Wartime Balance of Payments in Neutral Sweden

The First World War tested the fiscal systems of all belligerent countries, usually in unprecedented ways. Governments had to tax more than they ever had before, they had to borrow more than they ever had before, and had to restrict their economies, including with respect to trade and foreign exchange, in ways they never had before. Because of this, the value of most European currencies depreciated, whether one compares them to gold, prices, or the U.S. dollar. The exceptions were among the neutral countries, and Sweden’s experience provides a good example of this experience.

Trade in a Neutral Country

Sweden declared its neutrality at the start of the First World War, but like the countries at war, Sweden also suspended its gold standard. From August 1914, banknotes would no longer be convertible for gold and, starting from November, gold exports were banned too. Initially, this accompanied, or perhaps caused, a depreciation of the Swedish krona. However, the war would accelerate demand for Swedish exports and strengthen the currency over time.

Both sides in the First World War traded with neutral Sweden. Germany and Britain were already Sweden’s principal trading partners before the war but their appetite for the products of Swedish industry grew. The surge in demand for exports from Sweden was accompanied by only steady demand for imports into Sweden. Thus, a trade deficit turned into a trade surplus. Besides the trade surplus, the current account of the Swedish balance of payments was complemented by the increased revenues earned by the Swedish merchant marine. Revenues earned by shipping to foreign countries grew from around 120 million kronor before the war to 242 million in 1915 and to 416 million in 1916.

As a result of all of the above changes, the Swedish economy kept growing early in the war and industrial profits were lifted. The financial markets in the country became livelier too; in 1915, seventy-one new companies were listed on the Stockholm stock exchange and there were many more mergers too. Trading volume on the exchange also ballooned as a financial bubble got underway.

Stockholm’s Stock Exchange Building, Börshuset, c. 1910-1925 (unknown photographer; retrieved via Stockholm Stadsmuseet)

Effects of That Trade

There was no longer any near-term prospect for a strained balance of payments or shortages of gold or foreign exchange. Indeed, Sweden built up gold reserves at a brisk pace. The gold reserves of the country’s central bank, the Riksbank, rose 30% between January and December 1916 from 142 million kronor to 185 million. Almost half of that gain was in the first two months of the year, prior to a resumption of banknote convertibility.

Even while the gold standard had remained suspended, the Riksbank was legally required to buy gold at the mint price of 2,480 kronor per kilogram. There were many exporters who received gold from foreign trade and disposed of it with the bank. This was not welcomed by the Riksbank for several reasons. The compulsory gold purchases meant it either had to issue notes to fund the purchases of gold without regard to the monetary consequences, or it had to swap other assets it held with gold; it found the latter option unappealing because gold was a static asset that earned the bank no revenue.

Gold continued to accumulate; reserves increased a further 55% between December 1916 and the end of 1918, reaching 286 million kronor. Compare this to just 109 million kronor at the end of 1914. Besides gold, the Riksbank accumulated foreign currency, securities, and receivables due from foreign firms. Private firms had extended credit to foreign purchasers denominated in their currencies which, it was expected, would return to their pre-war foreign exchange rates after the war ended. This would prove a mistaken judgement in some cases. Nonetheless, the Riksbank’s own asset holdings of bills payable abroad rose from 43 million kronor in 1914 to 122 million in 1916 though these later retreated as trade volume fell in the second half of the war. In short, Sweden had become a large creditor to the countries at war, accumulating large credits due from them.

There was only so much trade credit Sweden could extend to its trading counterparties, yet their appetite for Swedish goods was insatiable. So, transfers of securities funded much of the trade. Swedish securities abroad, representing Swedish borrowings from the rest of the world in years prior, were repatriated back to Sweden.

This was essentially a means by which Sweden reinvested its exports earnings and financed the Swedish purchases of its trading partners, namely by buying back securities it had issued abroad in the past. Some 343 million kronor of Swedish securities were repatriated between the start of the war and the end of 1917; 76 million of this from Britain and 179 million more from Germany. These were massive transfers; they were so large that, coupled with ordinary repayments of the public debt and economic growth, they contributed to Sweden’s foreign debts falling from over 80% of GDP in 1914 to around 20% in 1920.

Swedish Exceptionalism ’14-16

Another effect of the brisk wartime trade with Sweden was that the krona’s depreciation from the early months of the war reversed by April 1915. Against the French franc, the krona appreciated from 0.78 krona to the franc in March 1915 to .60 by year-end 1916. Even against currencies that had held their value better, like sterling and the U.S. dollar, the krona appreciated. It rose from 19.5 to the pound in March 1915 to 16.77 by year-end 1916 and from 4.08 kronor to the U.S. dollar to 3.54 over that same period.

In the midst of this change in fortune, Sweden resumed converting banknotes for gold in January 1916 at the old rate of 2,480 kronor per kilogram, less a one-quarter percent fee. It was joined by other neutral Scandinavian nations, but such a resumption by the countries at war would have to wait years. The problem at the time of resumption in Sweden was not that there was too little gold but that there was too much. Too many were selling gold to the central bank in exchange for banknotes and, within a month, the central bank was given permission by the government to turn down purchases of gold for banknotes, in order to reduce its excessive, but still accumulating, reserves or at least slow the increase.

A ban on the import of gold, except from fellow Scandinavian Monetary Union countries Denmark and Norway, also came into effect. Indeed, the demise of this currency union, formed in 1873, came with the First World War. The movement of gold between Sweden, Denmark, and Norway was restricted after 1917 in order to prevent gold simply transiting through those countries into Sweden. The monetary union essentially dissolved when Sweden wanted to reduce gold imports while Denmark and Norway, which saw only smaller inflows, resisted.

The krona continued appreciating as Sweden essentially cut itself off from the international gold standard by the gold import ban, and opted instead to maintain an independent gold policy.

However, the demise of the ‘international’ element of the international gold standard meant that, as Sweden implemented both a gold import ban and an export ban, this gold standard was somewhat artificial. The key disciplining element of the gold standard, namely the flow of gold into and out of a country and the resulting self-adjustment of the money supply, remained essentially gutted. Nonetheless, demand for the krona was high enough that the currency likely would have at least sustained its value against gold even if gold were allowed to enter or leave the country freely. The currency had appreciated 34% against the pound by November 1916.

Normalization

After the boom years of 1914-16, Sweden’s economy contracted during the second half of the First World War. The primarily cause was declining trade as German submarines began to target neutral shipping. Together with poor harvests, this led to food shortages in 1917-18. Other goods became scarce too. Imports from Britain, for example, fell from 214 million kronor in 1915 to just 65 million in 1917.

With trading conditions changed, the krona began to depreciate as exports fell and many expected that foreign currencies, which had depreciated against the kronor, would return to their old values when the war ended. Many thought the war was nearing its end, in 1917 because of the prospects of a negotiated settlement, and in 1918 because of the growing likelihood of German defeat. As it happens, only some European currencies would appreciate meaningfully after the war.

As the krona fell and goods became scarce, prices were rising quickly, and faster than wages. Nonetheless, trading activity on Stockholm’s frothy stock exchange had not yet begun to decline; indeed, volume reached a peak in 1918 that would not be reached again, in real terms, until 1980! The financial windfall of the early-war years was not totally erased but it did not make up for the difficulties now faced by large amounts of the population.

“As far as our own country is concerned, we have used up a great amount of real capital – although with one great difference – that as a nation we have been compensated for this and thus accordingly we ought to be able to procure real capital in exchange for our monetary claims. The unfortunate thing is: a) that these claims are possessed by a relative minority of the population of the country; and b) that their real value is in doubt.” – Swedish economist Knut Wicksell in “The World War: An Economist’s View”, 1919

Trade returned in 1919 only for the economy to contract, as it had elsewhere in the world, in 1921. Deflation and high unemployment set in, again not unlike the experience of other countries. As with other European currencies, the Swedish krona depreciated after 1918; Swedish goods lost export demand even when world trade resumed after the war ended.

Return to the Gold Standard

Nonetheless, Sweden maintained a comparatively strong foreign exchange rate and the country’s central bank continued redeeming banknotes for gold for a little while, though this was suspended again in 1920. The Riksbank lifted its discount rate, despite the economic downturn, to support the currency further. The result was that many banks failed in a resulting financial crisis, but the exchange rate returned to near pre-war parity with other stronger European currencies by 1922. After this, the gold standard was restored in April 1924. Sweden was the first country in Europe to do this after the war. Yet, even here the resuscitated gold standard would not last long; the system would fall apart again as the Great Depression set in.

Lesson

Surging demand for Swedish exports supported the value of the krona at a time when most other European currencies were losing value. Still, between a financial bubble and drastic changes in central bank policy from time to time, there were plenty of downsides to this windfall too. The experience of Sweden during the First World War illustrates the dynamics involved in a nation’s balance of payments and the effects of large inflows and outflows. The experience provides lessons that would become more relevant after the demise of the international gold standard and its self-regulating (to an extent) price-specie-flow mechanism when the price level would adjust in each country to keep the balance of payments regular.

More from the Tontine Coffee-House

Read about the immediate financial repercussions of the First World War, the requisitioning of U.S. dollar securities by the British government, the restoration of the gold standard after the war and its quick demise. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.