These hopes were soon realized. In the later half of the i920s, American investment flooded into Europe. Some of it helped European business to reorganize itself on more modern lines. The great American automobile producers acquired European firms:
Ford built a plant in Cologne, General Motors acquired the Adam Opel factory.
But much of the American investment was misdirected. Europe was not ready for such an inflow. Schemes, for instance, to build a major free port on an island in the Danube near Budapest at Csepel came up against the reality that the successor states of the Austro-Hungarian empire imposed high levels of tariff. The low-price automobile producers found that the European market had not been sufficiently developed. Cars were still a luxury item, and smaller manufacturers, able to provide an expensive and individualized product, actually had a competitive advantage. Above all, a great deal of American investment took the form of bond purchases: of government or municipal authorities, which used the proceeds for the provision of municipal infrastructures, housing, roads, recreation facilities, etc., that had a high social benefit (and also brought political advantages to the governments responsible for them), but brought no immediate return.
The Great Depression
The flow of American capital dried up at the end of the 1920s, partly because of doubts about European developments and partly because returns on US investment were higher. After the crash of the New York stock market in October 1929, some flows resumed, but American investors were nervous, and after 1930 Europe obtained little capital from the United States.
By the end of the 1920s, European prospects had already deteriorated. The worsening trade situation was a major cause, but it was associated with the problems caused by financial stabilization.
The return to the gold standard was thought by most economic experts to be the best way of guaranteeing rentiers against expropriation, and of laying the basis for a revival of international trade. In 1925, Britain went back to gold at the pre-war parity; in 1926 France stabilized her currency. By the early 1930s, all European currencies, with the exception of Spain, had established a parity in gold.
The most important European currencies were the pound sterling and the French franc. The overvalued British exchange rate required the pursuit of deflationary monetary policies in order to prevent a run on sterling. France, which had had a sharp and painful experience of inflation before stabilization, received substantial inflows of gold after 1926, but neutralized them (i. e. did not allow the new gold reserves to be used as a basis for additional monetary creation). As a result, the system developed a deflationary bias: Britain, as a deficit country (because of the overvalued rate), was forced to contract; while France (and the United States, which also had gold inflows) did not inflate.
Faced by deflation in the major countries, the use of tariffs elsewhere was a logical response as part of a strategy of preventing the international transmission of deflation. The spread of protectionism received an additional impetus when in 1930 the United States adopted the Smoot-Hawley tariff. Other countries responded by raising tariffs, and by imposing quotas and other restrictive measures. The monetary problems of Europe had helped to produce a trading war of all against all. From the point of view of each country, the response was quite rational; but the overall result was that everyone had to pay a high price in terms of reduced output, unused capacity, and falling investment and consumption. The effects of the depression were felt until the outbreak of the Second World War, as in most countries, even though production recovered, unemployment remained at high levels.
The international depression at the end of the 1920s and the beginning of the 1930s was made more intense by two additional mechanisms. From 1925, agricultural prices on the world market had begun to fall. This development should have been predictable: the market for agricultural products is relatively inelastic, and as European production at long last recovered from the fertilizer and manpower shortages of wartime the surplus on world markets forced prices down. For many capital-importing indebted countries in central and eastern Europe (as well as in Latin America), the only way to service external debt lay in the export of agricultural products. As prices fell, the producers needed to sell more. As they sold more, prices fell still further.
For instance, Hungarian wheat exports doubled in quantity between 1929 and 1932, but the proceeds from exports actually fell because of the price decline.
In addition, the development of the real economy disturbed the financial sector, which in turn provided further shocks to output. The dramatic fall in prices reduced the value of bank-held assets and made many European banks insolvent at current prices. They responded by cutting back their credits to their customers, sometimes forcing these out of business. When depositors, sometimes domestic, and sometimes foreign, realized the extent of the problem, panic developed, and withdrawals led to bank closures. European banks fell down like dominoes after the closure of the largest Vienna bank, the Creditanstalt, in May 1931. Bank collapses in Austria, then in Hungary and Germany, as well as in the United States, intensified the deflationary process. As banks tried to save themselves by calling in credits, they drove many vulnerable manufacturing enterprises to bankruptcy.
World History
