Case Study 4.5e "Liberty Bonds"

Directions: Complete the following case study and record your answers on a separate sheet of paper.

Topic: The establishment of the Liberty bond program, and its use to fund a military buildup and lessen inflationary pressures.

Objective: To examine the creation and operation of Liberty bond drives and their function in supplementing military spending during World War I.

Funding military forces is very expensive. It becomes even more costly in times of war. Before World War l, the United States had a small military. It was necessary to spend the money needed to produce a strong military force that would be ready to fight in Europe. In fact, by the end of World War I in 1918, the United States had spent $33 billion on the war effort. But in April of 1917, President Woodrow Wilson and his administration faced the problem of raising money for this massive war effort.

There are three basic methods used by governments to raise the money necessary for fighting a war. One method is to simply raise taxes. Another is to borrow money. The third is a combination of increased taxes and increased borrowing. In order to raise the funds needed during World War I, the U.S. government sold Liberty bonds, also known as Liberty loans. The revenue from the sale of these bonds went directly to the war effort.

CS Question #1: What methods does a government use to raise money to fund a war effort?

The first Liberty bonds were sold in April of 1917. The Treasury Department was able to collect $3 billion from this sale. Bonds were sold to the public at an interest rate of 3.5 percent. In order to create an incentive to buy the bonds, the Treasury Department excluded interest income from taxable income. The bonds could also be turned in and converted to subsequent notes of higher interest. The government also used propaganda to sell the bonds. Posters depicting U.S. service members were placed in public areas to entice citizens to purchase the bonds out of a sense of duty to the war effort.

CS Question #2: What incentives did the public have to buy Liberty bonds?

Liberty bonds were sold three more times during World War I. In 1919, the Victory bond drive occurred. Each series of bonds was sold with similar interest rates and tax benefits. Consequently, bond sales contributed nearly 20 percent of the funds that paid for World War I. They also generated a sense of patriotism among Americans. President Wilson's treasury secretary said, "We went direct to the people; that means everybody -- to businessmen, to workmen, farmers, bankers, millionaires, school teachers, laborers. We capitalized on the profound impulse called patriotism."

CS Question #3: What type of nonfinancial effects resulted from the Liberty bond drives?

The United States government also sought to ease inflationary pressures by encouraging individuals to save money rather than spend it. Critics of the bond drives argued that when the Treasury Department borrowed from commercial banks in anticipation of the drives, they expanded the available pool of credit and money, in turn worsening the inflationary pressures on the economy. However, the bond drives succeeded in raising the money the government needed to fund the war effort.

CS Question #4: Why did critics object when the U.S. government borrowed money from commercial banks?

Further Thought: