Financing the Second French Indemnity

After France’s defeat in the 1871 Franco-Prussian War, the country was billed five billion francs for peace. This ‘indemnity’ was intended to cripple the country, but it failed. The French government was able to pay the demanded reparations faster than expected by refinancing the indemnity with perpetual bonds, or rentes. It succeeded in conducting the largest bond offering in French history up to that time in order to make timely payment on one of the largest international transactions in history. For this success, the country could thank the scale of its banking system and the monumental demand of investors at home and abroad.

Indemnity

After the Napoleonic Wars, France was required to pay reparations to the coalition that defeated it in 1815. The amount levied summed to 700 million francs plus payment of the occupiers’ armies in the country and the repayment of some previously defaulted debts. This would not be the only Napoleonic indemnity demanded of France in the 19th century. After Napoleon’s nephew Louis-Napoléon Bonaparte, as Napoleon III, lost the Franco-Prussian War, France had to pay a larger indemnity to the newly formed German state.

After tossing around figures ranging from one billion to eight billion francs, an indemnity of five billion was settled on by the two countries. As in 1815, the headline number did not include the entire cost of the defeat. Responsibility for a separate 200-million-franc indemnity was imposed on the city of Paris specifically and the French government was also required to fund the German army occupying part of its own territory.

Regardless, the five billion francs was a massive sum by itself, equal to perhaps 25% of French GDP at the time or about two years of government tax revenues. The unpaid portion of the indemnity was to accrue at 5% interest and payment was due in installments payable in gold, silver, or the banknotes, checks, or bills of certain banks, at France’s discretion.

Each payment was tied to the withdrawal of German troops from certain French dèpartament, starting with the Somme, the Seine-Inferieure, and the Eure with the June 1871 payment and ending with Marne, Haute-Marne, Ardennes, Vosges, Meuse, Meuse-et-Moselle and Belfort with the final payment due by March 1875. The first payment, due within thirty days of the signing of the peace treaty, was made partly in banknotes and gold and silver coins, but mostly through the surrender of railroads valued at 325 million francs in the provinces France lost to Germany, Alsace and Lorraine.

Rentes

Making the first payment within thirty days was challenging enough; the remaining payments would need to be financed over a longer period. This was done by large offerings of rentes, or French sovereign bonds. The first of these offerings and by far the largest up to that time, at 2.5 billion francs, was announced in June 1871. Of this amount, two billion francs would go to make payments under the indemnity and the remainder directed towards general government expenditures.

The rentes, earning 5% interest perpetually, were sold at 82.5% of face value for an actual yield of 6%. This was higher than pre-war French borrowing costs of closer to 4.5% but was still below what investors demanded from the French in the aftermath of Napoleon’s defeat at Waterloo or the Revolution of 1848. These prior national catastrophes had apparently been judged as more debilitating.

The subscription process for the rentes launched on June 26, 1871 and ran no later than through June 30. Investments as small as five francs would be accepted and the issue was marketed abroad as well, including in Germany. Investors were required to pay in their investment amount in sixteen installments.

Demand for the rentes was overwhelming. Within just one day, the entire 2.5-billion-franc issue was filled in Paris. The next day, another 1.25 billion francs in orders arrived from the rest of France and thereafter 1.125 billion francs from abroad, from investors as far away as India. Many of these buyers also prepaid their installments, generating initial proceeds to the French state several times higher than expected.

Ease of Payment

There was an expectation in Europe that the indemnity, the largest international transaction up to that time, would cause France to exhaust its gold and silver reserves. This did not happen though, at least partly because investors buying the French rentes funded their investments by selling foreign securities or from income generated by these securities, creating the corresponding inflow of money that reduced the net outflow.

Foreign purchases of the rentes also reduced the outflow of the precious metals and mitigated any weakening of the value of the paper Banque de France notes. Some monetary turbulence was unavoidable of course. For example, because the French paid part of the indemnity in British bills, their redemption would be a drain on Britain’s money markets, prompting the Bank of England to raise interest rates from 2% to 5% in just a month. This turbulence proved manageable and there was no meaningful inflation or currency depreciation in France during this year of French military defeat, the disorder of the Paris Commune, and the imposition of the indemnity.

Growing exports and high local savings rates also helped keep the international balance of payments in check. French exports of non-agricultural goods grew by 756 million francs between 1869 and 1873, while imports rose by only 288 million francs. In the period between 1872 to 1877, the French trade surplus ran at about one billion francs annually.

The entire 1.5 billion francs due by year-end 1871 was paid by October. The indemnity demanded by Prussia was meant to ruin France but the country was paying it ahead of schedule. Otto von Bismarck, the German Chancellor, was himself surprised by the promptness of payment. Patriotism and prestige may have helped; the rentes were issued in registered form, with investors’ names recorded in the Grand Livre de la Dette Publique. It was said that having one’s name on this ledger was a great honor in France, imparting a kind of distinction on a person only matched by owning an estate.

To pay the rest of the indemnity, another 3.5 billion francs in bonds were issued in July 1872. Seeing its first issue was oversubscribed, the French government raised the offering price, but only to 84.5. It also made this issue payable in just five monthly installments. This was not enough to deter to investors and the second rente offering after the war was thirteen times oversubscribed. Indeed, orders from distant Berlin alone totaled three billion francs. Between the two issuances, approximately half of the rentes were bought by foreigners. In the end, the French made indemnity payments equal to 8% of GDP in 1871 and 13% in 1872. The indemnity was paid by September 1873, largely refinanced into these perpetual rentes.

Banks

The banking system played a large role in the rente offerings despite the fact it was hardly clear at the start that the banking sector could absorb the issuance of the rentes. The London and Paris branches of the Rothschild bank led the syndication efforts despite the initial opinion of the Paris head of the family, Alphonse de Rothschild, that such an indemnity would be impossible to pay. Nonetheless, his firm played a major role. Alphonse was not keen on losing business and he was worried that other bankers, such as the new group Paribas would take the French business instead.

On top of their commissions, the syndicate of bankers led by the Rothschilds were paid to guarantee a minimum amount of rente sales, earning 2% in the case of slightly more than one billion francs guaranteed in the first offering and 1.5% for a similar amount of the second offering. This proved easy money given just how sought after the bonds were. The syndicate was also paid 25 million francs by the French government in exchange for an advance of 700 million francs ahead of the second rente issue.

While other banks jockeyed for some of this business, perhaps the Rothschild syndicate’s only real competition was, surprisingly, J. S. Morgan. This smaller American firm had advanced £10 million to the French government during the war, when other lenders, including the Rothschilds, were less keen. Nonetheless, while the Rothschilds led the syndicate, many other banks were among its members, spreading out some of the profits to be gained from the historic offering.

Bankers made money selling the rentes but so too from holding them. Of the first rente issue, the share reserved for the Rothschilds themselves was over 400 million francs, 16% of the entire issue. This first rente, issued in June 1871 at 82.5, was trading hands at almost 95 by the end of October. For those still holding the rentes thereafter, prices kept rising, reaching 100.5 in 1874 and 120 by 1880.

By the time of the second issue, some banks were placing large orders with the hope of selling the bonds before the second installment payment, making profits with minimum expense. Much of this most frenzied buying came from German banks excluded by the Paris Rothschilds from the syndicate selling the bonds. Nevertheless, they were still anxious to make money from what at the time could easily have been considered the issue of the century, even if this meant entering the transaction behind the Rothschilds and their peers and at higher prices.

Aftermath

The French indemnity of 1871 had large financial and economic effects in Europe. The payments enriched the Germans; the influx of money lowered German interest rates but also caused very high inflation for this period, with prices rising close to 40% over three years, this despite the country’s transition to a gold standard from one based on silver. The money was used to repay the debts of several countries being amalgamated into the new German Empire; the indemnity coincided with German unification. The old creditors of these governments, with money in hand, set about looking for new investment opportunities, fueling a boom in banking, real estate, and railroads that would abruptly end with the Panic of 1873.

France meanwhile was rather unaffected by the whole matter, at least in comparison to the pessimistic initial expectations. In comparing this crisis to earlier disorders, one contemporary economist wrote that “France was prodigiously richer in 1870 than in 1848, and she had an organized system of finance which enabled her to shake off the effects of her disasters, and to make these very disasters the germs of future progress” (M. Bailleux de Marisy). The financial development of France made the massive rente issuances and early payment of the indemnity possible.

Lesson

Historians often contrast the French indemnities of the 19th century with German reparations after the First World War and attempt to understand why France’s indemnity, while perhaps just as punitive in its aims, was so easily paid. Perhaps the most obvious reason is that post-war France, though it lost territory and was plagued by internal revolts just as Germany would be after the First World War, was still judged to be a creditworthy country. Investors lined up in droves to buy its bonds.

Unlike in the case of Germany after the First World War, where its leaders and outside observers alike did their utmost to demonstrate that Germany couldn’t afford to pay what was being asked of it, France’s post-war leaders seemed decided on demonstrating the opposite. This was not an obvious result; it was against the opinions of many financial commentators of the era. However, it is hard to believe that the syndication of the rentes could have been as successful without this optimism, whether warranted at its inception or not.

More from the Tontine Coffee-House

Read about the first French indemnity of the 19th century and the monetary consequences of German defeat in the First World War. Lastly, consider subscribing to this blog’s newsletter here.