Learning From Germany
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.
“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
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.