What separates victors of war from losers? Credit!
I have, for long, believed that war has finally lost its appeal.
Clearly, I couldn’t have been more wrong, for Russian forces are rampaging Ukrainian cities as I write this. The rise of an integrated world society should have logically decimated the desire for traditional military glory.
Evidently, logic is not what drives the world. Then what does? In all likelihood, it’s the desire for power.
They say a global power emerges every 100 years or so. Pax Britannica marked the 19th century and Pax Americana the 20th century. China is contesting to dedicate the 21st century to Pax Sinica.
Generally, analysis of how these countries managed to win their place in the world order points to geographical advantages, maritime capabilities, and economic systems. And of course, a defining war that seals the deal. As a rule, the true test of great power is in the test of strength for war.
The strength for war comes from the ability to mobilize financial resources continually until the end of fighting. Hence, the one factor that’s grossly underemphasized is the ability of a nation to leverage its limited base of wealth. It all really boils down to credit!
To get a further appreciation of a nation’s rise to the global throne, one must look at the pivotal role of their credit and debt management systems.
History shows that winners owe a significant proportion of their success on the battlefield to their ability to obtain credit inexpensively, sustain relatively large debts, and use leverage effectively to meet their staggering military expenses. Conversely, the defeat of losers - sometimes despite extensive resources at their disposal, can be attributed to their inability to generate sustained access to credit or systematize credit creation through institutions.
Credit built the British empire
It was said that the sun never set on the British empire. Such was its geographical expanse that at all times one or the other British colony would be experiencing warm sunlight.
That's a sizeable amount of planet to have to one's name. And these achievements were despite the challenges posed by seemingly formidable colonial powers such as France, Spain, and Portugal. For instance, the French were superior in terms of population, land area, natural wealth, and tax revenues.
Contrast this to Great Britain (not so great at the time) — an underdeveloped country with an equally underdeveloped bureaucracy and a relatively limited tax base. Yet, it managed to send a decisive fleet of ships to the Anglo-French conflict — thanks to revenues from debt instruments and an institutionalized system of public borrowing. They did not indulge in ad hoc ‘royal loans’ as the French did.
This is not to say that France and Spain were strangers to the idea of credit during wartime. The primary difference is that Spaniards and the French did not establish efficient credit procedures that would ensure uninterrupted access to cheap credit.
Similarly, 16th century Spain enjoyed annual revenues ten times the size of that available to Great Britain. When deficits occurred, they’d borrow expediently and mortgage future revenues. When interest payments became burdensome, or all means of mortgaging future revenues were exhausted, they’d declare bankruptcy, or unilaterally cut principals and interest rates. (Rasler, K. A., & Thompson, W. R,1983). Basically, they made lending to the government a super risky affair.
What the Brits did efficiently was to access short- and long-term credit continually through innovative and sophisticated techniques such as domestic bills of exchange, commoditized credit, and money markets. This does not mean that an efficient credit system is your way to win a war, but for sure, it’s an important factor among many others that propel you to power.
World War II: The economic miracle no one expected
World War II set the stage for American hegemony. It’s exemplary how Roosevelt mobilized an idle economy to run at full throttle. During the war, 17 million new civilian jobs were created, industrial productivity increased by 96%, and corporate profits after taxes doubled. The government expenditures brought about business recovery. The US is probably the only country that saw an expansion of consumer goods despite wartime rationing.
How was this possible? American inventiveness in leveraging credit. The war completely redefined monetary policies. The Federal Reserve pegged interest rates at low levels to make credit cheaper for the government and marketed government securities and war bonds. They devised securities such that they would involve the participation of all classes of investors — from small savers who wished to invest for the duration of the war to large corporations with temporarily idle funds. Interestingly, the majority of the bonds issued were in small denominations ($25 or less), you can imagine the humongous scale of the task.
What’s more, the Fed would draw a cheque on itself (generating book money) to purchase bonds on the open market. You’d ask why. This would add to demand for bonds, driving prices up, keeping yields down. A prudent government would be careful not to have a heavy yield burden on the exchequer, once the war is over. Well, this is what is now, rather fancifully, known as ‘quantitative easing'.
Then there was Roosevelt’s executive order that established a program of guaranteed loans to industry for war production. And the key to building a war industry from scratch is fast loan disbursals. The Fed deployed a swift, decentralized procedure where reserve banks and branches acted as fiscal agents, expediting operations for the government and loan applicants.
Financial inventiveness is all it took the US to overcome the stress of the Great Depression of 1930 and emerge as the victor of the bloodiest war in the history of mankind. But how far this is replicable in today’s era of financial globalization is debatable.
A new international economic order
Much has changed since WWII. Economies are now highly integrated and interdependent. World GDP has expanded at least eighty times. The dollar is king. What's more, an exchange rate fluctuation on Wall Street will affect everything I buy, from groceries to gas.
It’s a new world order. Countries now use material power to exert dominance. Flexing military muscle hasn’t helped anyone much. Case in point, trillions were wasted by the US for its military fiascos in Iraq and Afghanistan.
And yet, here we are today, witnessing the Russian saber-rattling. While I’m no advocate of war, I’m curious to know how Russia will manage its reserves and debt to support its war efforts in the face of sanctions.
The jury is still out on whether financial globalization has compromised central banks' ability to manage domestic financial conditions. Can any country, for that matter, survive global isolation? Maybe North Korea, but their model isn’t really ideal for adoption.
So, the question every country should really be asking is whether they can come up with ‘workarounds’ if it were to face US’ wrath.
Will Russia be able to beat the US in the geopolitical game of payment systems? In the face of sanctions, will the Central Bank of the Russian Federation continue to have a handle on the Russian economy? Will it be able to create sufficient credit at home to finance the war effort as the Rouble hits new lows?
Sanctions have shown that currency reserves accumulated by central banks can be taken away. Lesson for India? Its surplus foreign exchange reserves stored as US government bonds, gold, and SDRs can be worth nothing if someone decides so.
What’s more, Russia has been cut out of the SWIFT global payments system. The interconnectedness of global financial markets and jittery participants scared of falling foul of sanctions have scuttled energy deals. International cross-border payments are currently US-centric. An open-source alternative to SWIFT and, possibly, certain distributed ledger technologies could advance an international payment system of the global digital commons. It's unlikely to be built in time to help Russia but there's certainly a call for global alternatives from both big and small nations that want to hedge their relative economic prowess.
In addition, Russia is facing a serious liquidity shock, and the central bank has been going all out to buttress domestic banks. ATMs are running dry. Rouble plunges. Hyperinflation looms. To curb this, the Russian central bank hiked the key rate from 9.8% to 20% to curtail inflation. This will make borrowing super expensive.
On the other hand, Ukraine is raising war bonds. I’m not sure Russia has that option. Because ordinary Russians are not as invested in Putin’s war efforts, as is clear from protests in Russia. In fact, investors have been selling Russian dollar-denominated bonds and turning to US dollar-denominated bonds, further depreciating the Rouble. As a result, bond yields have been skyrocketing, adding to Russia’s debt burden. The sanctions seem to be driving Russia towards credit and economic crises.
How long Russia will hold out is yet to be seen, but however short or long it may be, it is bound to incur costs — both financial and political. Whether the Russian system of credit will find innovative ways to bypass sanctions, remains to be seen. However, one thing's for sure, the world moved decades over the past week and a new era of financial engineering is upon us. Technology must now deliver all its promises. Especially the one of reliability and mutual benefit that maintains peace.
Signing off this week with the hope that this is the last of war we have to witness.