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Underwriting Central Europe

ISSUE:  Winter 1936

When the United States Senate repudiated the Versailles Treaty, and when the voters endorsed the repudiation in the election of President Harding, the American people were apparently determined to withdraw completely from the affairs of Europe, and to assume again their pre-war isolation. In the political realm this was true, and America’s non-participation was one of the dominating influences in European diplomacy during the nineteen-twenties. But though, as a political gesture, isolation was easy, as an economic actuality it was harder to achieve. The American industrial machine had been unnaturally expanded in the World War to take care of Europe’s needs. As a result, the profits of the nineteen-twenties found an insufficient outlet for lucrative investment at home. Under the pressure of this situation, the profits of American industry began to flow abroad, in the form of investments in the neighboring countries of North America, in South America, and in Europe.

Germany, Austria, and Hungary, the three Central European countries defeated in the War, occupied a unique position among the debtor countries created by this process. Their debt to the United States reached some two billion dollars: excluding the governmental war loans, this was about twenty per cent of what America had loaned abroad, and about fifty per cent of what she had loaned to Europe. Moreover, the purpose for which the loans were contracted was entirely different from that served by practically all other American loans. Such loans have normally been made to “young” countries, such as the South American republies, for the development of hitherto unexploited industrial and agricultural resources. The countries of Central Europe were, however, already highly developed; their loans were not utilized for new developments, but to replace the economic reserves that had been destroyed by the War and its consequences.

The American investor probably saw no political or social implications in this vast movement of credit. At most, he thought that he was combining altruism with good sense, lending a helping hand to down-and-out nations and at the same time getting a high return on his capital. But the ultimate economic effects of America’s loans to Central Europe were predicted some years ago by both European and American economists, and have now become apparent to every one in defaulted bonds, the drying up of trade, and the breakdown of normal exchange relations. What has not been realized is that the main importance of these credits lay not in the economic, but in the political and social, sphere. Whatever the American investor’s ideas on the subject, his investments in Central Europe financed and made possible the artificial re-establishment and maintenance of the Central European social system, which had completely broken down after the World War.

During the War, the entire national capital of these three countries had been expropriated by the state and used for the purposes of war: the manufacture of munitions, guns, tanks, and battleships, and the financing of the production of substitute raw materials. This, of course, meant the complete loss of the capital spent. The compensation paid by the state in the form of government loans had lost all value by the end of the War, and was not even worth the paper on which the bonds were printed. The classes that had previously owned the national capital reserves and that now owned the government bonds, the upper and lower middle classes, had consequently lost their entire property and were no longer able to fulfill their economic task of financing trade and industry in Central Europe, nor their social task of maintaining the structure of a capitalist and bourgeois society. The destruction of these classes by the War was therefore equivalent to the destruction of the pre-war social structure. Furthermore, the working class and the farmers, who had fought the battles and suffered the privations of the War, demanded a larger proportion of the greatly reduced national income, and threatened revolution should their demands not be met.

The obvious solution of such a situation was complete social reconstruction, either by peaceful means or by revolution, Both methods were tried: the new parliamentary governments in Germany and Austria experimented with socialization on a very large scale, and in Hungary the workmen of Budapest set up a revolutionary communist government. Both were completely unsuccessful. While the bourgeoisie had lost its economic and social raison d’etre, it still retained its “bourgeois mind,” to use a Marxist expression. It would not voluntarily renounce its former position, and it was far too strong numerically to be compelled to abdicate, as it had been in Russia. Although unable to make any contribution to the economic fabric, the bourgeoisie was sufficiently powerful and determined to prevent any alteration. Socialization was therefore quickly abandoned in Germany and Austria in the face of imminent armed resistance on the part of the middle classes. In Hungary, a counter-revolution under the leadership of the landed upper middle class quickly reestablished the old regime.

The next step was inflation. This enormous cut in capital —in the proportion of one to one thousand billions in Germany and one to fifteen thousand in Austria and Hungary— did little more than make clearly visible the actual extent of the economic loss resulting from the War, and complete the expropriation of the middle classes in favor of the state, the only debtor. However, the inflation was not accompanied by an increase in the power and social position of the working class. Because wages did not increase in proportion to prices, the working class also suffered by the inflation, though to a less degree than the middle class. This being the case, those who understood the situation hoped at the beginning of the inflation that, without bringing on a revolution, it would establish a social structure corresponding to the real economic balance of power. This illusion was quickly dispelled. Inflation not only got completely out of control, but made all classes far more radical. Civil war threatened. At the height of the German inflation, communist revolts took place in Saxony and Thuringia, and simultaneously Hitler launched his “first Putsch” in Munich. Every attempt, intentional or unintentional, to effect social reconstruction by debasing currency had to be dropped in order to avoid a civil war the only possible result of which would have been a loss for all classes. The re-establishment of “sound money” became not only a major economic task, but even more a major social task.

After the stabilization, all attempts to arrive at a new social balance were abandoned. Ever since then, the main concern of the statesmen and business leaders of these three countries has been to re-establish and maintain the pre-war social structure, the one alteration being that the urban worker, and in agricultural districts the farmer, had to be guaranteed a larger share in the national income than before the War.


Of the three countries, Germany had perhaps the most difficult problem to face; and, with loans amounting to $1,600,000,000, she became by far the largest debtor to America. She had to pay reparations, whereas Austria and Hungary were completely relieved of this burden as early as 1923. Her capital losses had been the greatest: not only had she borne the brunt of the War, but also a very considerable part of her pre-war economic reserves had been invested abroad, and had been confiscated. Furthermore, the complete destruction of the economic and social position of the German bourgeoisie was particularly serious. This class was naturally very large in a country as industrialized and urbanized as Germany; furthermore, the whole administrative system depended on the existence of a large professional middle class. Matched against the middle class was the power of the numerous and completely organized working class. Though it was impossible to fulfill the workers’ demands, since the currency had been stabilized on far too high a level, they could exert a tremendous political pressure.

To avoid open class war, it was therefore essential to raise the income of the working class to a level not only higher than the economic structure justified, but also higher than what it could hope to obtain by a successful revolution. At the same time, it was necessary to make it possible for capitalist business to carry on, with a reasonable profit. Neither of these two aims could be achieved by further expropriation of the bourgeoisie; on the contrary, this class had to be saved from being crushed between the upper millstone of big business and the nether millstone of organized labor.

Accordingly, the money borrowed from the United States was used in the first place to finance extensive social legislation, such as the compulsory fixing of wages, unemployment and old-age insurance, and sickness insurance. German social legislation can certainly not be considered excessive from the social point of view, but just as certainly it was excessive in view of Germany’s economic possibilities under a capitalist system. It was probably in excess even of the measures that a thorough socialist system in Germany could have provided from Germany’s own resources. Consequently, even if its pre-war reserves had not been destroyed, German industry would have been unable to bear the burden of high wages and high social taxation. Competition in the world markets, not to mention the possibility of a profit, was out of the question under existing conditions of labor. German industrialists therefore had recourse to borrowing on a large scale in the United States—partly in the form of bonded debts, partly in the form of short-term bank credits—in order to “rationalize” and mechanize their plants, or, in plain language, to replace the costly human labor by machinery.

Large as were the amounts borrowed and spent for the maintenance of the working class and the rationalization of industry, they were trifling compared with those used for the maintenance of the middle classes. This task presented a far more serious and difficult problem. The restoration of only their earned income would not have been sufficient to save the German middle class, and with it the German social structure, from complete collapse. Before the War this class had relied largely on income derived from capital investments, accumulated for over a century and now completely destroyed in the course of four years. It was, of course, impossible to restore this lost capital to the middle class, and thereby enable them to finance German business and fulfill their economic and social role. But it was imperative to restore their total income to at least its pre-war level. Consequently a considerable increase in the earned income of the middle class over the pre-war figure had to be achieved to compensate them for the loss of income from capital investments.

The German middle classes have therefore received the main share of the money borrowed from abroad, and they have received it in the form of direct subsidies. First, a certain revaluation of their completely devaluated fixed interest-bearing investments was effected—directly financed from the proceeds of the first loans contracted in America. Of far greater importance, however, was the artificial expansion in the number of civil servants of all descriptions. In Germany the bureaucracy has always been important and great in numbers, but after the War the comparative security of the civil service was regarded as the best and only available compensation for the loss of the pre-war capital. Consequently, the number of civil servants was artificially increased by all public corporations, and was nearly trebled in comparison with pre-war times. Moreover, attempts were made to extend this security to the intellectuals and professional men by giving them a status similar to that of the civil service. The attempt to convert the medical profession into a civil service with a modest but guaranteed income, by means of an enormously extended and government-aided health insurance, is typical of this tendency. Needless to say, this enormous increase in the number of state-employed or state-subsidized middle-class people required growing means and led to unprecedented deficiencies in the budgets of all public bodies, which were being financed directly and indirectly by the United States. This is strikingly illustrated by what can be looked on as the worst detail in the sad story of German default: the situation of the Landesbank der Rheinprovinz, before the War an unimportant and unknown communal savings bank. After the War this bank borrowed some $200,000,000 abroad in the form of short-term credits and advanced this money long-term to small, practically unknown cities which had hitherto never required and could certainly not have obtained any credit.

The problems with which Hungary and Austria were faced were different from those of Germany only in degree. Because of the disruption of the old Austro-Hungarian Monarchy, on which both countries had been economically and socially dependent, the destruction of the pre-war social system had been even more far-reaching than in Germany. Of the two, however, only Hungary has made any attempt to re-establish pre-war social conditions completely. Consequently, with debts amounting to $320,000,000 for a population of only eight million, she is by far the largest per capita debtor to the United States. In Hungary the problem was chiefly the maintenance of the middle class, which in this semi-feudal agricultural country consisted of a landed petty aristocracy, the “gentry.” Of the other classes, the working class and the urban middle class did not count for much in this predominantly agricultural country. The upper classes, consisting of the fifty families of the higher nobility, who owned and governed the country, had not been very badly hit by the War. The mass of very poor peasants were easily satisfied with a half-hearted measure of land reform which granted them a small part of the largest estates, for the loss of which the owners were handsomely compensated. This was in fact paid by the state and financed by an American loan.

It was the gentry who presented the really serious social problem. Their social and economic position in pre-war times had been founded on the many positions practically reserved to them in the army and civil service of the old Austro-Hun-garian Monarchy. The income from their estates, which were for the most part leased to tenants, merely served to eke out their rather small pay, thus fulfilling a purpose similar to the capital investments of the German middle class. Both sources of income were completely destroyed when the Aus-tro-Hungarian Monarchy was dissolved, when Hungary was compelled to disarm, and when most of the Hungarian civil servants were dismissed by the new countries. Furthermore, a considerable part of the land owned by the gentry was expropriated, as it was situated in countries which had ceased to belong to Hungary. Since the peasants, content with the new land acquired under the land reform, ceased to lease more land from the gentry, their remaining property became valueless. As soon as the communist government was replaced by a government of the high aristocracy, the gentry organized themselves on fascist lines in order to demand subsidies. They supported their demands by the threat of civil war. To satisfy these demands, Hungary has from the proceeds of her foreign loans built up a civil service at least as great numerically as the pre-war civil service, which had been used for the administration of a country more than four times her present size. She has likewise built up an army which is supposed to possess more officers, under manifold disguises, than Hungary’s army before the War, On the other hand, the gentry have been subsidized by means of mortgages on their landed property, for which numerous mortgage loans have been obtained abroad—especially in the United States.

In striking contrast to that of Hungary, the chief characteristic of the Austrian problem is that all three classes in that country—the working class and middle class in Vienna, and the peasant class in the country provinces—have all been equally deprived of their economic and social foundations. Moreover, there has been no possibility of a restoration of their position, for all classes had been completely dependent on the economic possibilities of the large pre-war Empire, of which Vienna had been the industrial, financial, and social center. This is why the struggle to maintain the social system in Austria became a struggle to maintain Vienna’s economic predominance in the Danube basin. This is why the major part of Austria’s loans from America—$150,000,000 out of a total of $225,000,000—was taken up by the Viennese banks in the form of short-term money, and was used to finance industry and trade in the whole of the territory of the former Austro-Hungarian Monarchy. The social and economic foundations of pre-war society in Austria had been completely destroyed: as a natural corollary, the struggle between the different classes could never be appeased. For, despite American loans, each class could live only at the expense of the other. Consequently, there was a fierce fight between town and country, and in the town itself between the working class and the middle class. The result was the complete subjection of the working class outside Vienna, and the complete expropriation of the middle class in Vienna.


The total economic failure of the aims for which the American loans were raised is proved by the fact that practically all these loans are in partial or total default, and by the fact that the loans granted to the three Central European countries account for about fifty per cent of America’s defaulted foreign loans. But the failure in the economic field is of secondary importance compared with the failure in the social sphere. The American credits entirely failed to stabilize the pre-war social level. The money was wasted: it had had only the most temporary effect. The artificial maintenance of the social structure led to a serious aggravation of the social disease, beyond any hope of recovery. The social facade was maintained, but the props supporting the structure rotted away without any attempt to mend them until the whole building crashed.

One reason for this development was the rigid attitude of the various classes following the artificial raising and maintenance of their standard of life. This made every adjustment by peaceful means impossible, and further maintenance could come only from a further inflow of American money, on a rising scale. Perhaps the best illustration of this is the industrial rationalization of Germany. I have already said that this was not the outcome of technical progress or economic change. From political necessity the working class’s standard of living had been artificially raised. This forced German industry to supplant human labor as far as possible with machinery. Obviously, this economically unnecessary rationalization would result immediately in structural unemployment. This, in turn, would frustrate the effect of all previous efforts and of all previous loans to maintain the standard of the working class, and would thus necessitate new loans to care for fresh unemployment. On the other hand, industry, completely mechanized and burdened with heavy fixed charges, lost all elasticity: the slightest drop in sales below the maximum capacity resulted in practically a total loss of the capital invested. Such a recession was inevitable in view of the greater number of unemployed and the reduced purchasing power of the home market, and this naturally led to further rationalization and further borrowing. At the same time the attitude of big business towards the working class became more rigid, since only a radical reduction in wages and in social services could save the invested capital. On its side, the working class became even less inclined to grant concessions, since the workers had become accustomed to a higher standard of living. Much the same applies to the middle classes in all three countries.

The second and equally important reason for the breakdown of this artificial restoration lay in the insoluble problem of the younger generation. It was impossible to reconcile them to a social system that was so carefully and precariously maintained. The generation that came back from the trenches, as well as the generation that grew up during and after the war, felt the social artificiality almost as a physical pain. Since they had not lived through the period in which this social system had been a matter of course, they saw its iniquities, its cleavages, and its elaborateness much more clearly than their elders. They were not content to live by subsidies, particularly when these were not sufficient to provide work for them. Thousands of young men tried to shun a life without prospects by becoming “eternal students.” I have known many able young students who began to study medicine as soon as they had taken their degree in law merely in order to escape from the grim hopelessness of futile job-hunting into the comparatively sheltered existence of a state-subsidized student. The physical and spiritual misery, the hopelessness and despair, of the youth of Central Europe during the post-war years can hardly be exaggerated, and such youths could be placated only as long as increasing American credits made bribery possible.

In consequence, the social structure in Central Europe depended entirely on the continuation of American credits on a rising scale, in order to cover the growing economic and social deficiencies of the whole system. The sudden cessation of American loans in 1929 spelt immediate doom to this artificial social structure. It was, however, a serious and fatal mistake on the part of the German communists and the Viennese socialists to regard this breakdown as the “breakdown of the capitalist system” of their Marxist text-books. What had happened was exactly the contrary: the system broke down not because the bourgeoisie had become too weak to resist the working class any longer, but because all classes, among them the bourgeoisie, had been maintained at too high a level to allow any social adjustment, in spite of the growing deficiencies of the existing economic system.

It was, therefore, a moot point to whom the victory would fall in an open class war, and the resultant damage to all classes would obviously be considerably greater than the benefit to any individual class. The impossibility of waging a successful class war has played an outstanding role in the growth of fascist doctrine and in its attraction for the dispossessed of all classes in Central Europe, especially the younger generation. This doctrine promises the maintenance and even the raising of the standard of living of all classes without class war and without national cleavage, by the mystic panacea and new social justice of the “corporate state.” In the final analysis, this merely consolidated and perpetuated the same social structure that had hitherto been established and maintained by the American credits. This doctrine, promising everything to everybody and demanding nothing in return, attracted the unemployed worker as strongly as it did the big industrialist or the young intellectual. All classes equally dreaded a class war. Fascism in Central Europe was therefore bound to defeat both democratic doctrines and socialism. For democracy could not provide a way out when American loans had ceased; and socialism could offer only the obviously hazardous solution of class war. Both in Germany and in Austria the fascist state was established by a “legal revolution.” In Hungary a virtual dictatorship of the high aristocracy had been established in 1920; here the power was simply handed over to the fascist gentry by an internal revolution within the reigning party that passed off almost unnoticed by the outside world.

But can the fascist corporate state provide such a solution? On the basis of the existing conditions in Central Europe, can a balance be struck? The answer must be No. One cannot repair a profound structural disproportion merely by erecting a new facade; one cannot convert a deficit into a surplus by a new system of accounting. Consequently, in all three countries the attempt to consolidate and stabilize the existing social structure under a new name has already completely failed. In all three countries the new regimes have been compelled to use their dictatorial powers to expropriate the reserves of one class in favor of the others. In Austria, where social decomposition had progressed farthest, the corporate state broke down almost before its establishment. After the civil war against the Vienna workers in February, 1934, the victorious countryside began a silent but very thorough expropriation of the working and middle classes in Vienna. This expropriation has now very nearly exhausted the remaining reserves of Vienna. In Germany, where the fervor and enthusiasm of the fascist revolution has been greatest, the expropriation of one class was likewise unavoidable. Since both big business and the working class are comparatively too strong, expropriation on a larger scale has begun with the very class that helped the Nazis to power: the middle class. Wholesale and retail traders, the professional men, clerical workers, and the civil service have to bear the brunt of the economic burden. Their income is being steadily reduced by new taxes, by cuts in salaries, “voluntary” contributions, equally “voluntary” conversions of public and private debts, and by the enforced cut in the difference between the steadily rising costs of production and the artificially low retail prices. The complete destruction and pauperization of the German middle class is only a question of time.

Finally, in Hungary, where the landed middle class leads the fascist movement, a compulsory land reform, the aim of which is completely to expropriate the high aristocracy in favor of the gentry, has become unavoidable. But this measure will hardly be sufficient to restore the social equilibrium, since during the last few years the farmers and the workers have grown restive.

It is obvious that the expropriation of one class by another can continue only for a limited period. The limit has already been reached in Austria; it will very soon be reached in Germany. As soon as this class and its reserves have been completely expropriated, open class war will be inevitable, and an acutely revolutionary situation will develop. Whether it will then be possible to find some means of continuing the policy of postponing the necessary reconstruction, or whether this reconstruction will become inevitable—and if so, in what form and by what means—cannot even be surmised at the present stage.

However, the American investor as such is no longer interested in the failure or success of the attempt to evade social adjustment. Not only are his holdings in Central Europe in default; not only are they worth a fraction of what he paid for them; but the major part of the loans and credits granted by the United States to Central Europe has already been repurchased or amortised by the debtors at an average price of little more than twenty per cent of their actual gold value a few years ago. The American public has therefore lost practically everything, and has footed the bill of what can be considered the greatest—and most fruitless—experiment in social restoration ever known to history.


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