As the clouds of war gathered before the start of the Great War, the ‘War to End Wars’, WWI, the pundits were predicting that any major war could not last more than a few months; the treasuries of the combatants would rapidly run out of money…
This was an astute observation; war is by far the most expensive ‘activity’ that humankind can indulge in… Not only is the direct cost of supplying ‘guns’ enormous but also War entails capital destruction, population loss, trauma, desolation… truly Hell on Earth.
Nevertheless, instead of a ‘few months’ the carnage went on for years… millions killed and maimed, Europe razed… so how was this possible? After all, even though England called its loans, there was still far from enough money available in the treasury to support years of war instead of months.
Once the treasury is empty, Government seemingly has only two choices to keep the war machine fed; increase taxes, or borrow money. Neither option was possible; increasing taxes would lead to revolution… if there was in fact any more taxable income left in the economy. Borrowing was too expensive, if there was in fact any more money available to be borrowed.
Thus the paradox; how could the combatants pay for mayhem far beyond the money (Gold) holdings of their treasuries? To unravel this we need to examine the history of money, and the ‘classical’ Gold standard that the world lived under during the build up to WWI.
A true or ‘unadulterated’ Gold standard has three components or ‘legs’… Gold is first and most essential; Gold is money and only Gold is money… a la J. P. Morgan… with Silver and Copper as supplemental money to allow smaller transactions to take place. Gold coins are too valuable for day to day purchases.
The other two legs are debt (borrowing) and credit (not borrowing); today, debt and credit are lumped together… big mistake, they are two separate phenomena. Borrowing can be represented by the bond market, or by mortgages. Mortgages are simply collateral backed loans… while bonds are unsecured (based on ‘faith and credit’).
For example, the Treasury issues (sells) a bond; a promise to pay back the principle in a number of years, depending on maturity, and to pay interest during the life of the bond. The buyer ponies up cash to buy this paper, in order to collect interest… at least so it was. Today, holding bonds is a suckers game, most bonds are bought and sold in the anticipation of capital gains; a drop in interest rates will make the bond more valuable and vice versa.
Credit on the other hand involves no money changing hands; credit is given not borrowed. For example, a tank truck with 20,000 Liters of gasoline pulls up at the gas station, to refill the tanks. This delivery represents about $40,000, depending on the current price of fuel. No way the gas station attendant pays this sum; no COD. Rather an invoice or bill is signed with payment due in thirty, sixty, or up to ninety days.
In effect, the funds to pay this bill will come from ongoing sales of fuel. In the meantime, the signed bill has value as it will inevitably be paid, redeemed in cash; only a true calamity would prevent the ongoing sale of gasoline… or of beer, flour, cabbages… or any other consumer good in high demand.