Alongside this action that was favorable to both borrowers and lenders, situations periodically emerged that were consistently advantageous to creditors but difficult for debtor countries. These situations were generally characterized by the outbreak of crises, panics, and recessions, accompanied by a contraction in international capital flows and even by the withdrawal of capital already invested, regardless of which country had been responsible for the crisis that undermined investors’ confidence. At the very moment when the least well-equipped countries most needed access to credit, creditor countries withdrew their investments and refused to extend new loans. Once again, the equilibrium of the industrialized countries was preserved at the cost of a deeper and more lasting imbalance in debtor countries. Relations between the United Kingdom and the United States during the nineteenth century provide numerous examples of this asymmetry.
Table IV shows the evolution of foreign investment in the United States from 1899 onward; for the nineteenth century as a whole, however, one must rely on approximate estimates from various sources. British capital accounted for 75 percent of total foreign investment in the United States in 1899. This share declined slightly between 1900 and 1910 as a result of the more rapid growth of German, Dutch, and French investments. From 1860 onward, growth was particularly rapid, largely absorbed by railway development. European capital inflows exhibited specific fluctuations: in certain periods, withdrawals occurred that could not but compromise the equilibrium of the indebted country.
Great Britain, which was consistently the principal creditor, imposed on debtor countries—through imbalance—the cost of its own regulatory mechanism. This situation stands in clear contrast to the theoretical representation of the gold standard. Britain’s earliest investments in the United States took the form of purchases of shares in private companies and of public debt issued by the federal government, the states, and municipalities. The first major capital inflow, beginning around 1830, probably lasted until the onset of the depression of 1837–1839. As a result, interest payments on external debt were suspended in several American states, and the flow of European capital slowed. From the 1840s onward, railway expansion in Great Britain absorbed a large share of available savings. It was not until 1850 that the expansion of railways in the United States once again attracted foreign capital, whose total volume reached 400 million dollars by 1860. A further withdrawal of capital followed when the Bank of England raised its discount rate to 10 percent, prompting British investors to repatriate a significant portion of their funds and placing American and other foreign debtors in a difficult position.
In 1873, New York experienced a severe panic, as a result of which 400 million dollars were repatriated to Europe. A similar process occurred in 1884, though on a smaller scale.
Nevertheless, the economic development of the United States enabled it to shield itself more effectively from external influences, and from this point onward it began to emerge as a creditor country. The First World War accelerated this transformation, turning the United States into the world’s leading creditor and the dominant economy of the twentieth century. It was then that the nineteenth-century gold standard temporarily disappeared. Attempts were made to revive it after the war, amid considerable conceptual confusion, in which clear conflicts of interest were intertwined with the analytical errors highlighted here.
Favorable Influence
International capital movements, representing long-term flows, also played a major role in the adjustment mechanisms of external payments. New countries such as the United States, Canada, Australia, and Argentina were able to finance persistent current-account deficits thanks to the capital they received from the more industrialized countries of Western Europe, led by the United Kingdom. On the eve of the First World War, the total volume of foreign investments held by the main European creditor countries amounted to 40.5 billion dollars, while the United States had invested only 3.5 billion dollars abroad. At that time, the United States was still a net debtor, having received more than 7 billion dollars in capital from the rest of the world. The three principal creditor countries were the United Kingdom, with 18 billion dollars invested abroad, France with 9 billion dollars, and Germany with 5.8 billion dollars.
Throughout the nineteenth century, the United Kingdom consistently recorded a trade deficit in goods and a current-account surplus when goods were combined with “invisible” transactions. The annual average of this surplus rose from 35 million dollars in the period 1816–1855 to 870 million dollars between 1906 and 1913. Over the same periods, British foreign investments followed a similar upward trend: the annual average, which had been 30 million dollars between 1816 and 1855, exceeded 850 million dollars between 1906 and 1913 and reached 1 billion dollars between 1910 and 1914.
Under conditions such as these, which broadly characterized the major creditor countries, it is difficult to see how price and cost adjustment mechanisms could have operated effectively. In the British case, the deficit in merchandise trade grew steadily between 1815 and 1913, surpassing an annual average of 700 million dollars between 1901 and 1913. This deficit was regularly offset by income from exports of services—insurance, banking, and maritime transport—and by returns on foreign investments.
These international capital movements contributed directly to sustaining long-term external equilibrium. Nevertheless, they were largely disconnected from cyclical economic fluctuations, and while they generally exerted a rebalancing effect for lending countries, this was not always the case for borrowing countries. Creditor countries used their annual current-account surpluses to invest abroad. Chronic deficits in debtor countries were thus offset without requiring a reduction in imports. As a result, these new countries were not compelled to settle their net deficits in gold or to restrain domestic economic activity in order to restore external balance. The dynamics of international investment prevented the notion of equilibrium from being reduced to a narrowly accounting-based concept.