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In 1903, a lawyer in Germany took out an insurance policy and made
payments on it faithfully. When the policy came due in 20 years he cashed it
in and bought a single loaf of bread with the proceeds. [1] He was fortunate.
If he had waited a few days longer, the money he received would have bought
no more than a few crumbs.
Germany had been on the usual fractional reserve gold standard prior
to World War I, with the Reichsbank, its central
bank, expanding the money supply at a “mild” 1-2 percent
inflation rate. When war broke out in 1914, government followed the standard
policy of deficit spending rather than attempting to raise taxes. The Reichsbank’s role was to monetize the government
debt – that is, pay for new treasury obligations by printing more
money.
At the war’s end the number of German marks in circulation had
quadrupled and prices had gone up 140 percent. [2] But the mark was no worse
off than the currencies of other belligerents. It was weaker than the American
dollar but stronger than the French franc, and about the same as the British
pound.
Yet five years later, by December, 1923, Germans were paying trillions
of marks for ordinary goods, an almost inconceivable situation in a country
with a long tradition of education and scholarship, where Americans had once
gone to study for advanced degrees. What happened?
In addition to carrying the economic burdens of the Armistice, the
socialist German government had pushed ahead with state funding of health,
education, and welfare. It also had to deal with astronomical deficits from
its nationalized industries and demobilization expenses from the war. From
1914 to 1923, its tax revenues paid for only 15 percent of its expenses; by
October, 1923 tax receipts covered only 0.8 percent of government
expenditures.
Government’s choices throughout were either to cut spending,
borrow from the public, raise taxes, or print more money. It pursued the
latter policy, while vehemently denying it was inflating the money supply. To
the government and its supporters, its paper inflation was a consequence, not
a cause. The real culprit in Germany’s monetary
meltdown were the impossible reparation payments and other burdens
imposed by the Treaty of Versailles. Eventually, currency speculators shared
the blame, but the official press never placed responsibility for the inflation
on the institution actually printing the money.
In a fitting twist of justice, the government’s inflationary policies , in destroying taxable wealth, reduced its
revenue. With the mark collapsing, mortgages, bonds, annuities, pensions and
the like were virtually worthless, and tax authorities had almost nothing to
tax. Savers, especially rich ones, had moved their savings to foreign bank
accounts and foreign currencies in a massive “flight of capital”
to escape the plunder. With inflation increasing hourly, overall tax revenue
fell simply due to the time lapse between taxable transactions and tax
payments. Meanwhile, government expenditures accelerated, pushing deficits
higher. Government printed ever greater quantities of money to meet its liabilities,
which created even higher deficits . Like a man
caught in quicksand, each frantic struggle only moved it closer to the end.
As the hyperinflation accelerated people spent money as fast as they
got it, on the most durable goods they could afford. The “flight of
capital” was augmented and replaced by the “flight from
currency.” Factory workers were paid twice daily in large bundles of
cash, which their spouses or relatives took and rushed off to spend. People
began by buying diamonds, gold, pianos, antique furniture, land
and later bought just about anything to get rid of the currency. They
gradually switched from money transactions to barter. Desperate people began
to steal what they couldn’t obtain in trade. Gasoline was siphoned from
cars. Prostitutes of both sexes walked the streets of Berlin. But some of the
young people found the atmosphere exhilarating. Their parents had taught them
to work hard and save, but clearly this was a time to spend and pay close
attention to politics.
The Yugoslavia Meltdown
The German hyperinflation was one of many runaway inflations of the
last century. Hungary, China, Bolivia, Argentina, Peru, Brazil, Russia,
Austria, Poland, Greece, and the Ukraine, among others, all experienced
hyperinflations in varying degrees. But the worst case of monetary
destruction happened in Yugoslavia from 1993-1994. [3]
The Communist Party running the country had been financing government
projects with printing press money, a tradition it inherited from the Tito
regime but which it carried to a far greater degree. The government ran a
network of stores that were supposed to sell goods below market prices, but
the stores rarely had anything to sell. The government’s gasoline
stations eventually closed, leaving people dealing with roadside vendors who
sold gas at $8 a gallon from plastic cans sitting on the hoods of their cars.
Car owners turned to public transportation but the Belgrade transit authority
only had the funds to run 500 of its 1200 buses. The buses were so overcrowded
the ticket collectors couldn’t get aboard to collect fares.
The entire infrastructure was in shambles. Streets were full of
potholes, elevators stopped working, construction
projects shut down. Unemployment rose to over 30 percent. The government
tried to halt rising prices with price controls, but food producers refused
to sell their products to the government at its artificially low prices.
The government modified its edict by requiring merchants to file
paperwork every time they wanted to raise prices. But inflation got worse.
Merchants increased their prices in bigger increments so they wouldn’t
have to file forms again so soon. In October, 1993, in an effort to halt
soaring prices, the government issued a new currency unit, the dinar, worth
one million of the old dinars. By early 1995 prices
had increased by five
quadrillion (5,000,000,000,000,000) percent.
As in other super-inflated economies, people adopted new methods of
survival. Thieves robbed hospitals and clinics of needed medicines then sold
them in front of the places they robbed. People postponed paying their bills
as long as possible so they could pay them in near-worthless currency.
Postmen were responsible for collecting telephone bills but one postman found
it cheaper to pay the bills of 780 customers himself rather than try to
collect payment.
Fractional Reserve Banking
Hidden in all this gruesome detail is a quiet concept mentioned at the
beginning, fractional reserve banking. Fractional reserve banking is the
practice of creating money out of thin air, by expanding credit beyond what a
bank has in cash holdings. It is the modern method of inflation.
It has its roots in the West in mid-17th century England,
where merchants began storing their gold with private goldsmiths, who would
give them receipts in exchange. The receipts began
to function as money substitutes, being used in daily transactions as if they
were gold. People accepted the receipts because they had unfailing trust that
the goldsmiths could redeem them on demand for the gold they represented.
Because of the convenience paper offered, people got into the habit of
not redeeming the receipts. The goldsmiths noticed this. They always had gold
on deposit that no one was claiming. Eventually they decided to lend out fake
receipts for which no gold had been deposited. As long as they didn’t
get too grabby and issue too many counterfeit receipts, they could usually
meet the occasional demands for redemption.
The fake receipts circulated side-by-side with legitimate deposit
receipts and gold coins. Not only was the issue of counterfeit receipts
fraudulent, it also inflated the money supply.
Yet there were almost no laws to incriminate the goldsmiths –
and the deposit banks that followed – for the practice of printing fake
deposit receipts. The first test cases didn’t come until the early 19th
century in England, which ruled in favor of the banks. Though one of the
counsel argued that “a banker is rather a bailee
of his customer’s funds than his debtor,” the presiding judge
(“Master of the Rolls”), Sir William Grant, ruled that no, that
wasn’t true; money deposited with a banker becomes “immediately
part of his general assets; and he is merely a debtor for the amount.” [4]
In 1848, in Foley v. Hill and Others, the English judge Lord Cottenham went further, saying that “the money
placed in the custody of a banker is, to all intents and purposes, the money
of the banker, to do with it as he pleases . . . he is not bound to keep it
or deal with it as the property of his principal.” Thus, if banks are
unable to meet their obligation to redeem on demand, they become merely a
“legitimate insolvent instead of an embezzler,” as Murray Rothbard observes. [5]
American banking law has followed Foley faithfully in most key
respects. Rothbard concludes: “To Foley
and the previous decisions must be ascribed the major share of the blame for
our fraudulent system of fractional reserve banking and for the
disastrous inflations of the past two centuries.” [6]
Banks, of course, can pyramid fake receipts or credit on top of any
kind of money – whether it’s gold, government fiat paper, or
something more exotic. But their practice is perpetually shaky because they
always have more liabilities than assets, more notes or deposits outstanding
than they can redeem in cash. They are subject not only to depositor bank
runs, but to daily demands for redemption from other banks.
The free market is very unforgiving of fractional reserve banking.
Central Banking Institutionalizes the Fraud
The ability to create money out of thin air is very heady – and
enticing, if you’re the government in need of revenue. With banks
periodically facing insolvency from their inflationary practices, they were
in need of government-backed assistance. It is not surprising, then, that
banks and government worked out a deal. Government gave banks the laws they
needed in exchange for which banks would buy government debt – with
money created from nothing.
The institution that made everything tidy and discreet for both
parties was the central bank, which in the U.S. is called the Federal Reserve
System.
A major function of the Fed is to monetize government deficits, thus
avoiding the risky business of raising taxes or reducing spending. The
Federal Reserve Act, passed by a short-handed Congress on December 23, 1913,
endowed the Fed with a deeply inflationary structure so it could expand the
money supply at a controlled, even pace at whatever level it wished.
Because of the Fed, the U.S. had the funds to send our boys into the
slaughterhouse known as World War I. A little later it sponsored the boom
that led to the Crash. Since it began operations in 1914, it has ripped away
95 percent of the value of the dollar.
Most people view the Fed as our tireless public servant promoting a
stable economy and fighting the curse of inflation. The truth is the exact
opposite. The Fed is solely responsible for inflation and has caused economic
havoc since its inception. It has created what Rothbard
describes as a “chronic, permanent inflation problem, a problem which,
if unchecked, is bound to accelerate eventually into the fearful destruction
of the currency known as runaway inflation.” [7]
References
1 The German Hyperinflation, 1923, excerpt from Paper Money by
"Adam Smith," (George J.W. Goodman), pp. 57-62,
2 Hyperinflation in Germany,
Hans Sennholz
3 Episodes of Hyperinflation, Thayer Watkins
4 Rothbard, Murray N., The Mystery of Banking, p. 61
5 Ibid., p. 61
6 Ibid., p. 62
7 Ibid., p. 108
George F. Smith
Read his book : The
Flight of the Barbarous Relic
Visit his website
Read his blog
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