The financial crisis of 1914 in London around the outbreak of the First World War was a sensational event for those who lived through it ... and an extraordinary episode by any standard.
Yet today, it is virtually unknown to historians, economists and everyone else. This is in sharp contrast to other crises — which is surprising given its severity — and yet many lessons can be learnt from it as government officials grapple through the economic fallout of the current pandemic.
The most visible manifestation of the crisis was the unprecedented shutdown of the stock exchange, but this was of minor significance, especially given the fact that none of the major players at the time fell victim to the catastrophic War. Had there been an insolvency of scores of firms, it might have assumed the magnitude of other financial fallouts and even assumed greater historical significance.
Calling a moratorium
The fact that there was no domino effect was in large part due to the government response, which, apart from introducing standard monetary mechanisms such as flooding the system with money supply, undertook the boldest measure known as the “cold storage” scheme of August 12, 1914. Here, the Bank of England bought up more than a third of the commercial bills outstanding and declared a general moratorium, thereby forestalling failures among the discount houses and banks.
This was in response to an unprecedented shortage of liquidity that threatened the stability of the financial system, prompting the great economist John Maynard Keynes to declare an “unprecedented situation that would usher in a contraction the likes of which the world has never seen”. Furthermore, the Bank of England provided liquidity directly to acceptors, thereby averting the failure of thousands of SMEs, and despite the temporary plunge in asset prices, mass defaults were averted.
Help the most vulnerable
The motive of the authorities was to revive trade and asset values. In the process, the state become the guarantor to not only financial institutions, but other firms as well. In effect, where required, equity-like injections were given in order to normalise the system.
In the final analysis, the reason why the financial crisis of 1914 proved to be a footnote in history was because the intervention by the authorities worked spectacularly well. That is the reason why records of the times never included these tumultuous months, instead being relegated into the shadows of the great war that shortly ensued.
In Dubai, stimulus measures announced thus far have undoubtedly provided relief to cash-starved businesses, with more in the offing. However, even though it is early days, there already appears to be further pain in store, as businesses continue to contract, and cost cutting becomes more pronounced.
Some of this may indeed be unavoidable. However there is a larger picture, one where for longer term capital structure to change in companies, medium-term relief needs to be sufficient enough for such a transition to happen.
Picking the right relief
Indeed, as cash flow issues continue to proliferate, it is worth considering the “cold storage” scheme through longer term deferrals of debt and even equity injections that would allow for an orderly return to business in sectors that remain affected, but on which the foundations of the economy have been built upon.
The economist John Stuart Mill looked back on the first experiment with economic Darwinism when he wistfully declared “even though there had been an unexampled multiplication of international commerce, we have since had opportunities of learning a sadder wisdom”. That wisdom was the disruption caused by sudden reversals in tourism and trade at that point, which cascaded through the economy with the speed of a wrecking ball.
Since then, interventionism has been the ethos of regulatory authorities, (which itself has a spotty record).
The crisis of 1914 represents an example of where international coordinated economic policy responses were so immediate and forceful it prevented the disastrous consequences that seemed inevitable at the time. Today, we stand at similar crossroads.
History suggests that policy responses can be effective enough to withstand the “stormy present”. The end goal is not only for economic growth to resume as quickly as possible, but also for there to be minimal damage, what Almeida Garrett asked when she stipulated “we forever need to calculate the number of individuals that are subject to misery and poverty in order to produce wealth, before we declare success”.
— Sameer Lakhani is Managing Director at Global Capital Partners.