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How did the word “capitalism” come about? Ask most investors this question today and they might mumble about markets, trading and Adam Smith – or Karl Marx. However, according to Michael Sonenscher, a British historian, the term first appeared in 18th-century Europe in connection with war financing.
“’Capitalism’ began as a French word (capitalism), but was originally used to refer to several broadly British problems,” notes Sonenscher. “That was the most noticeable thing [18th-century] War financing system. In French, someone who lent money to a branch of the French royal government was called a capitalist (capitalist).”
On one level, this is just an amusing quirk of the story. But there should also be cause for serious reflection today. In the decades following the Cold War, the “peace dividend” was so great that modern financiers – and voters – rarely considered the question of how wars were paid for. However, this week the Stockholm International Peace Research Institute reported that rising geopolitical conflict led to a 7 percent inflation-adjusted increase in defense spending last year to a record $2.4 trillion, or 2.3 percent of global economic output.
This partly reflects the impact of the Russian invasion of Ukraine. Not only have American, European and Ukrainian spending skyrocketed, Russian military spending has also risen to over 6 percent of gross domestic product.
In fact, spending increased last year for the first time in all five geopolitical regions tracked by Sipri. “States prioritize military strength, but risk an action-reaction spiral in the increasingly volatile geopolitical and security landscape,” says Sipri researcher Nan Tian.
Rishi Sunak, the British prime minister, this week put Britain’s defense industry on a “war footing,” with spending set to rise to 2.5 percent of GDP by 2030, and NATO recently announced a $100 billion spending plan. Then there are the $95 billion military aid bills for Ukraine, Taiwan and Israel that were just approved by the U.S. Congress. The “action-reaction” spiral is underway.
Fortunately, this rate of increase is still lower than at various points in the 20th century – and it comes from a low base. Sixty years ago, before the Peace Dividend took effect, the United States and the United Kingdom each spent 8 and 6 percent of their GDP on the military. Given that most modern investors built their careers at a time when “capitalism” was still peacefully defined, there are at least three points they should keep in mind.
First, history shows that governments almost never tell voters the true cost of war or explain how they plan to pay for it. There are exceptions. In 1940, for example, John Maynard Keynes published a lucid pamphlet entitled How to Pay for War. And last year Denmark canceled a national holiday to raise additional revenue for defense spending. In the USA, political advisors are supposed to examine Congress’s spending plans. But transparency is rare. As Sonenscher notes, the main reason European kings issued debt to finance military adventures in the 18th century was to circumvent legislative control.
And while the recent furor over the Ukraine bill in Congress creates the appearance of Democratic control, “there is no public access to budget information about…”. . after September 11th [military spending] is imperfect and incomplete,” says a critical report from Brown University’s Watson Institute.
The second lesson is that even if the costs are ultimately wiped out by tax increases, inflation or looting, an increase in debt usually occurs. The Watson Institute estimates that the US has spent $8 trillion in military spending since 2001, “paid almost entirely by borrowing.” Without early repayment through massive tax increases, miraculous growth and/or defaults, “interest payments could total over $6.5 trillion by the 2050s.”
It’s hard to believe that things will be different in Europe. Yes, Sunak claimed this week that his mooted increase in military spending would be “fully funded” by departmental spending cuts. But that sounds like magical thinking.
Third, the shock of war encourages not only strong government economic intervention but also financial and technological innovation. For example, in 1694, the British government adopted the idea of a central bank to finance the war. In the 1940s, the introduction of American “war bonds” helped create a retail market for government bonds. World War II also led the British and American governments to develop policies of financial repression. Today, experiments are being discussed to securitize the proceeds of confiscated Russian assets for Ukraine.
Meanwhile, the US is outsourcing much of its military technology innovation to venture capitalists. And I’m told asset managers are testing digital customization techniques that would allow them to quickly exclude hostile nations or regions from portfolios, as governments unveil new ways to track offensive wealth flows and assets.
Will this innovation continue? Probably. However, it is already clear that debt issuance will continue to increase without huge tax increases as the threat of war increases. This could be a defensible geopolitical “insurance policy” for states fearing an attack. But it will almost certainly put upward pressure on interest rates. Modern “capitalists” – also known as bondholders – should take note.