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October 10, 2010
I've been reading a bit about the German hyperinflation of the early 1920s. Here
are some resources on the subject:
Jens Parssons The Dying of Money. Used to be available in online .pdf
format.
E. W. Kemmerer Exchange, Prices and Production in Hyper-Inflation: Germany, 1920-1923. Also used to be available in .pdf format.
Adam Fergusson When Money Dies. Another book once available in .pdf
format. Now you can get it from Amazon.com for $10 including shipping.
The histories had quite a few suprising elements in them. I thought I would
try to summarize the most important takeaways.
Several specific historical factors were part of the process. Germany of 1914-1950 was a country undergoing unbelievable political turmoil. Of course,
the country lost in WWI (effectively), which is never fun. This led to the
collapse of the monarchy, and the creation (by way of a brief military
dictatorship) of the Weimar Republic. The Republic's legitimacy was always
marginal, because practically its first act was to agree to the crushing
Treaty of Versailles and its unpayable war reparations. As a result of not
paying the unpayable reparations, Gemany's industrial Ruhr region was invaded
and occupied by the French military. Throughout the 1920s there were endless
political agitations -- a communist revolution akin to Russia's in 1917 was a constant worry -- which led eventually to the disintegration of the Weimar Republic in 1933, and the start of Nazi totalitarianism.
The policy of inflation began as a government funding measure. Paper
money was printed to finance WWI. By the end of the war, the mark's value had
fallen to about half of its prewar value -- not all that big a decline
really, as the British pound had also fallen by half. However, with the burdens
of reparations -- and having established the habit of financing the deficit
by printing money -- the government found that printing more money seemed the
easiest option.
As inflation continued, tax revenues plummeted while debt became
impossible to issue. Of course, nobody wants to buy the debt of an
inflator, although in fact the German government was surprisingly successful
in their efforts to do so. A sucker born every minute, apparently. As the
government lost legitimacy, tax revenues fell essentially to zero. They could
be easily avoided simply by delaying payment for a few months, although it
seems that after a while, nobody bothered to pay and nobody in the government
bothered to do anything about it.
The middle class failed totally to respond to the inflationary environment
with rational financial actions. The middle class was accustomed to
investing in government bonds, and stayed with their bond investments until
they were finally obliterated. Only a very small subset of individuals --
mostly Jews by the sound of it, as one would expect given Jews' better
understanding of finance and speculation -- moved their assets into
inflation-proof vehicles such as gold or foreign currencies linked to gold. For
the most part, the middle class was completely bewildered by the whole
episode, never able to understand rationally what was happening to them. Their
assets were stripped as they were sold to pay for food. Grand pianos,
paintings, automobiles, high-quality furniture, expensive furs, jewelry,
silverware and the like were sold for a few pounds of potatoes. The middle
class seems to have been able to hold onto their houses, but beyond that they
were scraped down to the literal shirts on their backs.
In the German case, the inflation was accompanied by "easy
credit" provided by the central bank. Often, as in Latin America in
the 1980s, inflation leads to a breakdown of credit. Nobody wants to make any
loans to anybody in a currency that is disintegrating. Interest rates are
prohibitive, maturities are very short, and volumes are tiny. However, in the
German case apparently the central bank made credit available to banks at
very low interest rates (about 30% annually). Some people figured out that
they could buy real assets on credit and pay off the loan in depreciated
marks. One landowner bought a farm on credit, and paid the loan off a few
months later with half the potato crop. Larger industrialists assembled huge
conglomerates in vast LBOs, as their debt was inflated away again and again. More
conservative companies purchased capital equipment and expanded capacity
using loans at a wildly negative interest rate. Banks had so much business
they were forced to build new offices. All of this helped to keep
unemployment low until the final implosion.
Politicians, industrialists and speculators were all adamantly in favor of
the inflationary process. The inflation was apparently keeping
unemployment low, and everyone feared (quite rightly) that stopping the
inflation would produce an explosion of unemployment. From the politicians'
standpoint, stopping the printing presses would result in the combination of
mass unemployment plus the inability to pay government workers, which could
easily lead to a communist (or other group's) overthrow of the young, weak,
and not-very-well-liked Weimar government. After several years of inflation
beginning in 1914, the most successful industrialists were those who
benefited from inflation, either through debt-financed asset buyouts or by
exporting goods at super-competitive prices due to the plummeting exchange
rate (in other words very low real wages). Revenue from export sales were
often kept overseas in foreign currencies, whose buying power soared as the
mark collapsed. Thus, the wealthiest and most influential industrialists also
favored the continuation of the inflation.
Those that benefited from the inflation were soon spending their winnings in
the most ostentatious ways, benefiting from the super-low real prices
resulting from the inflation. Nightclubs and other amusements proliferated,
while the middle class struggled for its next meal.
"Finding himself with a
single dollar bill in early 1923, vod der Osten gold hold of six friends and
went to Berlin one evening determined to blow the lot; but early next
morning, long after dinner, and many nightclubs later, they still had change
in their pockets."
"Not enough money" was a constant problem. It may seem
strange, but once things got going, everyone struggled with a constant shortage
of money. How could that be, when the printing presses ran day and night,
issuing ever-higher denominations of bills? Before too long, people
understood that money was falling in value, so they endeavored to get rid of
paper bills as soon as possible. People would be paid every week --
eventually every day -- and would dump their paper bills for real goods
immediately. After each week's payday, they would buy all the supplies they
needed for the next week. However, this also meant that they never had any
money! It was strictly hand-to-mouth. The same held true at employers. They
would hold money only for a few hours, to pay the workers at the end of the
week. With no way to store money values, everyone needed their money now.
If employers did not have their paper bills when the workers expected them on
payday, the workers could go on strike (there were many strikes during the
time), with further disastrous consequences. Thus, employers needed the money
now, and banks had to deliver it to them. The banks got it from the
Reichsbank. From the government's standpoint, they also had to make payroll
for government employees, not to mention the various welfare programs which
were ballooning in size. The government's source of funding was the printing
press, so they also needed the money now -- not one day later! At the
same time, remember that everyone was getting much poorer in real terms,
which means that they didn't have enough money (whatever the denomination
might be) to buy what they needed.
Politicians and the Reichsbank denied vehemently that the inflation and
loss of currency value was caused by the printing press. It appears that
the politicians and the central bank governors completely internalized the
justifications for their actions. By way of what appears to be an astonishing
self-delusion (as opposed to lying knowingly to the public), they were able
to rationalize away any causality between their money-printing activies and
the inflationary conditions. Foreign observers, such as members of the
British embassy, were bewildered by this. It continued year after year, until
the very end. Government and othe mainstream economists mostly parroted the
government's line, claiming that the money printing and inflation had no
causal connection.
The inflation ended when no more advantage could be gained by printing
money. If the government could print up pieces of paper (their only
option without tax revenue or the ability to borrow), and give them to
government employees (including the military) in trade for labor, and the
government employees could then trade those pieces of paper for food, the
process continued. The end of the process came when farmers refused to take
paper in any form in trade for their foodstuffs. After the harvest of 1923,
food remained piled in farmers' warehouses while people in cities faced
immediate starvation. At this point -- and no sooner! -- the political
consensus was made to find a new solution. Happily, this took the form of a
new, gold-linked currency, which farmers accepted in trade for their food. It
could have been some other sort of solution, such as forcing farmers to sell
their food at government-mandated prices or even just having the military
confiscate it. The result in both situations would be that farmers would not
grow food the next year, and everyone would starve. This is approximately
what happened in Zimbabwe.
The government made little effort to reduce its expenditures or headcount. For
the most part, despite the lack of revenue besides the printing press, the
government did not try to reduce its expenditure or headcount in any
meaningful way, or to raise prices for the state-run railroad or postal
services. If anything, government obligations increased due to welfare
spending and cronyism. It was all about maintaining the status quo until the
very end. When the new gold-linked mark was introduced, and government
printing-press finance became impossible, at that point it appears that quite
a bit of government spending reforms took place although even then not as
many as one might think. It appears that the government had rather high taxes
at the time, as they were intensely focused on acquiring adequate revenues. A
tax reform would have helped tremendously.
The process ended also with a new government, which used a wartime Enabling
Act to effective declare itself a dictatorship. The central bank governor was
replaced by a new one, who was promised that he could hold the position for
life. After the crisis passed, the Republic's normal democratic processes
were reinstated, but Hitler eventually used the same Enabling Act to declare
himself dictator.
Germany, for the most part, did not experiment with price controls. The
combination of price controls and inflation can be phenomenally destructive. People
simply stop producing altogether, as they do not benefit from selling their
goods at artificially low prices. Starvation results. This was generally not
the case in Germany, so people kept on working and offering goods and
services, with constant price increases. However, there was one important
exception: rent. Landlords were obliterated as government-mandated rent caps
resulted in the real value of their rental income shrinking to nothing. Fortunately,
their liabilities (mortgages) also shrank, but for the most part landlords
were crushed. As a result, property fell to very low prices, and foreign
university students were known to assemble large property holdings out of
their student allowances.
Inflation affected different members of society in wildly different ways.
Most working-class people did relatively well for most of the inflation, as
they were able to receive constant increases in wages. Their labor was needed
either for immediate domestic needs (coal) or for goods sold for export. Pensioners,
many government employees, and people employed in industries that did not
have an immediate survival value (universities, lawyers, many government
employees) saw their real incomes fall to tiny levels, far below that of
laborers. Farmers generally did quite well, as they had the ultimate
necessary resource, and were able to pay off their debts.
At the end, people's focus was reduced to the most basic necessities. It
eventually became all about obtaining food for one more day.
At the end of the hyperinflation, with a new gold-linked currency, lending
money was hugely profitable. After the hyperinflation, nobody had any
money. Their assets had been inflated away, or sold to pay for food. The need
for capital -- for the most basic things, such as delivering a shipment of
goods or paying for fuel -- was intense. Interest rates began around 100% --
in gold-linked marks -- and continued around 30% for some time. Bankers made
astonishing profits.
Parallels to today
The German case differs from that of today in several important details. Already
by the end of the war, inflation and government printing press finance had
been well established. The backdrop of political turmoil and foreign
occupation seems remote today.
However, there is a certain underlying pattern here, which is that the
process was driven by
a) Government financing needs to
maintain the status quo
b) A desire to maintain low unemployment (with low real effective
interest rates) in an effort to avoid public unrest
c) Encouragement by members of industry and the speculative community
who perceived a benefit from the inflationary policy
d) Once started, an inability to change course without immediate
consequences perceived as unacceptable
e) Extreme self-delusion by all leadership (politicians,
industrialists, government economists, central bank) about what was going on
f) The process continued until it physically could not go on any
longer. At that point, when a new political consensus was found, the process
ended.
g) This new political consenses involved a new government and new
central bank governor, both initially with dictatorial powers.
I will leave it to the reader to assign these generalities to today's
specifics.
Nathan Lewis
Nathan Lewis was
formerly the chief international economist of a leading economic forecasting
firm. He now works in asset management. Lewis has written for the Financial
Times, the Wall Street Journal Asia, the Japan Times, Pravda, and other
publications. He has appeared on financial television in the United States, Japan, and the Middle East. About the Book: Gold: The Once and Future Money (Wiley,
2007, ISBN: 978-0-470-04766-8, $27.95) is available at bookstores nationwide,
from all major online booksellers, and direct from the publisher at
www.wileyfinance.com or 800-225-5945. In Canada, call 800-567-4797.
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