 Notz, p. 571

5
human labor also became problematic, and the aftermath of the war saw the extension of capital-

intensive machinery into the industry.7 These experiences were to have a profound effect on

economics, and lead directly to a popular consensus that some areas of the economy could not be

efficiently directed by private interests. While the coal industry was cut loose from government control

in March of 1921, the seeds of government dirigisme had been sown. That nationalization seemed

possible, or even predictable, following the war was a direct result of the chaos unleashed when

mobilization strained the old system to the breaking point.8

To this wear and tear of war we must add the deliberate destruction of the enemy's coal-

production as a strategic aim. Germany's route into France through Belgium put the vast majority of

France's coal fields in the way of the invaders. The areas occupied by German forces produced an

astounding 68% of French coal9 During the German retreat, much of this productive capacity was

sabotaged, a Parthian shot with important consequences, as it further inflamed French feelings of

victimization by Germany, and one major element in the resulting Treaty of Versailles involved

Germany's responsibility to furnish France with sufficient coal to maintain its industry. All of these

factors lead to a major increase in the market price of coal, producing large profits for the industry,

combined with a shrinking supply of actual coal. And with any post-war peace dependent on a

resurrection of industry, the chaos in the coal markets seemed to augur badly. Keynes' argument here

is quite simple: (a) Germany, as the continents largest economy and greatest producer, is inextricably

linked into the economies of its neighbors; (b) the repair of the Allied economies was dependent on the

resumption of German's place in this economic system; (c) the Treaty, by preventing Germany from

recuperating, also prevents the Allies from doing so. Specifically, the Treaty obliged Germany to ship
7 Dintenfass, 1988
8 As far as public sentiment can be gauged by the press, by parliamentary debates, and by reports of special
commissions which have investigated the problems involved, it is a noteworthy fact that the view is apparently rapidly
gaining ground the world over that, if not complete nationalization, at least a much greater degree of state regulation
of the coal industry and trade than existed before the war is desirable and in the public interest. (Notz, 574)
9 Notz, 1918

6
20 million tons of coal to France in reparation for the destruction of the Nord and Pas-de-Calais mines

(half of France's total output), and another 25 or so million to France, Italy, Belgium, and Luxembourg.

This, despite the impending German loss of the Upper Silesia deposits (providing about 23% of

German production) to the new-born Polish state,10 and the French occupation of the Ruhr Valley.

Keynes argued that this was economic suicide due to Germany's centrality in the European economy:

Round Germany as a central support the rest of the European economic system grouped itself, and on the

prosperity and enterprise of Germany the prosperity of the rest of the Continent mainly depended. The

increasing pace of Germany gave her neighbors an outlet for their products, in exchange for which the

enterprise of the German merchant supplied for them their chief requirements at a low price. (Keynes , 65)

And the major factor preventing a resumption of this system, in Keynes' view, would be the shortage of

coal in Germany.

In the event, however, the problems affecting the European economy did not spring from a coal

shortage in the after-war years, but from relative overproduction. “The decrease of manufacturing

production in Europe, greater economies in the use of coal, the competition of lignite, oil, and

electricity produced by water-power were all factors which contributed to the result that more coal was

being produced than could be used (Macrosty, 1928).” This fact, while seeming to contradict Keynes'

assumptions, in fact reinforces them. Even if a Factory has closed due to higher energy prices, it is by

no means certain that a drop in the same would result in the reopening of that business. The capital

invested, once freed from its moorings, is under no obligation to be re-invested once conditions

improve unless there is effective demand for it – as indeed we see with the Great Depression that was

to follow. The lack of this aggregate demand represents a capital market failure, leading to a less-than-

optimum supply of capital being invested – that is, some portion of capital freed through closing

factories is instead held in liquidity, or spent on luxuries. 11 The result for the British coal industry is

10 The Treaty put Upper Silesia under an Allied mandate, with a final settlement to be determined by plebiscite. Not
surprisingly, it voted to join Poland.
11 For a full treatment of the Theory of Effective Demand, see Keynes (1936), “The General Theory of Employment,

7
indicative of the type of problems faced by other coal-producing nations. Oversupply led to low

profits, and low wages, and resulted in major labor disruptions, including the 1926 General Strike,

called in order to support the collier unions in their fight with the coal industry.12 Keynes' prediction

was about the level of production that could be maintained given the constraints on the coal supply, not

on the price of coal per se – and it was precisely this level of production whose collapse reduced the

demand for coal, leading to the drop in price.

The war brought out many contradictions in the continental economic system. In particular, the

seemingly impervious Liberal theory of laissez-faire was deeply undermined. Under the most urgent

test that an industry can face, mobilizing for a war to the point of exhaustion, where every efficiency is

needed, that industry, and many others, fell short. Increased demand, high prices and higher profits

were not enough to induce owners to increase wages sufficiently to keep labor happy, fragmentation of

the industry presented major problems, as firms had to alter their web of business partners to supply

coal to the war effort, and inhibited the diffusion of new capital-intensive machinery among mines.

The resulting spike in prices and disruption in the supply chain seemed to point conclusively to the

necessity of government intervention. In this new era of total war, anything less was to take

inappropriate chances with the fate of the nation itself. Eventually, the seriousness of the tensions

resulting from the supply of coal among nations led to the creation after the second world war, in

which control of coal supplies was an active part of Hitler's strategy for continental dominance

(Voskuil, 1942), of the European Coal and Steel Community.

Gold

The achievement of a nearly universal international Gold Standard must count as one of the

major achievements of the pre-war period. With the United States' conversion to Gold by 1900, all the
Interest, and Money.”
12 See Macrosty, 1928

8
major economies, including Japan, had committed their currencies to gold convertibility. This

monetary convergence was a major factor in the increase in trade during the latter half of the 1800s, as

traders were reassured that the value of the goods they transported between countries would not be

affected by major swings in currency exchange rates. Moreover, the Gold Standard seemed to confer a

particular type of prestige, and the international monetary system, with the Bank of England as its de

facto head, allowed those possessing capital to invest their money far afield, leading to a large increase

in Direct Foreign Investment (DFI). The United Kingdom in particular benefited from this

arrangement: as the center of international capital, many nations sought to hold the pound sterling in

their foreign reserves, in order to benefit from this market in capital. This increased demand for the

pound, raising its conversion rate, and allowing the UK to purchase imports from abroad cheaply,

holding down domestic prices. Furthermore, the negative balance of trade could be paid for through

remittances from overseas investments, made cheap by the same high level of the pound's value.

While the newly created Federal reserve System in the United States began to make the US a

competitor in international capital markets, Britain's leading role was still quite safe in 1913.

The first world war changed all of this. Suddenly gold, rather than passing from one nation to

another through trade, became once again a major source of power, to be guarded at all costs. The

impressive costs of the war, however, made that quite impossible for the belligerents. With the

massive expansion in government spending necessary to gear a nation for war (as well as the increase

in government regulation of the economy and its attendant bureaucracy, a necessity made clear by our

discussion above), the belligerent powers were forced to seek capital from elsewhere. Compounding

the situation was the shift from a civilian to a war-time economy: factories had to be converted to

producing war goods, leaving fewer social resources for the production of trade goods. Thus, as

governmental costs increased, the sources of revenue to pay for them (specifically gold obtained

through foreign trade) declined. The end result was a massive transfer of gold from Europe to the

9
United States, whose economy was well suited to picking up the slack. Loans from the United States

to the United Kingdom during the war came to ₤842,000,000, while those to France, Italy, Belgium

and Russia amounted to ₤550 million, ₤325 million, ₤80 million, and ₤38 million respectively. In

total, the United States lent out ₤1.90 billion: a vast sum indeed. These figures do not reflect the full

measure of inter-Allied indebtedness. The United Kingdom itself made many loans to other Allied

nations, in many cases acting as a clearing house for loans from the US. The United Kingdom had lent

over the course of the war almost as much as the Americans: ₤1.74 billion. France acted in a similar,

though far reduced capacity, loaning out ₤335 million.13

Making the situation far worse was the destruction of physical capital that the war itself

entailed. Invading armies were no more careful during the war to safeguard private property than

today, and indeed the destruction of captured physical capital, either through malice or as an attempt to

cannibalize matériale for the war effort. Furthermore, the requirements of the war machine dominated

those of the civilian economy: necessary repairs were deferred, upkeep dropped, and shortages of basic

materials meant that every year the war continued was another year of the degradation of the capital

stock. Finally, we cannot ignore a certain speculation in the actions of these nations. During the war,

it was certainly considered that the victors would be able to force the conquered to repay these debts in

the form of reparations. And for precedent, the belligerents did not have to look far back in history.

The peace treaty that ended the Franco-Prussian war in 1871 included a reparations clause forcing

France to pay billions of dollars in gold to the new German Empire. This influx of capital was then

used in the impressive industrial buildup that occurred in Germany from the 1870s to the 1890s.

Surely such powerful states as had developed since then, capable of engaging in such devastating

warfare for years on end would be able to sustain a flow of reparations sufficient to absorb this web of

indebtedness. We may identify this as an example of 'moral failure' – the economic term for the

13 Keynes (1919), p. 276

10
practice of gambling with other people's money. If the costs of the war could be externalized

successfully to the losing parties, then the clear economic crisis waiting in the wings might yet be

avoided.

This reliance on winning the war in planning the budget is no where clearer than in France.

Here not only did reliance on foreign loans subsidize a major trade deficit, the French government's

reluctance to raise taxes sufficiently to fund the war effort made winning, and the reparations it

entailed, of the utmost importance. The progressive nature of the disease can be seen in the estimated

trade imbalances in France recorded by Keynes. France's excess of imports over exports was 5 million

pounds in 1913. By 1918 it had climbed to nearly 53 million pounds, and by 1919 the imbalance had

reached almost 69 million pounds for July alone.14 Such a massive trade imbalance clearly made

repayment of US loans through gold earned from trade a lost cause. Instead, the capital for repayment

would have to come from the Axis powers, and since the utter collapse and dismemberment of the

Austrian and Ottoman Empires meant that they could not be expected to pay, this meant the money

would have to come from Germany. This explains in great part the absolute vehemence of French

diplomats on the subject of reparations from Germany, and the alliance between France and the United

Kingdom to ensure as Carthaginian peace as could be accomplished.

The dislocations of wartime, and the outflow of gold to the United States had deep implications

for the Gold Standard. By the midpoint of the war, most of the belligerents had abandoned gold in

favor of fiat currency. With gold leaving the country, states could either revalue their currencies, see

the value of the currency eaten away through wholesale inflation, or sever the link between paper and

specie, relying on price controls and heavy regulation to maintain the currency's buying power. The

damage done to currency prices was considerable, and every state involved looked forward to the day

when they would be able to reinstitute the Gold Standard.15 This reinstitution, however, was not
14 Keynes (1919), p. 254
15 Keynes estimated (according to Macrosty) that the value of the pound had fallen by 8 to 10%, while Italy's currency had

11
primarily an economic decision. The case of the United Kingdom is instructive in this regard. Under

Prime Minister Stanley Baldwin, the government went forward with a plan, implemented by

Chancellor of the Exchequer Winston Churchill, to return Britain to the Gold Standard. However, the

chosen price of the pound was at $4.86, a price set not according to market fundamentals, but for more

political reasons. Firstly, $4.86 was the price of the pound at the beginning of the war, and it was felt

to be important that Britain regain its former financial leadership as quickly as possible. Secondly, this

policy was of considerable importance to the Bank of England, whose position as the leading clearing

house for international capital would have been threatened by a fall in the pound.

For Keynes, this seeming act of madness was almost designed to make the post-war recovery as

painful as humanly possible. In his tract, entitled “The Economic Consequences of Mr. Churchill” he

estimated that the proper rate of exchange should have been around $4.48 – in other words, in order to

raise the pound to its previous level, the United Kingdom would have to suffer through an economic

retrenchment, including major unemployment, that could conceivably lead to a world-wide depression.

Just as the United Kingdom was looking to repair its tattered economy, Churchill's commission would

make British exports more expensive, and imports cheaper, leaving the UK at a considerable

disadvantage in terms of international trade. We can perhaps take comfort in the likely fact that the

Bank of England predicted that the strong pound would allow the UK to resume its place as financial

world leader, but the cost to the vast majority of the English people make such comfort decidedly

cold.16 Finally, a strong pound would considerably ease Britain's debt load to the US, a consideration

of no small importance. However, the effect on business was profound, as loans became considerably

more expensive, and businesses became wary of adding to their debt, and the likelihood of deflation

dropped by almost half (Keynes, 1918). France's peculiar budgetary difficulty was a constant source of instability for
the Franc, and the utter collapse of the German and Austrian Marks (as well as the Russian Ruble) is well known.
16 The case for an inverse relationship between terms of trade and money wages is made by Taussig (1925). He also
describes the economic effects of so-called trade in 'invisibles' – that is, export of capital and the returns on overseas
investments.

12
raised the specter of repaying cheap money with dear.

Keynes' argument that this situation was untenable was born out in spades in the next few years.

By 1923 Germany had entered hyper-inflation, as the loss of its gold stocks to Allied repayment,

combined with the extremely loose monetary policies put forward by the Reichsbank cut the value of

the Mark inside the country to the bone. While Germany was able to improve its economy shortly after

the war through increased exports, the lack of capital for expansion necessitated the bust by 1922.

Without German exports to trade for gold to repay the Allies, the Allied governments were in no

position to repay the United States. Making things worse, the debts incurred by the Allies from the US

were interest-bearing: in other words, every day that went by added to the burdens of debt. Finally, the

actions of the Federal Reserve during the war made any rational expectation of a new equilibrium

being found impossible. The US, facing a massive influx of gold, decided to sterilize a significant

portion of this booty, preventing it from passing into circulation in order to reduce inflation. This made

normalization of the post-war currency market next to impossible. Under normal circumstances, 17 as

one country increases its gold stock, its currency rises compared to those countries whose stock is

reduced. The result is inflation in the former, and deflation in the latter. Goods imported from the

deflated economy are then considerably cheaper – resulting (in the long run) in a reversal of the trade

imbalance, and a movement of gold back towards the deflated country. With the US sterilizing the

gold supply and with Britain maintaining an artificially high pound, however, this process was short-

circuited. Britain's exports became more, not less, expensive, and the inflation in the US, while

impressive, was not enough to allow for a major revaluation of the terms of trade. The result was a

considerable advantage for the US in terms of trade, and increasing calls in Britain for the erection of

tariff barriers to protect jobs from overseas competition.18 By 1926, the situation in Britain had gotten

17 Here I am indebted to Friedman and Schwartz's arguments regarding monetary theory.

18 One factor behind the push towards protectionism – the high price of the pound played havoc with the British coal
industry, one Britain's largest export goods. Viz. Shefftz (1967)

13
bad enough, and the political polarization advanced enough, that when the General Strike broke out in

1926, government-allied newspapers (such as Winston Churchill's government-issued British Gazette)

were willing to call the strike a mortal threat to the British state. Prime Minister Baldwin was quoted

as stating “Constitutional Government is being attacked. (.. .) The General Strike is a challenge to

Parliament and is the road to anarchy and ruin.”19

With economic dislocation battering the European economies, it became increasingly clear that

something would have to be done. The result was the institution of the Dawes Plan in 1924, and

following its failure, the Young Plan in 1929. Under the Dawes Plan, the US would undertake to

extend loans to Germany, in order to allow it to rebuild its industry, and switch more quickly to export-

oriented redevelopment. The result would be greater exports from Germany, which could be used to

pay down Germany's reparation debt. These reparations could then allow the Allied governments to

make good on their own debt to the United States. The problem lay in the plan's very conception – in

essence, it allowed the US to pay out money now, to recoup its own bad debts. The money would flow

from the US to the US. In the interim, however, Germany would be obliged to sink yet deeper into

debt, the repayment of which was already taxing its to the utmost. At most, this arrangement would

buy time for Germany to recover sufficiently to begin to reduce the ratio of debt to GDP. At worst, it

would further wed the European economic system to the United States economy, allowing for the

possibility of considerable financial contagion if a depression should hit the United States. And that

depression was to hit with full fury in 1929. With the stock market in free-fall, and the passage of high

tariffs under the Smoot-Hawley bill, capital available for export became increasingly rare, robbing

Europe of both a major trading partner (whose imports were crucial to any hope for a system-wide

recovery) and the primary source of the funds that allowed the financial house of cards to avoid

collapse. Every state in the system was eventually to follow suit, driving up tariffs to increase

19 British Gazette, May 6th, 1926, as quoted from Shefftz (1967)

14
domestic production, at the cost of trade and stability. Trade, it had seemed, had failed entirely, and for

the duration of the Great Depression many states would move towards economic autarky of one form

or another.20 It would not be until the Bretton Woods Agreement in 1944 that a new system of

international trade would be put in place.

Economic Nationalism

In essence, every nation in the inter-war period was faced with an economic dilemma of the

most serious consequence. The reconstruction of the national economies depended on two major

strategies: the first was to increase exports to pay for debt payments and stimulate the economy, and

the second was to close off the economy from international trade, protecting domestic jobs and cutting

off the pathways of contagion that spread the economic disease throughout the system. The problem

was the sheer number of major economies that would have to participate in this game of cooperation,

and the ultimate reliance of that system on the United States as the buyer of last resort. The logic of the

problem is easy enough to lay out, and we may do so with reference to the celebrated 'prisoners'

dilemma.' Each country seeks to improve its economy through development of exports and the

reduction of imports. But for every seller, there must be a buyer. And every import bought made the

job of developing a favorable balance of trade more difficult. Each country in such a bind would

therefore have been best rewarded by being the only player in the system to export more than they

import. And in situations where only a minority of the global economy is reliant on exports, more

wealthy nations are able to sustain the levels of imports to their economies without suffering undue

dislocation in the domestic labor market – that is, the incentive of the wealthier players is to engage in

20 This rise of autarky, and concommitant collapse of faith in the Market, were major contributors to the rise of Fascism
according to Karl Polanyi. In his 1944 work “The Great Transformation” he argues that Fascism results from an urge to
retake control of the economy, in order to lessen the vicissitudes of the market. The use of labor dirigisme in Nazi
Germany, Fascist Italy, and Soviet Russia (and to some degree in the Western powers as well) does much to support
such a contention.

15
as much trade as possible, since trade creates a surplus of wealth, making each nation theoretically

better off. But in a generalized economic downturn, every player is faced with the same incentives.

The result, according to theory, should be an equilibrium in which each player defects (shuts off

imports through high tariffs), refusing to be the only player who has an unfavorable balance of trade.

Viewed in this light, the question for the historian or political-scientist to answer is not “why did global

trade collapse' but rather 'why did it take so long?”

The logic of the game was apparent even in 1919. The Treaty of Versailles included several

stipulations geared towards the dismantling of the German overseas empire, with Japan and the US

gaining the Pacific islands, and Britain, France, and Belgium dividing up Germany's African

possessions. To understand the importance of this, it is instructive to examine how colonies operated

in the era of imperial capital. Colonies provided the 'mother country' with two major benefits: raw

materials, which could be extracted and sold to feed the imperial industrial economy (located in the

home territory), and a market for finished goods. Both of these would be necessary for the sustained

growth of the economy, and it was the possession of these colonies that provided the economic

breathing space for free trade between the empires. However, the expansionist nature of empire

ensured that the colonial powers would come to fight each other, and with the Great War, the

battlefront included Europe itself. With the Allied victory in 1919, the United Kingdom, Japan,

France, Italy, and the other Allied belligerents would not pass up the chance not only to chasten an

imperial (not to say hegemonic) rival, but to increase their own colonial holdings in the process. While

these territorial possessions were discounted from the reparations in gold and in kind that Germany

would have to pay, the loss of such territory, as well as the loss of East Prussia to Poland and of

Alsace-Lorraine to France, reduced not only Germany's supply source of raw materials, but also its

potential market for finished goods. The result was a decreased ability of Germany to make the

reparation payments that were not met by its imperial denuding. Furthermore, the damage to railway

16
infrastructure among the belligerents was intense, and part of the Treaty called for the surrender by

Germany of a considerable portion of its railway stock. We can see the importance of transportation to

production in the above discussion of bottlenecks in the British coal industry.

Germany, if it was to generate sufficient specie to pay the Allies, would have to sell its own

goods to those European powers. But this avenue was also substantially blocked. In the first place, the

popular mood in the Allied countries was positively murderous towards the Germans. After fighting

an exhausting war of attrition for several years, and being subjected to major propaganda by their

respective governments, and suffering the degradation of their own economies in the process, the

voting populaces of the democracies were unwilling to sacrifice their own well being in the short run to

ameliorate the bad condition of the Germans in the long run. The seriousness of the backlash against

Germany is evident in the rapid volte-face by British Prime Minister David Lloyd-George on the eve of

the 1918 General Election. Faced by a popular wave of anger, and not a little financial and economic

self-regard, the Liberal Party, in coalition with the Conservatives, was forced to swing considerably to

the right to counter a challenge from the insurgent Labour Party, a cabinet member of which party

declared “I am for hanging the Kaiser!”21 The result was an immediate cessation of all talk of

Germany's inability to pay, and the institution of a party platform declaring the following:

1. Trial of the Kaiser.

2. Punishment of those responsible for atrocities.
3. Fullest indemnities from Germany.
4. Britain for the British, socially and industrially.
5. Rehabilitation of those broken in the war.
6. A happier country for all.
The War Coalition had not originally intended to raise the hopes of the weary English by offering

German punishment as a national panacea, but the exigencies of the moment made any other course

politically suicidal. Similar emotions were at work in France and Italy, who regarded any settlement

21 Keynes (1919), p. 170

17
that did not make them whole (and then some) as a betrayal of the aims for which the war was fought.

In such an atmosphere, the idea of dropping barriers to trade with Germany in order to repair the

German economy, even if the long term result would have been to make such reparations plausible,

was simply impossible.

But without a German economic recovery, there would be hardly any surplus for the Allies to

garnish, threatening their own ability to repay US loans. Without the promise of substantial income

from Germany, the Allied nations would have to raise the gold themselves, necessitating the retooling

of their own economies for export. But the major customer for Western imports had been Germany

itself before the war. One observer in 1920, F.W. Taussig, argued that a potential out would be to set

up Russia as a potential trade partner with Germany, supplying raw materials in exchange for finished

goods, or perhaps South America or the 'Orient'. (p. 34) While some economic cooperation did take

place in the 1930s, the declared goals of the Bolshevik regime included the development of Russia's

own industrial sector, making it an unlikely candidate for a replacement German colony. German trade

with South America would have meant direct competition with British and US interests in the region,

while the loss of Germany's Asian colonies had been effected precisely to block German access to

these areas. That such ideas were put forward is perhaps indicative of the inability of the political

class honestly to deal with the problems of debt and disequilibrium that first the war, and then the

peace had brought.

The United States, as we have already mentioned, was the linchpin of the economic system:

loans floated by the US government were instituted to provide Germany with redevelopment capital,

without which the entire system would come crashing down. But the US' interests were not in

upholding the system alone. US financial interests, heavily represented on the Federal Reserve Board,

and influential with the government, expected that the loans made to the Allies were to be repaid, and

consequently, the issuance of further loans under the Dawes Plan became a dangerous necessity. The

18
US benefited mightily from the outcome of the war – with the European economy in tatters, the US

was in a perfect position to expand its own trade, increase its international presence, and maintain

effective control of Europe for the duration of the reconstruction. Under the relatively free trade of the

early 20s, the US economy expanded mightily, providing opportunities for advancement and expansion

on a hitherto unseen level. But these astounding gains were built on a foundation of sand: they

required a trade position that could not survive in equilibrium, where other economies borrow from the

US to support domestic consumption, buy such goods from the US, and still be able to earn enough

from foreign trade to make repayments. An excellent parable of this illusory, and ultimately dangerous

expansion can be found in F. Scott Fitzgerald's “The Great Gatsby,” wherein the hero, Gatsby, attempts

to infiltrate the upper echelons of society, but whose wealth cannot buy position. His life, like the

economy, was a bubble and it burst. The financial system of extended loans paying each other off

made contagion a certainty, and as Europe began raising tariffs, the over-investment in export goods

and real estate crashed in the face of a severe cut in effective demand. While it would be unfair to say

that the Crash of 1929 caused the Great Depression, it was at least a major symptom of the

contradictions inherent in the inter-war order.

Conclusion

With the Smoot-Hawley Tariff Act of 1930, and the abandonment of the Gold Standard during

the 1930s, the last vestiges of the old system were swept away, and a system dominated by autarky and

bilateral trade rose in its stead. Politically, the absurdity of the international loan situation and the

harshness of the Treaty of Versailles encouraged the rise of extremist parties in the conquered powers,

especially in Germany – no mainstream party could have honestly offered to break the treaty, relying

as they did on international loans, leaving this most popular of positions to be backed by the extreme

Right and Left. The two largest parties in the 1932 German elections were the National-Socialist

19
Workers' Party and the Communist Party of Germany. The lessons of the 1st world war were not lost

on the new fascist governments in Europe. Hitler's expansion into the east is argued for in “Mein

Kampf,” as a means of securing, within Germany's own borders, the necessary raw materials to prevent

a repetition of the deadly British blockade. Italy's corporatism was a direct response to an economic

system that had seemingly gone haywire. And Stalin's insistence on industrial growth drew on the

failure of the Tsarist economy to sustain a war effort of such magnitude.22

While the Fascist countries were successful at creating less penetrated economies that were still

capable of growth, their achievements were predicated on the arrest, and liquidation, of 'dangerous

elements' in order to redistribute jobs and rewards to those who were considered part of the body

politic. The demands of the economy for growth through political expansion did not ebb, but rather

became more severe, as trade became less available as a means for securing raw materials and markets,

leaving only conquest – a zero-sum game in which there can be no compromise for long. Furthermore,

the Western Democracies also experienced sharp swings away from economic liberalism, but in a more

social-democratic manner, with the British Labour Party taking power in 1924 for 9 months, Franklin

Delano Roosevelt elected President in 1932, and the rise of the Popular Front governments in France in

the 1930s.

The dislocation caused by the war, and the inability of the global economy to right itself

through market mechanisms, signaled not just the end of an era, but the end of an entire economic,

political, and social world. And much of the blame for this collapse can be laid on the system that

birthed it – a system wherein energy supplies were short, nations began to see international relations as

a zero-sum game, and bad loans were the cement holding things together. Keynes' ability to see these

problems in advance, during, in fact, the negotiations over the Treaty of Versailles, provided him the

means to critique, and even to predict with considerable success the effects of that treaty. And those
22 Following Polanyi, I include Stalin as a fascist leader, defining fascism primarily as a rejection of economic and social
liberalism, and not as an ideology of the Right or Left.

20
results were harsh: economic degradation, default, instability, revolution, and eventually, another Great

War.

21
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