Not Just Another Recession
Why the Global Economy May Never Be the Same
UNDER the Dawes Plan Germany pays her reparation annuity to the Transfer Committee in the form of German marks. The Committee, representing the Allies, uses some of these marks to buy goods in Germany for the Allies. With the remainder of the marks, the Committee buys foreign exchange for the Allies. In buying this exchange the Committee comes in competition with other demands for foreign exchange. Are the Transfer Committee's requirements entitled to priority? Is the service of Germany's foreign loans junior to the reparation demand for foreign exchange?
Public discussion of this question of priority as between Germany's reparation obligations and the service of her foreign loans has over-emphasized its legal side. Granted that reparations have no prior rights, or even granted that reparation claims upon exchange are legally junior to the rights of foreign loans, there remain these questions: How much can Germany as a whole wisely borrow? How much can foreigners safely lend Germany? And what kinds of borrowing and lending are wise and safe? If, on the other hand, we grant that rights of the reparation creditors to secure foreign exchange are legally superior, there remains the more practical question -- Is there danger of their exercising this superior right when, if ever, the exchange situation becomes critical?
The last report of the Agent General, Mr. S. Parker Gilbert, published in December, 1927, estimates Germany's outstanding foreign funded loans as close to four billion marks (not including the Reich reparation loan) and her short-term foreign credits as about three and one-half billion marks. Mr. Gilbert points out that public borrowings (state, municipal and commune) comprise much the larger part of the long-time loan. He expresses the opinion that some of these public borrowings have not been helpful either to German economy or to reparations. He thinks also that Germany as a whole has borrowed too fast for its own good and for the good of reparations.
Bankers should and will take account of these opinions because sound lending in any foreign country requires consideration of such points, because they desire to sustain the Dawes Plan and its representatives, and also because it is not good business to run counter to Mr. Gilbert's policy. Whatever his technical rights, he has great practical power, as the effect of his utterances has shown.
Emphasis of the legal side has tended to obscure the fact that the exercise of priority, even if the right exists, would in any critical exchange situation destroy what the Transfer Committee was created to preserve. The Transfer Committee was created to protect German exchange and credit. Any exercise of a priority right by it would destroy Germany's credit and put an end to exchange stability and to reparation payments. Mr. Gilbert estimates the deficit in Germany's visible foreign trade balance for the year ending in October, 1927, at about three billion six hundred million marks. Invisible items would probably reduce this deficit somewhat; but the deficit, whatever it is, has been made up and exchange stability maintained by foreign loans or investments. This (changed only in detail) will always be the situation if the priority question becomes a practical question. It is inconceivable that the Transfer Committee would destroy this possibility by exercising priority, even if it has the legal right to do so.
Foreign loans are necessary. The Dawes Plan anticipates them as an aid to reparations. Mr. Gilbert's report shows that he welcomes them, subject to the reservations he makes. He and the Transfer Committee are taking the right course in warning Germany in time that she is going too fast and too far. This is the practical way for them to exercise their rights, whatever they are.
In L'Europe Nouvelle of December 24, 1927, a French writer who has no doubt of the Committee's technical right says (the translation is mine):
"This having been said, we recognize willingly that it is difficult to conceive of an attempt on the part of the Transfer Committee to seize for reparation account foreign exchange destined for the service of a foreign loan, whether public or private, even if the Transfer Committee had not authorized the loan and even if the Committee had not known of it. In this respect we agree with the Schroder Bank. We agree on this point all the more readily because the life of the Dawes Plan is incompatible with such a seizure, which would strike a mortal blow at German credit and the stability of the mark. We admit an estoppel for past errors, if there have been any, and even for future errors if any escape the vigilance of the Transfer Committee. But on one condition, viz.: that Germany keeps within the general line of her contract either by watching over the situation herself, if she only will, or by submitting gracefully to supervision if that finally becomes necessary."
Nevertheless this priority question, having once been raised, will remain a psychological but very real obstacle in the path of Germany's credit until it is definitely settled, no matter how many lawyers give favorable legal opinions, no matter how improbable it may be that the Transfer Committee will act or try to act foolishly. The Powers interested in reparations, so dependent upon Germany's credit, would be well advised to authorize the Transfer Committee and the Reparation Commission to make a plain declaration that reparations not only will not claim exchange priority but will not even compete for exchange as against foreign loans. This declaration should be made now when the situation is not critical. Otherwise it may come too late to be useful.
The German External Loan of 1924, issued as part of the Dawes Plan, the only external loan of the Reich, was specifically granted priority by the Transfer Committee and the Reparation Commission over all reparation payments and transfers; and is in fact secured by the annuity as well as by the "controlled revenues".
Other German foreign borrowing began a few months later, first with industrial loans, gradually extending to city and communal borrowing, and finally including a series of State loans beginning with the loan of the State of Bremen in September, 1925. None of the State loans, prior to September, 1926, had come to the formal attention of the Transfer Committee. Their prospectuses dealt with the priority question in different ways. Some passed over the problem in silence (Bavaria, Anhalt); others stated that so long as payments were continued under the Dawes Plan "paragraph 248 of the Versailles Treaty does not affect this loan" (Oldenburg). The circular of the State of Hamburg (1926 issue) stated that the enforcement of the charge under Article 248 "is suspended so long as Germany performs its obligations." The circular of the State of Bremen loan (1925) represented that "no restrictions are imposed upon it which would hinder or prevent it from remitting dollars."
The prospectus of the Prussian loan of September, 1926, went farther by publishing a sentence over the signature of the Prussian Minister of Finance which read as follows: "Neither German law nor any international engagements assumed by the German Government involve any restrictions upon the acquisition by the Free State of Prussia of the foreign exchange requisite to meet the external obligations to be evidenced by these bonds." A similar sentence appeared in the London prospectus of a loan of the State of Hamburg issued a few days later, but was omitted in the New York prospectus of the same issue.
The Transfer Committee seems to have regarded the representation of the Prussian Minister of Finance as a declaration that German States, despite their contingent reparation obligation, might borrow at will, and that repayment of such State loans would have priority over reparation transfers. The Transfer Committee forthwith notified the German Government that it disagreed with the statement of the Prussian Minister and asserted that not only reparation payments in German currency but also the transfer of these payments abroad had priority over the service of the State loan. It is generally understood that the German Government replied that it did not concur in this view.
The correspondence did not become public. The Report of the Agent General of November 30, 1926, however, made a veiled reference to the question, quoting Article 248 of the Treaty and remarking that its terms had not exercised the restraining influence which one would pre-suppose.
Upon the eve of the proposed issue of the second Prussian State loan, about September, 1927, the Agent General notified the bankers that he did not consider that their previous or their proposed prospectus dealt fully with the reparation obligation of Prussia. The 1927 prospectus was modified to meet the view of the Agent General, and as issued stated:
"Reparation Obligations. The Dawes Plan and the London Agreements specify the present payments to be made by Germany for account of the Agent General for Reparation Payments; for the year ending August 31, 1928, these payments are fixed at 1,750,000,000 gold marks or their equivalent in German currency and thereafter, normally during the operation of the Plan, at $2,500,000,000 gold marks or their equivalent annually. According to the Dawes Plan the above payments are the definitive act of the German Government in meeting its financial obligations under the Plan. To secure such payments specific German assets and revenues are pledged and certain of the enterprises or properties of the German States will be obligated, in accordance with Reich legislation, to make currently payments to the Reich corresponding more or less in amount to the secured yearly payments imposed under the Dawes Plan on private industries of like character. The Plan provides also that the German Government and the Reichsbank shall undertake to facilitate in every reasonable way within their power the work of the Transfer Committee in making transfers of funds, including such steps as will aid in the control of foreign exchange.
"The first paragraph of Article 248 of the Treaty of Versailles, provides as follows: 'Subject to such exceptions as the Reparation Commission may approve, a first charge upon all the assets and revenues of the German Empire and its constituent States shall be the cost of reparation and all other costs arising under the present Treaty or any treaties or agreements supplementary thereto or under arrangements concluded between Germany and the Allied and Associated Powers during the Armistice or its extensions.'
"No application for an exception under the above Article has been made in the case of this loan."
The negotiations regarding this prospectus became public property and precipitated the public discussion. In Great Britain the discussion became particularly active in view of a statement issued by J. Henry Schroder & Co. that, "Under the Dawes Plan the order of priority for the purchase of foreign currencies in Germany is as follows: 1. The service of the 7% (Dawes) Loan. 2. The service of all Loans and Advances in foreign currencies made to States, Municipalities and other borrowers including of course all industrial issues and private advances. 3. Reparation payments."
The Transfer Committee has made no statement affecting loans other than Reich and State loans, although issuing bankers have endeavored at times to secure assurances with respect to the relationship between reparation transfers and such other external loans. The Committee has hitherto replied that it was not in a position "to give any assurances whatever" and has referred inquirers to the Dawes Plan and the Treaty of Versailles.
Article 248 of the Treaty of Versailles
The purely legal problem depends on the interpretation of the first paragraph of Article 248 of the Treaty and the pertinent portions of the Dawes Report. The first paragraph of Article 248 reads:
"Subject to such exceptions as the Reparation Commission may approve, a first charge upon all the assets and revenues of the German Empire and its constituent States shall be the cost of reparation and all other costs arising under the present Treaty or any treaties or agreements supplementary thereto or under arrangements concluded between Germany and the Allied and Associated Powers during the Armistice or its extensions."
Note first that this language is limited to the assets and revenues of the German Reich and of the eighteen German States. It does not extend, nor has it in practice been claimed to extend, to the assets and revenues of cities, provinces, communes, public utilities, industrial corporations or private individuals. Also that the security, whatever it is, is for "costs," that is, for financial obligations, not for obligations in general.
What does "first charge" mean? Nobody doubts that the language gives the Reparation Commission priority rights in assets and revenue of the Reich and its States -- if Germany defaults in payment of its financial obligation as fixed by the Dawes Plan. But this gives no ground for anxiety; no one expects Germany to default. In fact the Dawes annuities, payable in marks, not in foreign currency, seem amply secured by assets and revenues specifically pledged. The real concrete question for the purpose of the present discussion is, can the Reparation Commission avail itself of this "first charge" if Germany is not in default in paying the "costs" described in Article 248 itself? The answer is naturally in the negative. The Commission has a "first charge" to secure payments; when the payments are made, no excuse exists for exercising the "first charge." Under the Dawes Plan the "cost of reparation" is a certain number of marks. When these marks are paid to the Reichsbank for account of the Transfer Committee, the obligation is fully performed. The Dawes Plan says that this payment shall constitute "the definite act of the German Government in meeting its financial obligations under the Plan."
The opposite point of view is that Article 248 gives the Reparation Commission rights in the assets and revenues of the Reich and its States at all times, regardless of default in payments. This claim, however, seems to be negatived by the correspondence prior to the execution of the Treaty. The German Peace Delegation, with particular reference to Article 248, pointed out (May 29, 1919) that the Treaty provisions involved a virtual abdication of the German Government in favor of the Reparation Commission:
"The Commission will possess in Germany incomparably greater rights than the German Empire ever possessed. . . . Set aside the right to dispose of the revenues of the State and the parliamentary system vanishes. The budgetary powers of the Reichstag become a sham." The provision implied "a complete financial control over Germany by the Allies and a complete empire over the imperial budget."
The Allied and Associated Powers replied (June 16, 1919):
"The German Delegation have greatly misinterpreted the Reparation proposals of the Treaty. . . . They do not provide for that interference with the internal life of Germany by the Reparation Commission which is alleged. They are designed to make the payment of that reparation which Germany must pay as easy and convenient to both parties as possible and they will be interpreted in that sense."
With specific reference to Article 248, it was added,
"Within the Empire the Allied and Associated Powers have claimed a charge only on the property and resources of the Empire and the German States. Their right in this regard, resulting from the financial clauses, has been limited as far as possible and an effort has been made to avoid giving it any vexatious character."
The view that the charge exists at all times regardless of default is also inconsistent on the whole with the practice of the Allies since the Treaty went into effect, though there have been occasional instances where this theory has been asserted.
The natural and reasonable interpretation of Article 248 is that it constitutes what is known as a "floating charge," available in case of default, but not otherwise. If the Treaty had meant something stronger than this, provision would necessarily have been made for machinery to carry the intention into effect. The Reparation Commission would have been practically a receiver for Germany and its States. Their budgets would have needed the express approval of the Commission, in fact they could have performed no financial act without express release from the "charge." It was this narrow interpretation which the German Peace Delegation feared, and the language of the Allied reply, with its emphasis on the "misinterpretation" by the Peace Delegation, its denial of intention to interfere with the internal life of Germany, its promise of liberal interpretation, relieved their fear, and confirms the natural and reasonable interpretation.
The Transfer Committee's statement of its position with respect to the Prussian Loan prospectus is quoted in Mr. Gilbert's Report of December 10, 1927 (p. 101):
"The Transfer Committee finds itself unable to accept this statement, and feels that in the absence of an express exception under Article 248 of the Treaty of Versailles this statement cannot properly be made, when any loan of the Reich or any of the Federal States is concerned, unless qualified by reference to the priority of reparation payments and transfers. In view of the secondary character of the external loan of the State of Prussia, as regards both reparation payments and reparation transfers, and in view also of the relatively large share of the annual budget of the State of Prussia which is financed by transfers of revenue from the German Reich, the Transfer Committee considers that the service of the Prussian external loan must necessarily be regarded as secondary to the obligations in respect to the transfer of reparation payments which the German Government has assumed by virtue of the Experts' Plan and the London Agreements."
The secondary character of a State loan under Article 248, with respect to payment when and if reparation payments are in default, is obvious and needs no comment, but its asserted secondary character with respect to transfers which take place when the reparation obligation is not in default is the reverse of obvious. The Transfer Committee derives this thought by combining Article 248 (in itself insufficient) with the provision of Annex 6 of the Dawes Plan that the German Government shall facilitate "in every reasonable way" the work of the Transfer Committee in making transfers of funds, including such steps "as will aid in the control of foreign exchange." (In the French text, "as will aid in the maintenance of exchange stability.")
Pertinent Provisions of the Dawes Report
The claim of the Transfer Committee snatches the provision of Annex 6 out of its proper setting, and combines it with Article 248, with which it has no real relation. The Dawes Committee had no intention of re-enforcing Article 248. Instead of trying to tie Germany more tightly, they tried to give her more freedom. Their plan is "strictly dependent upon the restoration of Germany's economic sovereignty" (p. 38)[i]. "We do not hesitate to reject as undesirable, for the purpose which all have in view, save in certain extreme events, any system which would involve directly or indirectly the virtual control of all Germany's revenues and expenditure" (p. 33). "The use of this safeguard of general budgetary control should be reserved for the case of Germany's wilful failure to meet the obligations now laid upon her" (p. 33).
The provision requiring the German Government " to facilitate in every reasonable way the work of the Transfer Committee (which has no rights under Article 248) in making transfers" appears in proper perspective only when read in conjunction with the many expressions and provisions of the Dawes Report and Plan which grouped together show that one important aim of the Plan was to make possible and to encourage foreign credits to Germany. The Committee considered foreign credits essential to Germany's economic and financial rehabilitation, to the stability of her currency and to the payment of reparations. These foreign credits, like the Transfer Committee, are part of the Plan, and Annex 6, instead of being related to Article 248 is closely related to them.
The Dawes experts were appointed "to consider the means of balancing the budget and the measures to be taken to stabilize the currency" of Germany (p. 10). This "implies the restoration of Germany's credit, both externally and internally" (p. 11). The recommendations will secure "to German economy those credits in stable value which are essential to its reinvigoration and to the payment of reparation" (p. 15).
"More important still is the fact that the success of our proposals to attain financial stabilization depends essentially upon the return of confidence. Without this the return of German capital invested abroad, the attraction of foreign capital for the purposes mentioned in the scheme and of foreign credits for the current conduct of business, and even the proper collection of taxes, will alike be impossible" (p. 16).
"Obviously, the first loan (German External Loan 1924) should be fully secured, but it is equally true that it is neither in the interest of a first loan nor of the Reparation Commission to create a situation which would prejudice the flotation of subsequent German loans. . . ." (p. 36).
The Dawes Plan makes a sharp distinction between "first, the amount of revenue which Germany can raise available for reparation account, and, second, the amount which can be transferred." The second "cannot, in the long run, exceed the sums which the balance of payments makes it possible to transfer" (p. 19). "We propose safeguards against such transfers of these mark payments into foreign exchange as would destroy stabilization and thereby endanger future reparation" (p. 20).
Payment of the fixed annuities in marks is " the definite act of the German Government in meeting its financial obligations under the Plan" (p. 31). "The use and withdrawal of the moneys so deposited will be controlled by a Committee" (p. 31) and funds "are only to be withdrawable by the creditor nations under conditions and safeguards which will adequately protect the German exchange market and the interests of the creditor nations and the German economy" (p. 14). The Committee will "so act as to secure the maximum transfers without bringing about instability of the currency" (p. 32).
"Experience, and experience alone, can show what transfers into foreign currencies can in practice be made" (p. 21).
The power and duty of the Committee to utilize the marks paid by Germany for payments to the Allies are "to be exercised to the extent to which in the judgment of the Committee, the foreign exchange market will permit, without threatening the stability of the German currency" (Annex 6, p. 104), and the German Government and the Bank undertake "to facilitate in every reasonable way within their power the work of the Committee in making transfers of funds, including such steps as will aid in the control of foreign exchange" (Annex 6, p. 104). In the French text the last phrase is not the same as in the English text, but means "including such steps as will aid in the maintenance of exchange stability."
The Dawes Plan itself nowhere states, in express terms, whether reparation transfers have priority, or are on equal terms with or are subordinated to other transfers. The general implication of the foregoing quotations is that the reparation transfers of Germany are to be superimposed upon normal business transactions, and this implication combined with the fact that no reparation transfers may be made which affect the stability of the currency has convinced some authorities that reparation transfers must as a matter of legal interpretation cease first in the event of exchange difficulties. The argument seems to the writer much stronger than the opposite argument for legal priority for reparation transfers, but I venture to express the opinion that the authors of the Dawes Plan had no intention of conferring a legal priority in exchange on anybody, and that their Plan cannot fairly be interpreted as conferring such priority.
It should be noted that the Transfer Committee was not given any general control of German exchange, nor power to restrict the purchase or use of foreign exchange by Germany or by Germans. It can secure priority of transfer only through the German Government whose legal obligation is merely to facilitate "in every reasonable way." Germany has the right to exercise judgment in good faith as to reasonableness and it is the obvious fact that no request or order for transfer priority in a critical exchange situation would be "reasonable."
The legal position even as to State loans seems sound, but as four-fifths of the loans to Germany issued in the United States have been loans other than State loans, it is important to emphasize that neither the Transfer Committee nor any other reparation authority has ever asserted priority with respect to such other loans or any right to interfere with their service, though the Transfer Committee has declined to give assurances the other way. But the fact that the claim has not even been asserted is significant in view of the fact that the Transfer Committee has asserted and reasserted its claim as to priorities in connection with State loans.
It is also important to note that the argument for transfer priority of reparations over State loans, resting as it does on Article 248 combined with Annex 6 of the Dawes Report, is not applicable even by analogy to loans other than State loans, for Article 248 is limited to the assets and revenues of the Reich and its constituent States. As regards these other loans the claim, if it should ever be made, would have to rest solely on the sweet reasonableness of Annex 6.
So much for the legal situation which I have been asked to discuss for the readers of FOREIGN AFFAIRS. I repeat that in this matter the legal technicalities are really unimportant. The fundamental safeguard is the fact that it would be financial folly for anyone to place obstacles in the way of providing exchange for the service of any of these foreign loans. Reparation payments are dependent on Germany's credit. Germany's credit is bound up with them, and any failure to meet them would destroy that credit. It took five years after the Armistice to drive this lesson home and make the Dawes Plan and reparation payments a reality. It is inconceivable that any government or agency interested in reparations should ever need to learn that particular lesson again.
[i] Page references are to "The Experts' Plan for Reparation Payments," published by the Reparation Commission, October 1926.