War finance, providing "the sinews of war," has usually determined a war's outcome. Fear of military defeat stimulates innovations in finance (among other reactions) that may have lasting consequences, whether victory or defeat follows. Many, if not most, of the lasting innovations in the way governments have collected taxes, managed the money supply, controlled wages and prices, serviced their debts, and regulated trade have emerged under the duress of war.
Innovations in war finance fall under the three ways governments can finance their expenditures—taxes, debt, and seigniorage (money creation). Perhaps the earliest example is the creation of coinage, originating in Lydia in the seventh century b.c. The use of coins allowed more efficient collection of taxes and tribute by military leaders. It also allowed governments to hire
mercenaries instead of maintaining standing armies. It is a matter of conjecture whether coins or mercenaries came first, but it is indisputable that they spread together throughout Asia Minor and the Mediterranean. Coinage also facilitated the collection of taxes, including tribute from foreigners.
The first financial innovation to appear after coins was recoinage by the victor of an opponent's money supply, which could bring substantial payoffs. In the later Roman Empire and in medieval Europe, recoinage of one's own money was an occasional expedient of princes or cities under duress. During the
military revolution of the sixteenth and seventeenth centuries, they relied upon it increasingly, culminating with the issue of fiat money (the value of which was determined by decree, rather than by the metallic content). This became standard by the end of the eighteenth century. Forerunners of fiat money were tokens issued on occasion in medieval cities, probably for use during sieges when coins were not available, but also available for daily transactions even in peacetime.
Credit had to be extended on occasion, even in the wars of antiquity, from the mercantile community. But it took the pressure of the military revolution in Europe during the sixteenth and seventeenth centuries to make credit the most important share of war finance. Spain's Philip II at first used foreign bills of exchange, backed ultimately by tax receipts, to maintain his forces combating the
Dutch Revolt. As the expenses of warfare grew, Philip II and his successors were forced into repeated bankruptcies. Essentially, they converted the accumulated short-term debt, asientos, into longer-term debt, juros, on which they had to pay only the interest. This eased the immediate liquidity problem of the Spanish rulers and enabled them to apply their extraordinary revenues to the next war. But used repeatedly—in 1560, 1575, 1596, 1607, 1627, 1647, and 1653—these conversions inhibited merchants from giving credit again. During the
Thirty Years' War (1618-1648), capital levies were imposed by both sides on cities and towns, which bore them indefinitely. The discovery that taxes collected regularly by any permanently existing governmental unit such as a city could be multiplied many times by assigning them to the service and repayment of a specific war debt (called "funded debt") laid the basis for far-reaching innovations in public finance throughout Europe in the second half of the seventeenth century. Non-Western societies were unable to imitate this practice because of the absence of credible commitment mechanisms to ensure continued debt service by the sovereign. Their failure in finance may have contributed to the rise of the West.
The "Glorious Revolution" of 1688 allowed the English Parliament to extend financial techniques previously confined to cities to an entire kingdom. Even so, modern national debt was not established until the traditional means of finance had failed in the
War of the Grand Alliance. The recoinage crisis of 1696, caused by the flight of silver from Britain to finance the war effort on the Continent, demonstrated that the British-funded debt, first held by the Bank of England established in 1694, had to be expanded. In the
War of the Spanish Succession and thereafter, the national debt grew in each war to the extent that by the end of the eighteenth century, the British national debt far exceeded its national income. As a consequence, however, Britain won its "second Hundred Years' War" with France, and the restored Bourbon monarchy after 1815 quickly adopted the elements of British finance—a permanent national debt secured by specific taxes levied by a permanently constituted legislature.
Over the course of the nineteenth century, other emerging industrial nation-states followed suit—the
United States with the Civil War, Germany after the
Franco-Prussian War, and Japan after the Meiji Restoration in 1868 and victory in the 1895
Sino-Japanese War. Many other states attempted to follow—tsarist Russia, Greece, and Spain to mention a few—but military defeats thwarted them.
In the twentieth century, the success of the Allies in
World War I in mobilizing external finance, especially from the United States, stood in contrast to the experience of the Central Powers, whose domestic tax base was diminished by the war effort and whose access to foreign loans was nil. The result at the end of the war was a huge stock of inter-Allied war debts among the victors and an overwhelming stock of domestic debt owed by the separate Central Powers. Their domestic tax bases were further diminished by the
terms of the peace treaties and the reparations demands. The refusal of the Central Powers to increase taxes to service reparations, combined with the efforts of the Allied powers to extract resources from their expanded colonial domains while reconstituting the gold standard, led to the financial collapse of the international economy in the 1930s.
The lessons learned were applied in
World War II. On the Allied side, the United States supplied war materials under the Lend-Lease Act to avoid inter-Allied debts at the end. On the Fascist side, heavy occupation taxes were levied upon each conquered country as well as levies of forced labor. At the conclusion of hostilities, the method chosen by the United States to minimize its outlay on occupation costs and reconstruction expenses led to the economic revival and miraculous export-led growth of Japan, West Germany, and Italy. Its European allies eventually learned the financial benefits of decolonization. American attempts to finance the
Vietnam War with credit rather than taxes, however, led in 1971 to the collapse of the dollar as a standard for fixed exchange rates, which had been established after World War II. Meanwhile, the attempt of the Soviet Union to imitate the economic and financial policies of wartime Nazi Germany in its occupation zones in central and eastern Europe led ultimately to economic collapse in 1989.
Cold War, including both the
Korean and Vietnam wars, the United States used its dominant economy to finance overseas bases and military actions, but relied increasingly on contributions from allies, especially Japan and Germany. These culminated in the
Gulf War of 1990-1991, in which all outlays by the United States were covered by allied payments, reminding historians of the way the Athenian navy had been financed by the Delian League in antiquity.
P. G. M. Dickson and J. G. Sperling, "War Finance, 1689-1714," in The New Cambridge Modern History, vol. 6, The Rise of Great Britain and Russia (1688-1715/25) (1970); Larry Neal, ed., War Finance, 3 vols. (1994).