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Some notes on Keynes’s 1919 “grand scheme for the rehabilitation of Europe”.

July 19, 2012, 8:30 pm

I mentioned in my previous post that Keynes, in April 1919, put forward a plan for the financial rehabilitation of Europe. Here is how it was supposed to work:

Germany would issue bonds, at a present value of £1 billion. (That’s a US billion.) They would pay 4% p.a. and have a 1% sinking fund to retire the debt beginning in 1925.

Most of the money raised from the bond issue would go to the Allies for reparations – something like seventy percent. Much of the remainder would stay in the hands of the German government, dedicated to a special fund for reconstruction.

Why would anyone buy the bonds? The securities had several safeguards. First, they would have priority over all other German obligations. Second, other enemy nations would guarantee them jointly and severally. Third, in the event of a default, the League of Nations would impose a penalty, or forfeiture, of “a financial, economic, or commercial character.” Fourth, the Allied and Associated powers would also provide an ultimate guarantee for the bonds, in a set proportion – the US, UK, and France would each take twenty percent, other countries would take smaller percentages.

Further, the bonds would be acceptable as payment between Allied governments and as first-class collateral at central banks.

So the French could use the bonds to pay debts to the British and the British could use them to pay debts to the Americans.

Keynes’s plan included provisions for the other Central Powers and new nations to issue similar bonds, similarly secured.

The state of international debt at the end of the war had both the UK and US as net creditors, with the US by far the largest net creditor.

Before the bond issue, the Germans owed the British money but had no wherewithal to pay nor capital to invest in reconstruction of the means to pay. The British owed the Americans money but had no wherewithal to pay unless the Germans paid – which they could not.

One could thus foresee, for example, that with the bond issue the British might buy the bonds, get back seventy percent a share1 of the purchase price in reparations, and pass the bonds along to Americans in payment of debt, leaving the Germans with twenty percent of the purchase price to invest in rebuilding their economy.

The size of the bond issue wasn’t anything like the size of the outstanding debt, which Keynes estimated as, net, £1.7 billion to the US and £650 million to the UK. But it would go a long way toward reducing those sums and thus reducing the interest owed as a share of each nation’s annual budget.

Under the proposal, the Americans would have got something in payment of their debt – a security backed by (a) German ability to pay (now shored up by the ability to invest in reconstruction), (b) the other Central Powers’ ability to pay (likewise shored up), (c) the League of Nations’ ability to encourage payment (shored up by American interest in seeing it strengthened), and the Allies’ and Associates’ (the only Associated power that mattered was the Americans themselves) ability to back up payment (shored up by the debtor Allies having a large part of their debt relieved).

You could look at this arrangement as one that left the Americans “holding the bag,” as one critical historian remarks. Certainly the Americans would be the guarantor of last resort if everyone defaulted.

You could also look at it as a plan to give the US a material interest in the reconstruction of Europe, the creditworthiness of the defeated and new nations, and the credible authority of the League of Nations. The US would have wanted all these institutions to succeed, so as not to be left holding the bag, and presumably would have acted to ensure the success of these institutions and with them, the peace. Which, it seems to me, would have been no very bad thing, and probably better than what actually happened.

The objection Americans made at the time to the Keynes plan, and one still deployed by historians critical of it, is that it would never have been accepted by Congress, so (the reasoning goes) Wilson was right to reject Keynes’s plan out of hand.

On the other hand, the same was true of the Treaty as it was – which is to say, it had no chance of being accepted by Congress, either. Yet Wilson expended upon it what remained of his political capital and, arguably, his vital energy. There would have been little added harm in making the peace more nearly financially sound.


1I realized this was wrong, that of course the British weren’t getting the entire reparations payment – it was being distributed among the Allies.

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