Fighting the First World War was phenomenally expensive, made even more so by rampant inflation. Even before the war, Britain was engaged in an arms race, spending £74m, or 21% of total expenditure, on defence in 1913. This figure was to be utterly dwarfed in the next five years. In 1918, Britain's military expenditure reached £2.4bn. It was the exceptional challenge of funding such enormous expenditure that David Lloyd George foresaw when he spoke in the House of Commons on 5 August 1914, the day after Britain entered the war: 'In this tremendous struggle finance is going to play a great part. It will be one of the most formidable weapons in this exhausting war.'
Taxes were raised in order to bring more money into the public coffers. Income tax rates more than doubled in the course of the war, and earnings inflation meant that a higher proportion of the population reached the payment threshold. By 1920 three million people in Britain were eligible to pay, compared to 1.1 million in 1914. Indirect taxes were also increased, and a new excess profits duty was introduced for companies. In all, the government's tax income rose from just under £300m in 1914 to over £1bn in 1919. Nevertheless, war expenditure outstripped it three to one. The shortfall in 1916 alone was twice the size of the total national debt before the war.
We are most of us above the military age, at present. Our time may come; but if we cannot go into the trenches we can, at any rate, endeavour to take our part in providing the sinews of war for the gallant fellows who are fighting our battles for us.
Chairman's speech to Williams Deacon's Bank AGM, January 1916
The government needed to borrow enormous sums. International borrowing became a necessity, but the government strove to raise as much as possible domestically. To achieve this, it needed extensive support from the British banks.
As before the war, treasury bills remained a key strand in the government's financing activities, and the banks remained significant holders of them. As the war went on, however, it became clear that such short-term instruments were insufficient. Three longer-term instruments came to the fore:
- Exchequer bonds had been the government's usual source of medium-term borrowing before the war, and remained so. As with the treasury bills, banks were a key buyer. British government securities came to dominate the British banks' balance sheets, representing 75% of their total securities by 1918, compared to 13% in 1913.
- A series of war loans, raised in 1914, 1915 and 1917. Initially aimed principally at institutional investors, the later loans also sought investments from the wider population, and were extensively marketed and sold by the banks.
- National war bonds, first sold in 1917, introduced a system of continuous medium-term borrowing. These, too, were bought through the banks, as well as through post offices.
Still needing more money, the government broadened its focus, seeking to attract investments from the broadest possible range of the population, including those on relatively low incomes. Marketing to the population at large was managed by War Savings Committees, often supported by banks and bankers, both nationally and at the local level. Their work became the beginning of an initiative that was to endure much longer than the war itself; the National Savings movement. During the war, the committees promoted continuous efforts to sell war savings certificates and war bonds, many of which were sold through the banks. They also undertook targeted campaigns, including the famous Tank Bank tour.
In seeking investments from the wider population, the government was asking for money that, in many cases, would otherwise have been in bank savings accounts. Nevertheless, many people's incomes rose in wartime, and in spite of the competition for customers' money, the banks saw their deposits rise from just over £1bn in December 1914 to nearly £2bn four years later. The value of money had, of course, been hugely reduced by inflation, but it is still true that, after the initial shock of summer 1914, the banks fared well in the difficult circumstances of war.
Through its network of borrowing vehicles, combined with international borrowing, the government managed to continue funding the war. Nevertheless, the long-term cost was high. By 1920 the national debt was £7.9bn. Just paying the interest on that debt cost the country £375m in that year - more than the nation's entire expenditure had been in 1913.