Financing Bad Ideas
Turning the tap off is only half the equation
As we’ve all becoming nauseatingly aware, a large producer of a crucial commodity has a lot of leverage in the world. If you are in the position, the world will get pretty mellow about some top-shelf evil – up to a point. As the Number two oil producer in the world, Russia has growled about turning the energy tap off to get his way, and it has largely worked until the West united to turn it off from the other end. Yet, that is only half the equation: eventually you are going to want to turn it back on.
With gas prices the way they are, I didn’t want to fly across Hell’s half acre for a case study on how this works (or doesn’t). So, I just looked out my library window. As a Southerner, I remember the bumper stickers that read “The South is gonna do it again.” I also remember thinking: Do what again? We lost, and vividly. Conventional military wisdom holds that the war was (theoretically) winnable by the South until July of 1963 when Robert E. Lee’s Army was mauled at Gettysburg in the east and Ulysses S. Grant took Vicksburg in the west. Granted, that was a bad month for the Confederacy but if you follow the financing, the South’s fate was sealed a year earlier.
Wars cost money, heaps of it, and the South didn’t have any. It was sparsely populated and a large chunk of its population were held as illiquid assets of a much smaller chunk. They were land and asset rich, but cash strapped. The rest of the white people were just poor. So, the Confederacy did what ambitious, cash-strapped governments always do: issue debt. Their first stop was the House of Rothchild, which refused to underwrite the bonds. Not over a distaste for slavery, but as a bad credit risk. It was a shrewd assessment. Jefferson Davis, the CSA president had advocated skipping out on the national debt when he’d been a US senator.
A French firm, Emile Erlanger & Co., was willing float the “Cotton Bonds” paying a 7% coupon on a maturity of 20 years. Since everyone agreed that the South was a terrible credit risk, the bonds were convertible into cotton at the pre-war price of 6 pence per pound. More to the point, the debt instrument was its own collateral. In a world before a polyester, Cotton was king. And as the South’s #1 export, they had piles of the stuff. Assuming you could get your hands on it. The issue was a huge hit, especially in Britain where the British textile industry - the cornerstone of the industrial economy – got 80% of its cotton from the American South. It didn’t matter if the coupons weren’t paid, as the war dragged on, the price of cotton, and the bonds, kept rising.
Like Russia with its oil, the Confederacy could then finance its ill-advised war. It also reckoned that the world’s economic dependency on its main export could be leveraged to bring in allies. Outgunned as it was, the South needed more than money, it needed Britain to wade into the fracas. Britain did have a huge material interest in a Confederate victory, but they’d abolished slavery throughout the empire and the political optics of involvement were just terrible. Plus ça change. To force the issue, the South placed an embargo on cotton to Liverpool; the price skyrocketed as imports to British manufacturing centers slumped, causing mass unemployment that was referred to in England as “the cotton famine.” The wheeze may have worked for all we know, except that in April of 1862 New Orleans fell.
Historians rarely accuse the citizenry of New Orleans of taking their occupation seriously. There were no epic stands for glory. The city’s resistance generally entailed not inviting Yankee officers to the best parties. With the port of New Orleans blockaded, though, so was the cotton. Or in the eyes of European investors, the collateral.
The Confederacy had turned off the cotton tap only to lose the ability to turn it back on. By 1863, the question was moot: Britain had found new sources of cotton in China, India and Egypt. It didn’t really matter if the tap came back on or not. Desperate, the Confederacy started to just print money and, as always, inflation in the South soared to 4,000%. The North saw inflation too, prices rose by about 60%. That too has a topical warning for today, and I’m looking at you, Joe Biden.
The commodity lesson is that the scramble to replace Russian energy has already started. Even if Putin does come to his senses and pulls out of Ukraine tomorrow – and Confederate bonds look like a safer bet – the world will keep looking for alternate sources. Domestically fuel prices are well past the point where alternate domestic supplies and renewables make economic, not just environmental sense. Sure, the kids my go berserk over shale, but it’s hard to drive to the pipeline protest when gas is $9 a gallon.
Be warned though, that New Orleans fell in April of 1862. It took another year for Vicksburg to fall and the Army of Virginia to be mortally wounded. Even then, the war didn’t end until April of 1865. Showing that a determined government in the grip of a ill-advised idea can defy gravity longer than you might think.