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On 15 November 1923 decisive steps
were taken to end the nightmare of hyperinflation in the Weimar Republic: The
Reichsbank, the German central bank, stopped
monetizing government debt, and a new means of exchange, the Rentenmark, was issued next to the Papermark
(in German: Papiermark). These measures succeeded
in halting hyperinflation, but the purchasing power of the Papermark was completely ruined. To understand how and
why this could happen, one has to take a look at the time shortly before the
outbreak of World War I.
Since 1871, the mark had been the
official money in the Deutsches Reich. With the
outbreak of World War I, the gold redeemability of
the Reichsmark was suspended on 4 August 1914. The
gold-backed Reichsmark (or “Goldmark,” as it was referred to from 1914) became
the unbacked Papermark. Initially, the Reich
financed its war outlays in large part through issuing debt. Total public
debt rose from 5.2bn Papermark in 1914 to 105.3bn
in 1918.[1]
In 1914, the quantity of Papermark was 5.9 billion, in 1918 it stood at 32.9 billion. From August
1914 to November 1918, wholesale prices in the Reich had risen 115 percent,
and the purchasing power of the Papermark had
fallen by more than half. In the same period, the exchange rate of the Papermark depreciated 84 percent against the US dollar.
The new Weimar Republic faced
tremendous economic and political challenges. In 1920, industrial production
was 61 percent of the level seen in 1913, and in 1923 it had fallen further
to 54 percent. The land losses following the Versailles Treaty had weakened
the Reich’s productive capacity substantially: the Reich lost around 13
percent of its former land mass, and around 10 percent of the German
population was now living outside its borders. In addition, Germany had to
make reparation payments. Most important, however, the new and fledgling
democratic governments wanted to cater as best as possible to the wishes of their
voters. As tax revenues were insufficient to finance these outlays, the Reichsbank started running the printing press.
From April 1920 to March 1921, the
ratio of tax revenues to spending amounted to just 37 percent. Thereafter,
the situation improved somewhat and in June 1922, taxes relative to total
spending even reached 75 percent. Then things turned ugly. Toward the end of
1922, Germany was accused of having failed to deliver its reparation payments
on time. To back their claim, French and Belgian troops invaded and occupied
the Ruhrgebiet, the Reich’s industrial
heartland, at the beginning of January 1923. The German government under
chancellor Wilhelm Kuno called upon Ruhrgebiet workers to resist any orders from the
invaders, promising the Reich would keep paying their wages. The Reichsbank began printing up new money by monetizing debt
to keep the government liquid for making up tax-shortfalls and paying wages,
social transfers, and subsidies.
From May 1923 on, the quantity of Papermark started spinning out of control. It rose from
8.610 billion in May to 17.340 billion in April, and further to 669.703
billion in August, reaching 400 quintillion (that is 400 x
1018) in November 1923.[2]
Wholesale prices skyrocketed to astronomical levels, rising by 1.813
percent from the end of 1919 to November 1923. At the end of World War I in
1918 you could have bought 500 billion eggs for the same money you would have
to spend five years later for just one egg. Through November 1923, the price
of the US dollar in terms of Papermark had risen by
8.912 percent. The Papermark had
actually sunken to scrap value.
With the collapse of the currency,
unemployment was on the rise. Since the end of the war, unemployment had
remained fairly low — given that the Weimar governments had kept the
economy going by vigorous deficit spending and money printing. At the end of
1919, the unemployment rate stood at 2.9 percent, in 1920 at 4.1 percent,
1921 at 1.6 percent and 1922 at 2.8 percent. With the dying of the Papermark, though, the unemployment rate reached 19.1
percent in October, 23.4 percent in November, and 28.2 percent in December.
Hyperinflation had impoverished the great majority of the German population,
especially the middle class. People suffered from food shortages and cold.
Political extremism was on the rise.
The central problem for sorting out
the monetary mess was the Reichsbank itself. The
term of its president, Rudolf E. A. Havenstein, was for life, and he was literally unstoppable: under Havenstein, the Reichsbank kept
issuing ever greater amounts of Papiermark for
keeping the Reich financially afloat. Then, on 15 November 1923, the Reichsbank was made to stop monetizing government debt
and issuing new money. At the same time, it was decided to make one trillion Papermark (a number with twelve zeros: 1,000,000,000,000)
equal to one Rentenmark. On 20 November 1923, Havenstein died, all of a sudden, through a heart attack.
That same day, Hjalmar Schacht, who would become Reichsbank president in December, took action and
stabilized the Papermark against the US dollar: the
Reichsbank, and through foreign exchange market
interventions, made 4.2 trillion Papermark equal to
one US Dollar. And as one trillion Papermark was
equal to one Rentenmark, the exchange rate was 4.2 Rentenmark for one US dollar. This was exactly the
exchange rate that had prevailed between the Reichsmark
and the US dollar before World War I. The “miracle of the Rentenmark” marked the end of hyperinflation.[3]
How could such a monetary disaster
happen in a civilized and advanced society, leading to the total destruction
of the currency? Many explanations have been put forward. It has been argued
that, for instance, that reparation payments,
chronic balance of payment deficits, and even the depreciation of the Papermark in the foreign exchange markets had actually
caused the demise of the German currency. However, these explanations are not
convincing, as the German economist Hans F. Sennholz
explains: “[E]very mark was printed by Germans and issued by a central
bank that was governed by Germans under a government that was purely German.
It was German political parties, such as the Socialists, the Catholic Centre
Party, and the Democrats, forming various coalition governments that were
solely responsible for the policies they conducted. Of course, admission of
responsibility for any calamity cannot be expected from any political
party.”[4]
Indeed, the German hyperinflation was manmade, it
was the result of a deliberate political decision to increase the quantity of
money de facto without any limit.
What are the lessons to be learned
from the German hyperinflation? The first lesson is that even a
politically independent central bank does not provide a reliable protection
against the destruction of (paper) money. The Reichsbank
had been made politically independent as early as 1922; actually on behalf of
the allied forces, as a service rendered in return for a temporary deferment
of reparation payments. Still, the Reichsbank
council decided for hyperinflating the currency.
Seeing that the Reich had to increasingly rely on Reichsbank
credit to stay afloat, the council of the Reichsbank
decided to provide unlimited amounts of money in such an “existential
political crisis.” Of course, the credit appetite of the Weimar
politicians turned out to be unlimited.
The second lesson is that fiat
paper money won’t work. Hjalmar Schacht, in
his 1953 biography, noted: “The introduction of the banknote of state paper
money was only possible as the state or the central bank promised to redeem
the paper money note at any one time in gold. Ensuring the possibility for
redeeming in gold at any one time must be the endeavor of all issuers of
paper money.”[5]
Schacht’s words harbor a central economic insight: Unbacked paper money
is political money and as such it is a disruptive element in a system of free
markets. The representatives of the Austrian School of economics pointed this
out a long time ago.
Paper money, produced “ex
nihilo” and injected into the economy through bank credit, is not only
chronically inflationary, it also causes malinvestment,
“boom-and-bust” cycles, and brings about a situation of
over-indebtedness. Once governments and banks in particular start faltering
under their debt load and, as a result, the economy is in danger of
contracting, the printing up of additional money appears all too easily to be
a policy of choosing the lesser evil to escape the problems that have been
caused by credit-produced paper money in the first place. Looking at the
world today — in which many economies have been using credit-produced
paper monies for decades and where debt loads are overwhelmingly high, the
current challenges are in a sense quite similar to those prevailing in the
Weimar Republic more than 90 years ago. Now as then, a reform of the monetary
order is badly needed; and the sooner the challenge of monetary reform is
taken on, the smaller will be the costs of adjustment.
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