through London, and payment coming from credits designated for Allied accounts at the Bank of England. ‘His quick mind and inexhaustible capacity for work rapidly marked out a kingdom for him,’ Niemeyer recalled. Keynes’s powers increased after May 1915, with the formation of the wartime coalition government, in which Lloyd George became Minister of Munitions, and Reginald McKenna replaced him as Chancellor of the Exchequer. ‘McK’, wrote the Whitehall-watcher Sir Vincent Caillard a few months later, ‘has an almost mysterious hold on the P.M.’s judgment and even affection.’ Keynes soon acquired a similar lien on McKenna’s views. He became the leading authority on questions of external, and particularly inter-Allied, debt.20
The government initially assumed that if it raised the money to pay for its wartime expenditure, there would be a corresponding fall in other expenditure. In expectation of a short war, it did not levy heavier taxes, but in November 1914 issued a war loan of £350 million to pay for its munitions. The banks subscribed for most of this loan, counted their Treasury bonds as part of their reserves and continued their lending as before. As a result, both public and private expenditure rose. Keynes helped McKenna to prepare his first budget, in September 1915, whereby income tax was raised to three shillings and sixpence in the pound, and an Excess Profits Duty of 50 per cent (raised to 80 per cent by 1917) was imposed together with the so-called McKenna Duties, which levied 33.3 per cent on luxury imports such as motor-vehicles and watches. These McKenna Duties were of signal importance: introduced by a free-trade Liberal, they were a victory for protectionists; intended as a wartime improvisation, they remained in force until the Labour government’s free-trade budget of 1924; were reimposed in Winston Churchill’s budget a year later; and continued until 1956 when they were abolished in Harold Macmillan’s last budget before becoming Prime Minister. In effect, for forty years, the McKenna Duties served as a protective measure to defend British motor-car and lorry manufacturers from international competition.
Keynes toiled during September 1915 in negotiations that resulted in British financial credits to Russia, British control of Russian purchases and Russian loans of gold to Britain. ‘I doubt if I’ve ever worked harder than during the last two weeks; but I’m wonderfully well all the same,’ he told his parents on 18 September. ‘The work has been as interesting as it could be. I’ve written three major memoranda, one of which has been circulated to the Cabinet, and about a dozen minor ones.’ When the pressure of work relented, Keynes went for a Sussex weekend with Bloomsbury friends and showed no sign of strain: ‘Maynard is equable and optimistic and very agreeable,’ reported Clive Bell. Keynes’s experiences at this time convinced him of the benefits of latitude and discretion. ‘There is a case for controls which those in charge know to be imperfect and incomplete and deliberately leave so; especially in England. It is far more trouble than it is worth to be too logical about controls.’ Only a day after establishing the principle that Russian credits should be confined to munitions, he had to initial a Bond Street bill for a Grand Duchess’s underwear, and approved a shipment of beeswax to provide candles for Russian Orthodox churches. On another occasion, Spanish currency was urgently needed for Allied international transactions. With difficulty a smallish sum was raked up, as Keynes reported. Chalmers expressed relief that for a short time, at any rate, the Treasury had its reserve of pesetas. ‘Oh no!’ replied Keynes to his aghast chief, who like most civil servants had scant understanding of markets. ‘I’ve sold them all again: I’m going to break the market.’ By dumping the Treasury’s holding, he jolted the value of Spanish pesetas downwards in international currency exchanges and was then able to buy back the necessary reserve of pesetas at lower prices than those for which he had sold them.21
From early in 1915 until the United States entered the war in 1917, there was a continuous exchange crisis of a gravity that became more acute as gold reserves were depleted. By the summer of 1916 Britain was paying for all of Italy’s war expenditure, most of Russia’s, two-thirds of France’s, half of Belgium’s and Serbia’s. It did this by heavy borrowing from the United States (amounting to about 40 per cent of total war expenditure by September 1916). This sum was paid from dwindling gold reserves, the sale of American and Canadian securities under British ownership, the sale of Treasury bills, bond issues and collateral loans. Keynes estimated that British borrowing would soon have to rise to over $200 million a month in the USA. In a memorandum of 10 October 1916, he advised: ‘the policy of this country towards the USA should be so directed as not only to avoid any form of reprisal or active irritation, but also to conciliate and please’. Robert Skidelsky has identified these words as fixing the moment when New York replaced London as the world’s chief financial power.22
McKenna submitted on 24 October a Cabinet memorandum which Keynes had prepared for him on Britain’s financial relations with the USA. In it McKenna warned of insolvency and concluded as a ‘certainty that by next June or earlier the President of the American Republic will be in a position … to dictate his own terms to us’. This infuriated Lloyd George, who rejected these views. On 27 November the US Federal Reserve Board instructed American banks to reduce their credit to foreign borrowers and warned private investors against advancing loans secured by Allied Treasury bills. The chief motive for this was to pressurize the Allies towards a negotiated peace, as Keynes had long wished the Americans to do. In early December gold flowed out of Britain with startling speed.23
Chalmers and Sir John Bradbury, who were Joint Permanent Secretaries at the Treasury from 1916, were committed to the belief (as Keynes later wrote) ‘that in a run one must pay out one’s gold reserves to the last bean’. As a result, although they had prefigured this crisis to the War Cabinet, they kept the extent of the gold outflow from ministers. This was because they feared that politicians, in a funk, would jettison sterling’s gold convertibility. ‘I thought then, and I still think, that they were right,’ Keynes judged in 1939 of Chalmers and Bradbury. ‘To have abandoned the [gold] peg would have destroyed our credit and brought chaos to business; and would have done no real good.’ He recalled one occasion when the Treasury mandarins bamboozled the politicians. ‘Well, Chalmers, what is the news?’ Lloyd George, who became Prime Minister on 7 December 1916 after forcing Asquith’s resignation, asked at the first meeting of his War Cabinet. Chalmers replied ‘Splendid!’ in his high, quavering voice. ‘Two days ago we had to pay out $20 million,’ he added, ‘the next day it was $10 million; and yesterday only $5 million.’ Chalmers did not add that a continuance at this rate for a week would finish Britain, and that the Treasury thought an average of $2 million too heavy. After outfoxing his political masters, Chalmers returned triumphant to his room at the Treasury, where Keynes was waiting apprehensively.24
In the government reconstruction of December 1916 the Canadian-born Andrew Bonar Law replaced McKenna as Chancellor of the Exchequer. Keynes found his dealings with Law easy: ‘there was no one who could be briefed quicker than he and put au courant with the facts of the case in those hurried moments which a civil servant gets before his chief before a conference’. He found the Chancellor a grateful man: mistrustful of intellectual schemes, but with ‘an inordinate respect for Success’, and therefore ‘capable of respecting even an intellectualist who turns out right’. As a Glasgow iron merchant, who had been reared in a wooden Presbyterian manse in New Brunswick, Law had (as Keynes wrote in 1923) ‘no imaginative reverence for the traditions and symbols of the past, no special care for vested interests, no attachment whatever to the Upper Classes, the City, the Army, or the Church’. He regarded himself as ‘a plain business man, who could have made a lot of money if he had chosen to, with a good judgment of markets rather than of long-term trends, right on the short swing, handling wars and empires and revolutions with the coolness and limited purpose of a first-class captain of industry’. It was to both men’s credit that Keynes had a reciprocated liking for Law, an ‘extreme partisan, a vehement mouthpiece for the Conservative party, who distrusted any emotional enthusiasm which grasped at an intangible object’.25
In
