Yugoslavia was an amalgam of different countries when it was formed after World War I, and its original name, the Kingdom of the Serbs, Croats and Slovenes indicated its origins. After World War II, Yugoslavia’s dictator, Josip Broz Tito, distanced himself from the Soviet Union in 1948 and sought his own path for Yugoslavia. The country played a unique role during the cold war. Yugoslavia was a socialist country that relied upon the market to allocate goods. Some economists looked upon Yugoslavia positively as a country that had found the middle ground between the socialism of the Soviet bloc and the capitalism of the West. Unfortunately, this middle ground worked better in theory than in practice.  

War, Sanctions and Hyperinflation

Slobodan Milošević became the President of Serbia on May 8, 1989. Though his goal was to restore Serbian supremacy in Yugoslavia, he was instrumental in destroying Yugoslavia. The collapse of the country may have been inevitable, but the collapse of the economy and currency were not. In January 1991, Slobodan Milošević ordered the Serbian National Bank to issue $1.4 billion in credit to his friends. After Milošević resigned from power, he would be charged with corruption and embezzlement because of this and other actions. In 1992, the United Nations imposed sanctions on what was left of Yugoslavia as a result of the carnage that was occurring in Bosnia and Herzegovina. Consequently, both GDP and fiscal revenue declined while the cost to Milošević of fighting his wars with Yugoslavia’s former republics rose. Milošević had already raided the Serbian National Bank and by this time, most of the country’s hard currency was gone. The sanctions hit Yugoslavia hard, and its financial resources dried up. Milošević saw only one solution to survive: print money. Inflation was nothing new to Yugoslavia. Yugoslavia had suffered double-digit inflation in every year save one between 1969 and 1986. Inflation rose to even higher levels after 1985, moving from 87% in 1985 to 162% in 1987 and to 2719% in 1989. When the United Nations imposed sanctions on Yugoslavia in 1992, the country quickly collapsed into hyperinflation. Prices increased 17,200% in 1992, and an incredible 3 quadrillion percent in 1993. Inflation was 1788% in December 1993 and 4139% in January 1994, though one wonders how the government arrived at such exact figures. The hyperinflation finally ended in March 1994, and by 1995, the annual inflation rate was a more “normal” 122%.  

The Government Tries to Regulate Inflation but Causes the Economy to Collapse

In November 1993, the government delayed turning on the heat in government-owned apartment buildings in order to save money, so the buildings’ tenants bought inefficient space heaters which overloaded the electrical system leading to blackouts. Pensioners and other Yugoslavs delayed making payments for government services, knowing that even a few days’ delay would wipe out the cost of making any payments. In short, the economy collapsed. As the inflation got worse, businesses began using Deutsche Marks instead of Yugoslav Dinars to avoid losing money from the continual erosion in the value of the Dinar. To keep up with the inflation, Yugoslavia had to continually issue new currencies to get rid of the zeroes that were piling up. On January 1, 1990, a new Dinar replaced the old Dinar at the rate of 10,000 to 1, in July 1992 another Dinar was introduced at the rate of 10 to 1, and in October 1993 another new Dinar was introduced at the rate of 1 million old Dinar to 1 new Dinar. In January 1994 the 1994 Dinar was introduced at the rate of 1 billion 1993 Dinar to 1 1994 Dinar, which was replaced in turn by the Super Dinar at the rate of 12,500,000 to 1 in less than a month. In one year, between December 1992 and December 1993, the effective exchange rate between the Yugoslav Dinar and the US Dollar had gone from 900 Dinars to the US Dollar to 3 billion million million Dinars (3 sextillion for anyone who cares) to the US Dollar. In February 1994, 1 new Super Dinar was equivalent to 1.2 Octillion (1.2 billion billion billion, i.e. 27 zeroes) Dinars from 1989.  

Milošević Is Kicked Out of the Country He Destroyed

In his own way, Slobodan Milošević was probably one of the greatest counterfeiters of all time, and though Slobodan Milošević may not have suffered the death penalty for his destruction of Yugoslavia’s currency and economy, at least he spent the rest of his life in prison for his crimes.

Although successful in the construction business, Kreuger focused on developing the match company his family owned. He established AB Svenska Förenade Tändsticksfabriker (Swedish Match) in 1918 and spun off the construction business to expand Kreuger and Toll’s match business. Kreuger’s ultimate goal for the firm was the complete horizontal and vertical integration of the match business in Scandinavia, which he achieved. Kreuger took advantage of an innovation in the production of matches which the Swedes had introduced in order to triumph over his competitors. Kreuger and Toll replaced flammable and volatile yellow phosphorus with the safer red phosphorus. Since matches were needed to light any fires, demand was inelastic, and this created huge profit opportunities for Kreuger and Toll. During the 1920s, “three on a match” was a catchphrase that warned people against lighting three cigarettes with the same match. The superstition originated during World War I when matches were scarce. Soldiers would light three cigarettes with a single match, but it was rumored that this was long enough for a sniper to focus on the cigarette and kill the third smoker. A Hollywood movie was made in 1932 in which one of three childhood friends ignored the warning and paid the price. Cynics said the superstition was a fraud and Kreuger had spread the rumor just to increase match sales. No one would put it past him. Kreuger took over lumber and other companies that provided the raw materials for matches. He introduced innovations to increase efficiency in production, administration, distribution and marketing. In a few years, Kreuger had established his match monopoly in Scandinavia, and prepared to conquer the rest of Europe. Providing loans to a government in exchange for a monopoly is a European tradition. Monopoly power was the origin of the Bank of England in 1694 and the basis of John Law’s schemes in France in the 1720s. Kreuger learned the lessons of the past and used governments to build his empire. During the 1920s, Europe was recovering from World War I. European governments were desperate for money in the late 1920s, and just as Kreuger knew how to wheel and deal in the construction business to get contracts, he knew how to encourage cash-poor European governments to provide him with the match monopolies he wanted. Kreuger negotiated with governments throughout Europe by offering them loans in exchange for state monopolies. It was a classic win-win. Kreuger ended up loaning almost $400 million to European governments during the 1920s, and was hailed as the “savior of Europe.” Loans were made to Poland, Danzig, Greece, Ecuador, France, Yugoslavia, Hungary, Germany, Latvia, Romania, Lithuania, Bolivia, Estonia, Guatemala and Turkey. Kreuger was able to provide funding because he owned the Skandinaviska Kreditaktiebolaget in Sweden, the Deutsche Unionsbank in Germany, the Union de Banques à Paris, the Banque de Suède et de Paris in France, and the Bank Amerykański w Polsce in Poland. He worked with banks in Europe and in America, using the assets of Kreuger and Toll with the promise of future profits and dividends to negotiate these loans. Kreuger promised the world though he often didn’t even know where the money for loans to Poland, Germany or France would come from. One way or another, during the 1920s, the money always showed up. In addition to the match business and banks, Kreuger controlled most of the forest industry in northern Sweden, planned to become head of a cellulose cartel, and attempted to create a telephone monopoly in Sweden through his ownership of Ericsson. Kreuger also had a major interest in the pulp manufacturer SCA, the Boliden gold mining company and the SKF ball bearing manufacturer, real estate companies, movie companies, trading companies, and railroads. All of these were profitable businesses which allowed him to expand Kreuger and Toll at a rapid pace. Success bred even greater success.  

Financial Innovations of the Leonardo of Larcenists

Kreuger, or the Leonardo of Larcenists as John Kenneth Galbraith referred to him, was able to achieve his rapid expansion because of his financial innovations and financial engineering. This enabled him to control how profits were reported, registering profits when none existed and shifting profits from one company or division to another to show a steady increase in profits. Kreuger wanted complete control. He created “A” and “B” shares for Kreuger and Toll, which enabled him to raise capital while not giving up power over his company. The “B” shares had the same rights to profits and dividends, but not the same votes. “B” shares had 1/1000of a voting right compared to an “A” share. Issuing different classes of shares to maintain control is commonplace today. In 2014, Google issued new shares that had only 1/10 of a vote of the original shares. Kreuger was able to attract additional capital to Kreuger and Toll by consistently paying a high dividend of 15% to 20%. When Kreuger and Toll issued American Depository Receipts (another innovation) for their shares in New York, they were able to raise tens of millions of dollars. Kreuger and Toll also issued convertible gold debentures paying 6.5%, a high rate at the time, which could be converted into common stock if the price of Kreuger and Toll stock rose. When Kreuger loaned money to governments he used binary foreign exchange options to protect his company from exchange rate fluctuations. These enabled Kreuger and Toll to specify in which currency, Dutch Guilders or United States Dollars, governments would pay back their loans. Kreuger always demanded payment in the stronger currency. Kreuger’s real innovation, however, was in using off-balance sheet entities to expand the company’s operations. Kreuger shifted losses into companies that were not included in the firm’s consolidated balance sheet so the company would always appear to enjoy growing profits. Kreuger differentiated between companies he had a majority interest in and ones he had a minority interest in. Profitable companies with a majority interest were placed on the balance sheet; companies with a minority interest were treated as investments. This enabled Kreuger to hide many of his loss-making investments from investors and competitors. The technique gave the company leverage which meant soaring profits in a bull market. But as Enron, Bear Stearns and Lehman Brothers were to discover decades later, this technique could also lead to large losses or even the collapse of the company when the market declined. Kreuger and Toll was not a Ponzi scheme. Profits were reinvested in Kreuger and Toll’s divisions and subsidiaries to maintain the growth and success of the company. However, because Kreuger and Toll was highly leveraged, Kreuger needed to constantly expand his operations to pay the high dividends his companies provided, to issue new loans to governments, to purchase new companies, to obtain new monopolies, to expand his conglomerate, and to show expanding profits to shareholders and stakeholders. Like a hamster on a wheel, Kreuger had to run faster and faster to maintain the appearance of success.  

House of Cards

The Great Depression contributed to the collapse of Kreuger’s house of cards. When revenues and profits declined, Kreuger needed loans to keep his company going. Rumors began to spread that Kreuger and Toll was facing financial difficulties and the price of the company’s stock began to decline. As the graph below shows, the price of Kreuger and Toll “B” shares plummeted from 46 in March 1928 to 6 in September 1931 and traded around that level until March 1932 when the complete collapse of the company made the shares virtually worthless. Shares in Kreuger and Toll immediately collapsed, falling from $8 to $0.50 on the New York Curb. In the end, debenture holders did get 43 cents on the dollar, but shareholders got nothing. Freely manipulating balance sheets was not uncommon in the 1920s and 1930s, but no one had pushed accounting to the creative levels of Ivar Kreuger. In part, it was because of Kreuger’s actions that the SEC, when it was formed a few years later, introduced the concept of generally accepted accounting practices to avoid the future fleecing of investors. This hasn’t prevented the deceit and lies of an Enron or a Bernie Madoff, but it has reduced the number of frauds. Kreuger was a flawed genius. The way he ran Kreuger and Toll, the collapse of the company seemed inevitable despite the monopolies and highly profitable businesses which made up his conglomerate. As Warren Buffett once put it, when the tide goes out in a bear market, you’ll find out who is swimming naked, and Kreuger, as it turns out, didn’t have a stitch of clothes to his name. Kreuger knew it, and when the game was up, he took his life, leaving investors to pick up the pieces.

The National Bureau of Economic Research was founded in 1920 as a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works.

The impact on global stock markets was immediate: the closure of every major European exchange and many of the exchanges outside of Europe. Although no one would have predicted this result at the beginning of July 1914, by the end of the month, European stock exchanges were making preparations for the inevitable war and its impact. Never before had all of Europe’s major exchanges closed simultaneously, but then again, never had such a global cataclysm struck the world. There had been crises before when the stock market in the United States or other countries had closed, such as the 1848 Revolution in France, or the Panic of 1873 in New York, but never had all the world’s major stock markets closed simultaneously.  

Open Financial Markets Led to Closed Exchanges

Ironically, it was because of the openness of global financial markets before the war that the global closure of stock markets occurred. At the beginning of 1914, capital was free to flow from one country to another without hindrance. All the major countries of the world were on the Gold Standard, and differences in exchange rates were arbitraged through the buying and selling of international bonds listed on the world’s stock exchanges. A country such as Russia would issue a bond that was listed on the stock exchanges in London, New York, Paris, Berlin, Amsterdam and St. Petersburg. Differences in exchange rates between countries could be arbitraged by buying and selling bonds in different markets. In effect, this made European stock exchanges a single, integrated market. In 1914, currency flowed between countries with lightning speed. During the Napoleonic wars, money could only move as quickly as a ship could venture from one country to another. By 1914, cables stretched across the oceans of the world, and money as well as stock orders could be wired telegraphically from one corner of the world to another in minutes. Traders throughout the world could sell bonds and shares instantly, and it was the fear of massive selling, and the impact this would have on global markets that led to the shutdown of European exchanges. There was a concern that investors would try to repatriate their money leading to massive selling, a sharp fall in prices, and large amounts of capital flowing out of one country and into another. The impact of selling on brokers and jobbers was exacerbated by the way shares were traded on the London Stock Exchange. Individual trades were made on a daily basis, then carried until Settlement Day when trades were matched and crossed. Brokers would make up the surplus or deficit on their accounts by settling outstanding trades with cash. As long as there were no significant swings in stock or bond prices, brokers had sufficient capital to settle their accounts. However, since traders relied on credit, large swings in prices could and would bankrupt many of the brokers, worsening the financial panic. To avoid this problem, stock markets were closed until a solution could be found.  

The War Drives Stock Prices Down

Of course, to investors not being able to buy or sell shares is even worse than selling them at a loss. Although stocks could not be traded on the main exchanges, over-the-counter markets replaced exchanges for those who were desperate enough to sell. Although the NYSE was closed between July 30 and December 12 of 1914, stocks were quoted by brokers and traded off the exchange. Global Financial Data has gone back and collected stock prices during the closure of the NYSE to recreate the Dow Jones Industrial Average while the NYSE was closed. We collected the data for the 20 stocks in the new DJIA 20 Industrials and calculated the average of the bid and ask prices from August 24, 1914 to December 12, 1914. This enabled us to discover that the 1914 bottom for stocks actually occurred on November 2, 1914 when the DJIA hit 49.07, over a month before the NYSE reopened. Few people realize that stocks in the US had already bottomed out and were heading into a new bull market when the NYSE reopened on December 12, 1914. The DJIA did not revisit this level until the Great Depression in 1932. The graph below shows how the Dow Jones Industrial Average behaved during 1914, including the period of the NYSE’s closure. Although the market declined with the onset of war, investors eventually realized that war in Europe would bring opportunities to American companies to sell industrial goods and war materiel. Once this fact settled in, the stock market rose steadily for the next year. Unlike the United States, stocks on the London Stock Exchange declined in price during World War I. This was due not only to the decline in earnings that occurred and general selling of shares to raise capital, but just as importantly, because of the lack of new buying and the shift of capital to government war debt. British companies were allowed to issue new shares only if the issue was in the national interest, and foreign governments and companies were not allowed to issue any new shares. The British government wanted to insure that all available capital was used to fund the growing war debt. Most of the new bonds that listed on the London Stock Exchange were British government bonds and their share of the London Stock Exchange’s capitalization rose from 9% to 33% during the war. The performance of the London Stock Exchange between 1913 and 1919 is shown below. As can be seen, stocks lost value continually during the war, hitting their bottom only in 1918, despite the general inflation that occurred in Britain during the war, which normally would have carried prices upwards. Exchanges were subjected to extensive regulation that did not exist prior to the war. Germans were not even allowed to trade on the London Stock Exchange for years after the war was over. London lost its place as the center of global finance during the war as its role as the center of global finance was passed on to New York. Nevertheless, New York was never able to take on the pivotal role in capital markets that London held prior to World War I. After the war was over, financial markets had to deal with the dislocations created by the war: inflation, increased government debt, reparation payments, the Russian Revolution, the creation of new countries, England’s failed attempt to return to the Gold Standard, the stock market crash of 1929, the Great Depression, debt defaults, competitive devaluations, the concentration of gold in France and the United States and a hundred other financial repercussions that resulted from World War I. Governments and stock exchanges did learn their lessons from World War I. When World War II began, the London Stock Exchange closed for only a week, and the New York Stock Exchange never closed during World War II, save for August 15-16, 1945 when the NYSE closed to recognize V-J Day and the end of WWII. The Berlin Stock Exchange remained open during World War II, though price floors and capital restrictions kept the prices of shares from falling until the devaluation of 1948. Although global stock markets reopened between 1914 and 1917, it wasn’t until the 1980s that the restrictions on financial markets that prevented the free flow of capital that had existed before 1914 were removed. Only after the fall of Communism did stock markets become as globally integrated as they had been before 1914. Though the focus of the hundredth anniversary of World War I will be on the massive destruction of World War I, the deaths of millions, and how World War I laid the foundations for World War II, the impact on stock markets and international finance should never be forgotten.