Not Just Another Recession
Why the Global Economy May Never Be the Same
ON June 30th the two tasks of financial reconstruction undertaken by the League of Nations, in Austria and in Hungary, were brought to a successful and simultaneous conclusion. In that month the Council was able to certify in each case the attainment of an assured financial stability, and the appointments of Dr. Zimmerman in Vienna and of Mr. Jeremiah Smith in Budapest came to an end.
Two years ago, in June, 1924, I had the privilege of describing in these pages the task first undertaken, the reconstruction of Austria. The corresponding work in Hungary, though concluded on the same date, was begun eighteen months later.
In this second task of the League the central figures have been those of the Prime Minister, Count Bethlen, and the Commissioner-General, Mr. Jeremiah Smith, Jr., of Boston. The original framing of the scheme on sound lines, and its negotiation through the difficulties which beset its adoption, was a collective work in which the members of the Financial Committee and other organs of the League coöperated. But its successful, and above all frictionless, application is due very largely to the qualities and personality of the Commissioner-General. The Council at its June meeting paid a deserved and appropriate tribute. "At the moment," runs the resolution, "when the Commissioner-General is about to leave his office, on the successful accomplishment of his task, the Council desires to express to Mr. Jeremiah Smith, Jr. its deep appreciation of his work. The rapid completion of his task at the date contemplated in the original programme is due in no small measure to the personal qualities he has shown -- to his disinterested devotion and his sound judgment. The Council desires to express to him and to his collaborators its gratitude for the services they have rendered."
The decision to terminate the office of the Commissioner-General in Budapest at the end of June was of special interest for several reasons. Not only did it mark the conclusion of the work at the earliest date contemplated in the original scheme, but it was taken at the height of the political excitement which had been roused by the franc forgeries in Hungary. Doubts have sometimes been expressed as to whether the technical execution of the League's financial reconstruction schemes might not be interfered with by general political considerations. No severer test could have been found than the submission to the Council of the question of withdrawing the Commissioner-General at the time when the indignation against the franc forgeries was at its height in France and in Czechoslovakia. It is worth recalling, therefore, that the decision to end his control was taken unanimously by the Council (which included French and Czechoslovak members), on the unanimous recommendation both of the Financial Committee (which also included French and Czechoslovak members) and of a political Committee which included representatives of France, Czechoslovakia, Rumania and Jugoslavia.
The importance of extending to Hungary the advantage of stable financial conditions which, by the end of 1923, had already been enjoyed for a year by Austria, needs little emphasis. Experience had shown the political advantages of stability in Austria, and the situation of Hungary is even more vital. Her internal conditions and her relations with her neighbors, especially Czechoslovakia, Rumania and Jugoslavia, are the crucial factor in the political situation of south-eastern Europe.
And in 1923, Hungary was well on the way to the collapse which a year earlier had threatened her neighbor. Her budget was unbalanced. Expenses largely exceeded receipts. The deficit had been met by inflation. Her crown had fallen, was still falling, and indeed ultimately reached an even lower point than the Austrian at its worst. Meantime this diminished value of the crown reduced the value of taxation receipts, and thus increased the budget deficit and the need for new inflation. Her finances proceeded from bad to worse in the vicious circle so familiar in the finances of Europe during the post-war years. And the whole of her economic life, deprived of a sound financial basis, was crumbling and rotting.
The problem was thus, in essentials, the same as that presented a year before by her neighbor and, as we shall see, the solution adopted was in its main features also the same. The similarities must not, however, blind us to some very striking contrasts between the situation and recent history of the two remnants of the old Austro-Hungarian Empire which have been restored by the League.
The new Austria, although with more agriculture and forestry than is generally recognized, has in her great capital of Vienna a concentration of population dependent upon banking, trade and industry, which were originally adapted to the requirements not of a small country but of a great empire. She is far from self-sufficient, and the bulk of both her food supplies and her raw materials require to be imported from outside her new frontiers. Hungary, on the other hand, is more than self-sufficient in the prime necessities of life. One result was that the fall of the currency which, by depriving Austria of her ability to import, menaced her with imminent starvation, was less catastrophic for Hungary. The fall of the Hungarian crown was less rapid, the immediate consequences less serious. Ultimate disaster was indeed inevitable, if the fall were not arrested, but there was more time to act.
Nor did the structure of the new Hungary cause such peculiar and special difficulties. The new Austria was an amorphous fragment of the older Austria, with a capital including nearly a third of the total population, with frontiers whose new tariffs formed barriers between her urban populations and their food, between her industries and both their raw material and their markets. The new Hungary, though reduced to a third, retained her essential character and configuration. Her population and resources were alike reduced, but she remained capable of much the same economic equilibrium. Partly as a result of this, and partly as a result of a difference in national temperament, Hungary retained a strong sense of nationalism which, if it added to her political difficulties, stiffened her efforts at restoration.
The histories of the two countries in the years succeeding the war reflected these contrasts. Before the social upheaval the more pliant Austria bent; there was no violent clash. The Left, the Social Democrats, for a time assumed power. They were succeeded by the bourgeois party, the Christian Socialists, who for over four years now have governed the country with the aid of small minority parties, the Left Opposition throughout this period comprising nearly half the Chamber.
The history of Hungary, with an intense national feeling and a less pliant population, was very different. The movement of social unrest found its expression not in a political capture of the reins of government, but in revolution. For four and a half months Bela Kun ruled with the methods of Red Terror. The reaction was equally violent. The Rumanian army marched in. The Hungarian Right resumed power; a White Terror succeeded the Red. When order was restored, Hungary had a strong, competent and drastic Government.
For a time the contrast in the financial history of the two countries was no less striking. Austria's difficulties were from the first obviously too great for her unaided strength. Over $125,000,000 of public loans, mostly in the form of relief credits, were used on current consumption and no real financial reform had preceded the international action of 1922. Hungary, on the other hand, made a remarkable effort to restore her finances without external aid. Her relief credits were only a fiftieth of the Austrian. Her courageous but misguided Finance Minister, Hegedus, made a really heroic attempt to balance the budget and restore the currency. He failed for three reasons. Hungary had been weakened and disorganized not only by the war but by the subsequent revolution and foreign occupation. She was burdened not only by specific debts but by the weight of an indefinite and unassessed reparation obligation. And, lastly, Hegedus tried not only to stabilize but to increase the value of the crown. No country could have stood the strain of such an impossible and misdirected effort. Failure was inevitable and it made any renewed attempt more difficult. It is my personal conviction that if the reparation charges had, two years earlier, been assessed at the amounts at which, under pressure of the reconstruction scheme, they have now been fixed, and if Hungary had aimed not at the appreciation but at the stabilization of the crown, she would have restored herself. No international action, no external loan, no external control would have been necessary. The incidental results of the reconstruction scheme, however, especially those of a political character, have, as we shall see, been so valuable that it is difficult to regret the past.
The crucial difficulty in the Hungarian case was the political situation. Technically, the task was much easier than the one which Austria presented. There the country was in actual collapse; starvation and dissolution were immediately threatened. There was no confidence in the country or outside in her recuperative power. The scheme produced was an untried experiment; the League itself had no record of achieved success in financial reconstruction. But when the Hungarian task was begun the principles of financial reconstruction were no longer theories; they had been tried in practice. Those who had applied them enjoyed the credit which Austria's recovery had given them and were able to use it to launch a new scheme.
But there was one obstacle to Hungarian reconstruction which had no analogy in Austria. Towards the latter there had been a genuine and general good-will. No one feared a restored Austria. But several countries speculated with doubt and anxiety as to Hungary's probable attitude when conscious of her new strength. Now the League, by its constitution, can only undertake such work as this if there is unanimous agreement in the part of all the countries specially interested. And in this case these countries included not only Hungary herself and the Great Powers, but Czechoslovakia, Rumania and Jugoslavia. I need not dilate on the long, difficult and intricate negotiations which preceded action. Those who are familiar with the political position in central and south-eastern Europe in 1923 will realize what an achievement in international conciliation was marked by the unanimous adhesion of all the above countries in the winter of that year to a scheme designed to reëstablish and strengthen Hungary. During these earlier negotiations the necessity of securing unanimity was a hard, and it often seemed an impossible, condition. But it proved an extremely valuable one. If the political obstacles to agreement were great, the political fruits of agreement were correspondingly valuable. For years a host of unsettled differences had poisoned the relations between Hungary and her neighbors. The feeling between the countries was such as to make even discussion difficult to arrange. Both Dr. Beneš and Count Bethlen, for example, had long recognized that a personal meeting between them was desirable. But if Dr. Beneš had gone to Budapest, he would have had political difficulty in Prague. If Count Bethlen had gone to Prague, he would have had difficulty in Budapest.
The reconstruction scheme gave just the impetus, the time, and the material opportunities for negotiation that were required. Everyone knew that reconstruction could not begin until every interested country agreed; that this condition could not be realized until the outstanding disputes had been settled; and that it must begin soon, if it was to begin at all, or the confidence on which an external loan depended would be destroyed. Moreover, the meeting of the Assembly afforded the ideal opportunity, and a favorable atmosphere, for the negotiations. Both Dr. Beneš and Count Bethlen, as well as representatives of the other negotiating powers, were at Geneva for a month as members of the Assembly. Being there for this purpose they had the opportunity of meeting frequently and quietly for long and intimate discussions. The League, as everyone knows, assures the world of publicity for the last stage of negotiations and for all conclusions and decisions. It is not so generally recognized that it also affords new and very valuable opportunities for the confidential conversations which are often the indispensable preliminary to international agreement. With these advantages the negotiations, protracted or renewed throughout the winter of 1923-1924, were at last concluded. Willingness to sign the Protocols was a barometer of good relations; and on March 14th, 1924, when they were ultimately signed, the glass stood higher than at any time since the war. "There were," said Count Bethlen at the Assembly of that year, "at least a hundred questions outstanding between us and . . . there were nearly as many disputes as questions. Most of the questions have been settled and the disputes removed."
The scheme launched with such difficulty may be briefly described. It is based on the same principles as the Austrian. Inflation was at once stopped. The monopoly of note issue was transferred to an independent Bank of Issue. A scheme of administrative reform designed to give permanent budget equilibrium by June 30, 1926, was enforced. Reparation charges were fixed at a moderate figure. In order to meet budget deficits during the period of reform (since inflation was stopped at once and was no longer available as a means of meeting them) a reconstruction loan was raised. This loan was secured on certain Hungarian revenues (customs, tobacco, salt and sugar) specifically assigned and controlled. The whole scheme was placed under the control of a Commissioner-General appointed by and responsible to the Council of the League. As a basis of confidence the technical Protocol was supplemented by a political Protocol in which all the countries interested undertook to preserve the political independence, territorial integrity and sovereignty of Hungary.
Lastly, the scheme was clearly limited to that of financial reconstruction. "The Financial Committee," so runs their Report, "has no hesitation in recommending that, as in the case of Austria, any financial operations for which the League undertakes any responsibility should be definitely and expressly limited to remedying the budgetary, and therefore the financial, position. . . . It is true that the Hungarian trade balance needs improving; but the necessary economic adaptation must be effected by Hungary herself. The essential contribution of the proposed scheme is to give a stable basis on which this adaptation can take place."
It is interesting to notice the differences between the two plans. In the first place, Hungary's case was less desperate. The loan required was only 250,000,000 as compared with 650,000,000 gold crowns. Partly for this reason, partly because of her more solid agricultural basis and more stable conditions, partly because of the confidence in the League's methods of reconstruction acquired through the Austrian experience, it was possible to issue the loan without the guarantees of external governments, the obtaining of which had been the most difficult part of the Austrian task. Experience also enabled improvements in detail to be made. It was provided that there should be a Bank Adviser for a limited period; that Trustees of the loan should be appointed; that after the Commissioner-General's office and the control of the budget had been terminated the assigned revenues should be under the control of the Trustees, but that if things went seriously wrong, his office, with his powers over the budget, could be reestablished. All these improvements have been introduced into the Austrian scheme by subsequent agreement.
The most interesting difference, however, between the Austrian and Hungarian schemes is to be found in the provisions about reparation, for the arrangement made for Hungary foreshadowed in some important respects the solution of the German problem.
With Austria the position was simple. No one expected, at any rate within any period near enough to be important, that she could pay anything.
The Hungarian position was very different. Disorganized as were the country's finances for the moment, it seemed possible that she would be in a position to pay substantial sums in a few years' time. Not only did her reparation creditors feel this strongly, but some of them were nervous as to the uses to which she might devote her restored finances. Her anxious neighbors felt, not without reason, that it was hard to ask them not only to sacrifice their treaty claims on her but in doing so to make a possible enemy free at a later date to turn her liberated resources to preparations against themselves. And behind these local considerations was the preoccupation of other reparation countries as to the effect upon the German settlement of another abandonment of reparation. The Dawes Committee was about to meet. Germany's finances too were in disorder. She too would need an external loan and reconstruction. Was the doctrine to grow up that external loans to aid in reconstruction implied an abandonment, or long postponement, of reparation? On the other hand, there was the greatest reluctance on the part of some of those without whose aid a reconstruction loan could not be successfully issued to agree to its being used directly or indirectly for reparation.
This difference of view proved the most difficult part of the negotiations. The solution ultimately gave some satisfaction to both points of view. Reparation payments were not excluded altogether, but were fixed at a most moderate amount. The total demands in respect of treaty payments, including not only reparation but restitution, costs of armies of occupation and armistice obligations, were limited for a period of twenty years to an annual average of 10 million gold crowns. But the most interesting and novel feature is the provision that reparation payments are to be made in Hungarian crowns, and are only to be converted into foreign exchange so far as such conversions are compatible with the maintenance of the exchange value of the crown. This principle, included in the Hungarian scheme published in December, 1923, was the precedent for the famous "Transfer System," technically the most interesting feature of the Dawes Plan.
The execution of the plan can be rapidly described. It is a tale of rapid and unqualified success. A League delegation went to Budapest in March, 1924. The detailed budget program was agreed. The Bank of Issue was constituted under statutes approved by the delegation. The necessary legislation was passed strictly in accordance with the schedule. The loan was successfully raised. The Commissioner-General, Mr. Jeremiah Smith, Jr., was appointed and began his control on May 1st, with the assistance of a small but most able staff, consisting of Mr. Royall Tyler (American, Deputy-Commissioner-General), Mr. H. A. Siepmann (English, since Bank Adviser to the National Bank), M. Charron (French) and M. Licen (Italian).
The Hungarian crown was at once stabilized, but in relation not to the dollar but to the pound sterling. It has remained stable in relation to the pound throughout the period, has appreciated with the pound, is now on a gold basis and is strongly secured. Confidence in continued stability has been marked by recent legislation for the introduction of a new standard coin, the "pengo" (equivalent to 12,500 paper crowns), directly based on gold, which will come into use at once and will become sole legal tender in 1927. All restrictions on transactions in foreign exchange have now been removed, and a recent law has established the principle that all balance sheets of banks, industrial and commercial enterprises will be shown in terms of the pengo, that is, on a gold basis. The same confidence is reflected in substantially cheaper rates of money. The discount rate of the National Bank, which at the end of 1924 was 12½ percent, fell to 9 percent in October last and is now 7 percent, and general interest rates show a corresponding reduction.
This monetary position would have been impossible, or precarious, if in the meantime the budget had not been placed on a sound basis. This has been attained solely by an increase in the yield of the revenues. While some economies in expenditure have been made they have been offset by other necessary increases; a net reduction would have been impossible and was never contemplated in the original scheme. The remarkable increase in the receipts may be illustrated by the revenues assigned as security for the loan, which in the last financial year gave, and are still giving, a yield of approximately eight times the amount required for the annual service charge.
The total achievement is astonishing. The budget was in chaos at the beginning of 1924. League control started in May of that year. The loan was drawn on for expenditure in the early months. But the closed accounts of the financial year, July 1, 1924 to June 30, 1925 -- for which a deficit of 100,000,000 gold crowns had been provided in the loan -- showed instead an actual surplus of 90,200,000 gold crowns. The following financial year, ending in June last, again showed a surplus of about 60,000,000 gold crowns. These surpluses exceed the deficits of the first few months of reconstruction. Thus, taking the period of reconstruction as a whole, we have the astonishing result that the ordinary receipts of the Hungarian budget will have been more than sufficient to meet all its ordinary expenditure, including the service of the loan itself.
The whole of the loan, therefore, designed to meet deficits during this period, will in effect have been available either to increase Hungary's productive resources by capital investment or as a reserve for the future. As the experience in Austria has not been very different, we draw the interesting conclusion that these reconstruction loans, raised specifically for the purpose of meeting budget deficits in the interval between the arrest of inflation and the attainment of budget equilibrium, are scarcely needed for this purpose. They serve the useful, and indeed indispensable, purposes of clearing up the errors of the past, of restoring confidence, of supporting the currency by the influx of foreign exchange, and of increasing the permanent resources of the country by capital investment. But the budget balances itself almost at once, however large the previous deficit, with the aid of restored confidence, of stabilization of currency and the consequent stoppage of the loss to Treasury receipts in the interval between assessment and collection, and of improved administration stiffened by external control. The recuperative effect of stabilization in disorganized countries has largely exceeded the hopes of the most sanguine experts, whose optimism was greeted with general scepticism three years ago.
A few words will suffice as to the economic position. As I have explained, the League's specific effort has been directed to providing a solid foundation for economic development by the reform of the currency and public finances. It remains true, however, as the Financial Committee recognized, that "Hungary cannot be in a sound position until both her budget and financial position and also her trade position are satisfactory. She must not only meet her public expenditure by taxation but she must produce (and dispose of) as much as she can consume." The economic position has, therefore, been carefully studied in both Hungary and Austria.
Hungary has never suffered from the graver anxieties which have sometimes been felt as to the possibility of economic recovery in Austria. The only question has been, not whether she could live, but at what level of prosperity.
The progress during these last two years is at least encouraging. Agricultural production has not yet reached, but is rapidly approaching, a pre-war level. Foreign trade in 1925 showed a notable improvement over 1924, imports increasing by 5 percent and exports by 16 percent. The visible adverse balance has fallen during the same period from 98,000,000 to 51,000,000 gold crowns (Hungary has always had an adverse showing on her visible trade balance). Her population is increasing and may sometime cause difficulties, but over-population does not constitute a serious problem either of the present or any calculable future. Taxation is heavy for a country where the population is agricultural, amounting probably to something between 14 percent and 18 percent of the total national income. But this is not an intolerable burden, it can hardly be said to be repressive to economic development, and the budget position indicates a prospect of relief.
It remains true, of course, that the tariff policy of central Europe and of Hungary herself renders her level of prosperity less than the maximum she should attain with her national resources and the capacity of her people. The advice which the Financial Committee gave in their original report they have never ceased to repeat whenever they have since reviewed the situation. In this sphere there is still much room for improvement. The principles advocated are of such importance not only for Hungary but for the whole of Central Europe (and perhaps for other parts of the world, too) that I venture to quote the passage to which I refer.
"The most vital thing for Hungary is that she should achieve the best production of -- and find markets for -- the products for which her natural resources and her national aptitudes best fit her. To the extent to which she diverts her resources in labor and in capital to producing what can be more cheaply obtained from abroad at the expense of what she can produce better than other countries there must be a net economic loss.
"We notice, for example, that her agricultural production and to some extent the industries based upon it are far from attaining their full development, and that markets for her surplus (particularly of wine) are not available; while, on the other hand, she is developing certain new industries which have no affinity to her natural resources. We wish to point out that, while we realize the many factors involved in the problem, the development of such industries in this way must necessarily have the triple result of diverting capital from her main production (where it is urgently needed), increasing the cost of living (with reactions on the whole of her economic life, including the power to export), and increasing the difficulties of negotiating commercial treaties which are needed to secure markets for her most valuable produce.
"So far as Hungary develops a policy of producing (by artificial aids) for her own consumption those goods for the production of which she has no natural advantages, she must necessarily make it more difficult for herself to dispose of the surplus of what she can produce better and more cheaply than her neighbors and with greater advantage to herself."
There are several points of special significance in connection with the two great experiments in international reconstruction in Austria and Hungary.
Excluding Russia, where the conditions are so different as to make comparison difficult, the only countries whose currency fell to less than a thousandth part of its original value were Austria, Poland, Hungary and Germany. None of these has yet succeeded in restoring itself except in conjunction with an international scheme and an external loan. Hungary made an heroic effort and failed. Poland made a much more effective attempt. She followed closely the Austrian model but she had neither the international coöperation, the international loan nor the internal and external confidence which follows from them. And for want of them, though it looked for more than a year that she was achieving her aim, she has not yet succeeded. Austria and Hungary have been restored, as we have seen, through League action. Germany could doubtless have restored herself, had she been relieved of reparation, but with that burden upon her, international action and an international loan, closely following the experience of Austria and Hungary, were essential. For it is evident that the stabilization of the Rentenmark, though achieved for the time before the Dawes settlement, could not have been maintained without it.
Some of the countries, though unhappily as I write some only, whose currencies though depreciated were never disorganized, have achieved a practical stability. But the efforts would have been vain, or at least much more difficult and precarious, if the currencies which had been not merely depreciated but also disorganized had not been restored, and restored as they could only be by international action. And in this action the League took the lead and offered the model in Austria and in Hungary.