"The ones who fared best were the small
minority who had the foresight to exchange marks into foreign money or gold
very early, before new laws made this difficult and before the mark lost too
Foreword: The many parallels between 1924 Germany and present-day
United States are cause for concern. Though the U.S. has not yet reached the
depths to which Germany descended in that era, few can look at the constant
depreciation of the dollar since the early 1970's and fail to be alarmed. It
seems contemporary America differs from 1924 Germany only in the duration
between cause and effect. While the German experience was compressed over a
few short years, the effects of the American inflation have been more drawn
In my view, this has occurred for two good reasons:
First, American central bankers have learned enough from the German
experience to delay and extend the consequences of printing too much fiat
Second, Germany was a small state isolated from the rest of the world,
a pariah nation of sorts following World War I. As a result, it had a
difficult time finding a market for its government bonds. German deficits had
to be financed internally -- a difficulty which greatly accelerated the
printing of fiat currency.
Up until recently, the United States enjoyed a strong world-wide
demand for its government paper. Thus, the negative affects
of government deficits have been subdued. Now, with consistently low interest
rates, and a growing fear globally that U.S. deficits may have run out of
control, foreign support for the U.S. bond market has faltered. In the
absence of international buyers, the Fed could be forced to monetize an ever larger portions of the debt -- the modern
equivalent of printing money.
Whether or not the situation will slip out of control is a matter for
debate. The trend, however, is alarming. The largest annual contribution to
the outstanding public debt during the Nixon years was $30.9 billion; Ford -
$87.2 billion; Carter - $81.2 billion; Reagan - $302 billion; Bush(Sr.) - $432 billion; Clinton - $347 billion; GW Bush
- $596 billion.
As this report points out, the correlation between deficits and
inflation is sacrosanct -- deficits lead to inflation and uncontrolled
deficits lead to uncontrolled inflation. Whether or not there will be a
Nightmare American Inflation remains to be seen. Let it be said though that
the trend is not favorable.
The survivors of the German debacle did so by purchasing gold early in the process. As a citizen and an investor,
the best you can do is prepare, and then hope that
it doesn't happen here. This report of Germany's hyperinflation, originally
published in 1970 by Scientific Market Analysis, could play an important part
in your preparation process. There is little
doubt it will affect your thinking. - Michael J. Kosares
If history teaches anything, it is that government cannot be trusted
to manage money. When currency is not redeemable in gold, its value depends
entirely on the judgment and the conscience of the politicians. (That is the
situation in this country today.)
Especially in an economic crisis or a war, the pressure to inflate
becomes overwhelming. Any alternative may seem politically disastrous.
Whether it be the Roman emperors repeatedly debasing their coinage, the
French revolutionary government printing a flood of assignats,
John Law flooding France with debased money, or the Continental Congress
issuing money until it was literally "not worth a Continental," the
story is similar. A government in financial straits finds its easiest
recourse is to issue more and more money until the money loses its value. The
entire process is accompanied by a barrage of explanations, propaganda and
new regulations which hide the true situation from the eyes of most people
until they have lost all their savings. In World War I, Germany -- like other
governments -- borrowed heavily to pay its war costs. This led to inflation,
but not much more than in the U.S. during the same period. After the war
there was a period of stability, but then the inflation resumed. By 1923, the
wildest inflation in history was raging. Often prices doubled in a few hours.
A wild stampede developed to buy goods and get rid of money. By late 1923 it
took 200 billion marks to buy a loaf of bread.
Millions of the hard-working, thrifty German people found that their life's savings would not buy a postage stamp.
They were penniless. How could this happen in a highly civilized nation run at
the time by intelligent, democratically chosen leaders? What happened to
business, to wages and employment? How did some people manage to save their
capital while a few speculators made fortunes?
The Years 1914-1921
When the war broke out on July 31, 1914, the Reichsbank
(German Central Bank) suspended redeemability of
its notes in gold. After that there was no legal limit as to how many notes
it could print. The government did not want to upset people with heavy taxes.
Instead it borrowed huge amounts of money which were to be paid by the enemy
after Germany had won the war, Much of the borrowing
was discounted and monetized by the Reichsbank. As
explained later, this amounted to issuing straight printing press money.
By the end of the war, the amount of money in circulation had
increased four-fold. In view of this, the extent of inflation was less than
one might have expected. The consumer price index had risen 140% by December
1918. This was equal to the inflation during the same time in England, a
little more than in the United States, but less than in France. Yet the
floating debt of the Reichsbank had increased from
3 billion to 55 billion marks!
Why was inflation kept within bounds? For the same reason that it got
off to a slow start in the Unites States during World War II. Necessities
were rationed and luxury goods were not easily available. Millions of men
were at the front and not in the market for goods. Civilians worked hard and
had little leisure for spending. People saved money against peace time, and
in some cases to evade taxes. But the fuel for inflation was accumulating in
the form of vast hoards of money.
The harsh reparation payments imposed on Germany led the mark to
depreciate against foreign currencies. Also, the new democratic socialist
leaders had promised the people all types of bounties--increased wages,
reduced hours, an expanded educational system, and new social benefits. But
all this meant a vastly increased demand on a limited production capacity.
For these reasons inflation resumed after the peace until by February
1920 the price level was five times as high as it had been at the armistice.
Yet during this same time the amount of currency in circulation had only
doubled. Prices were in fact rising much faster than the rate at which money
was being printed. Therefore, reasoned the officials, the price inflation
could hardly be blamed on the government. Actually, as we shall see, the ebb
and flow of confidence can play a big role in the short-term trend of prices.
Confidence in the mark had weakened. At the same time, and as a consequence,
billions of hoarded marks came out of hiding and entered the marketplace. The accumulated fuel was burning.
By February 1920 this inflationary episode had run its course. For the
next fifteen months the price index held stable. The mark actually gained in
value against foreign currencies, so that prices of imported goods fell by
some 50%. Here was a golden opportunity to establish a stable currency.
However, during these fifteen months the government kept issuing new money.
The currency in circulation increased by 50% and the floating debt of the Reichsbank by 100%, providing fuel for a new outbreak.
In May 1921, price inflation started again and by July 1922 prices had
risen 700%. The Reichsbank continued printing new
currency, although more slowly than the rate at which prices were rising. In
fact, all through this period the issue of currency proceeded at a fairly
smooth steady rate, while the price index moved up in great surges,
interspersed by periods of stability.
After July 1922 the phase of hyperinflation began. All confidence in
money vanished and the price index rose faster and faster for fifteen months,
outpacing the printing presses which could not run out money as fast as it
The Years 1922-1923 -- Hyperinflation!
From Mid-1922 to November 1923 hyperinflation raged. The table above
tells the story. Seemingly Reichsbank officials
believed that the basic trouble was the depreciation of the mark in terms of
foreign currencies. In late 1922 they tried to support the mark by purchasing
it in the foreign exchange markets. However, since they continued printing
new currency at a feverish rate, the attempt failed. They merely succeeded in
buying worthless marks in return for valuable gold and foreign exchange.
All hope of checking the collapse of the mark vanished in January 1923
when the French--alleging treaty violations--occupied Germany's key
industrial district, the Ruhr. Germany subsidized the occupied companies and
financed an expensive program of "passive resistance." New billions
of marks were printing to finance these heavy new costs. By late 1923, 300
paper mills were working top speed and 150 printing companies had 2000
presses going day and night turning out currency.
Under the forced draft of inflation, business was now operating at
feverish speed and unemployment had disappeared. However, the real wages of
workers dropped badly. Unions obtained frequent increases, but these could
not keep pace. Workers --domestics, farm workers and various white collar
groups-- fared especially badly. They had no unions to fight for pay boosts
for them, and often they were reduced to hunger. Many people showed visible
signs of malnutrition. Skilled workers, writers, artisans and professionals
found their wages lagging until they reached the unskilled worker level,
which often meant the bare minimum needed to support life.
Businessmen began to abandon their legitimate occupations to speculate
in stocks and in goods. Thousands of small businessmen tried to eke out a
living by speculating in fabrics, shoes, meat, soap, clothing--in
any produce they could obtain. Each fall in the mark brought a rush to the
shops. People bought dozens of hats or sweaters.
By mid-1923 workers were being paid as often as three times a day.
Their wives would meet them, take the money and rush to the shops to exchange
it for goods. However, by this time, more and more often, shops were empty.
Storekeepers could not obtain goods or could not do
business fast enough to protect their cash receipts. Farmers refused to bring
produce into the city in return for worthless paper. Food riots broke out.
Parties of workers marched into the countryside to dig up vegetables and to
loot the farms. Businesses started to close down and unemployment suddenly
soared. The economy was collapsing.
Meanwhile, middle-class people who depended on any sort of fixed
income found themselves destitute. They sold furniture, clothing, jewelry and works of art to buy food. Little shops became
crowded with such merchandise. Hospitals, literary and art societies,
charitable and religious institutions closed down as their funds disappeared.
Then by a mere effort of will, the government stepped in and
stabilized the currency overnight.
Throughout the "miracle of the Rentenmark"
the depreciation halted in its tracks, business revived, the
inflationary spree was ended although, as we shall see, there was a nasty
hangover yet to come.
Millions of middle-class Germans--normally the mainstay of a
republic--were ruined by the inflation. They became
receptive to rabid right wing propaganda and formed a fertile soil for
Hitler. Workers who had suffered through the inflation turned, in many cases,
to the Communists. The biggest beneficiaries of this enormous redistribution
of wealth were feudalistic industrial leaders who distrusted the democracy
and who proved willing to deal with Hitler, thinking that they could control
him. The democratic parties and the labor unions
lost their capital and were weakened. The liberal democratic regime was
What caused the inflation?
Our thesis is simple: The inflation was caused by the government
issuing a flood of new money, causing prices to rise. Then, as the inflation
gained momentum, events seemed to demand the printing of larger and larger
issues of currency. To half the process would have taken political courage,
and this was lacking. As usual, the true facts were hidden behind a barrage
of excuses, explanations and propaganda laying blame on everyone except the true
First, it would be wrong to think that everyone was opposed to
inflation. Many big business leaders accepted it cheerfully. It wiped out
their debts. They knew how to protect themselves and even profit--by
speculating in foreign exchange, by converting money into goods and fixed
plant, by borrowing money from the bank and using it to buy up cheap stocks
and competing companies. Their wage costs, in true value, decreased, swelling
their profits. Yet many workers also thought that they were benefiting, at
least in the earlier stages of the inflation. Their wages were increased, and
it took time before they recognized that, with prices soaring even faster,
they were actually suffering a cut in true income.
A crew of speculators arose who traded in goods and foreign exchange, they had a vested interest in continued
inflations. And the government could not help realizing that the inflation
was wiping out its burden of debt and would ease its financial problems.
Above all, it became an article of faith among the political leaders
and most ordinary citizens that the inflation was really due to the burden of
reparation payments imposed by the peace treaty. This meant, so the argument
ran, that Germany would be stripped of its gold, foreign exchange and wealth;
it would be bankrupt. Hence, the mark fell in value in terms of gold or
dollars. This drop in the foreign exchange value of the mark was said to be
the true reason for the inflation.
The German leaders felt that the collapse of the mark was proving how
impossible it was for Germany to pay the reparations which were demanded.
Stabilization of the mark would have spoiled this "proof."
Especially after France occupied the Ruhr in January 1923,
it was felt that the destruction of the mark was somehow a blow against the
hated occupier--the only patriotic response available to disarmed Germany.
Finally, inflation seemed to bring prosperity. In 1921, when the rest
of the world was in a severe post-war recession, production indices in
Germany rose sharply. Late in 1921 the mark stabilized temporarily, and
business promptly weakened. By early 1922 the mark was sliding again, and
business immediately revived. People were buying
goods as fast as they obtained money; companies rushed to expand plants and
turn money into fixed investment. Germany was actually envied for its
"prosperity" by many foreigners. [Does this sound like
modern-day America, albeit with people spending on stocks in addition to
The mechanism of inflation was simple. The government issued paper
promises to pay, and the Reichsbank issued money on
the security of these promises. When a government spends more than its
income, it must borrow. If it merely borrows money from its citizens by
selling them bonds, there need be no inflation.
Instead of that money being spent or invested by the citizen, it is borrowed
and spent by the government, but the total amount of money is not increased.
When the government needs more money than its people are able or
willing to lend it, it monetizes the debt. That is what happens in this
country when the government runs a big deficit. The Federal Reserve (our
central bank) "buys" as many bonds as necessary to stabilize the
market. It prints money on the security of these bonds. Despite the facade of
the government supposedly "borrowing," the net result is the
creation of printing press money. (Actually these days the money is created
in the form of new bank deposits--checkbook
money--but the net result is exactly the same as if bills were printed.)
This is what happened in Germany. The government issued notes which
were promptly discounted by the Reichsbank, i.e.,
the bank issued money on the "security" of these worthless notes.
To compound the evil, the bank failed to raise its interest rate
sufficiently. Businessmen found it very profitable to borrow money from the
bank and buy up goods, shares and companies. Their debt was wiped out within
weeks by the rapid inflation, and the businessman remained holding the
valuable assets he had bought. The net result was a huge "private
inflation" caused by the rapid expansion of credit. Even foreign
exchange was bought with borrowed money, so that the Reichsbank
actually financed speculation against its own currency. Yet the bank refused
to raise interest rates, arguing that this would only add to the cost of
business and thus would increase inflation!
The tax system virtually broke down. Businessmen found that by merely
delaying tax payments, the depreciation in the mark would virtually eliminate
their true value. But the government, lacking adequate income, felt forced to
resort more and more to creating money. By October 1923, 1% of government
income came from taxes and 99% from the creation of new money.
But the main force which gave inflation its momentum was the steady decrease
in the true value of money in circulation. This has been observed in all past
rapid inflations and it is vital to understand it if inflation is to be coped
with. During the war, as we saw, the price inflation lagged behind the rate
at which money was issued. But now, as people lost confidence, prices began
jumping much faster than the government could generate new money. Thus the
total circulating currency fell drastically when measured in terms of its
true value. One economist stated that, "In proportion to the need, less
money circulates in Germany now than before the war. This statement may cause
surprise but it is correct. The circulation is now 15-20 times that of
pre-war days, whilst prices have risen 40-50 times." In fact, the total
currency when calculated in gold value fell from 7428 million marks in
January 1920 to a mere 168 million by July 1923.
Despite the proliferating billions of trillions of marks, the average
citizen found it harder and harder to get enough money for necessities. Banks,
short of money, could not honor checks. Businessmen
were strapped for money to buy materials and meet payrolls. The government
faced the same problem. It appeared that there was not too much money around,
but rather much too little. The clamor for more
money grew on all sides. It seemed that any halt to the printing presses
would bring business to a standstill and throw millions of workers out on the
street. The government itself would be unable to carry on. Riding a tiger, it
dared not dismount. On October 25, 1923, the Reichsbank
noted that it had that day printed 120,000 trillion marks. Unfortunately, the
day's demand had been for one million trillion. However, it announced that it
was expanding production and the daily issue would soon be 500,000 trillion!
Once people lose confidence in a currency, they try to get rid of it.
As Lord Keynes pointed out, this makes circulation speed up enormously, and
hence prices rise faster than the government can print new money. Marshall,
studying this process, concluded that, "The total value of an '
inconvertible paper currency cannot be increased by increasing its quantity;
any increase in quantity which seems likely to be repeated will lower the
value of each unit more than in proportion to the increase."
Customarily, however, governments blame everyone and
everything except themselves for inflation. When inflation lags behind issue
of money, as it did in the war, they say that this shows that the issue of
money is not dangerously high. Later, when confidence vanishes, and prices
soar ahead of currency issues, that again is taken
to prove that the government is not to blame--it is only reluctantly issuing
money that is desperately needed in view of rising prices.
We will conclude this discussion with a quotation from Dr. Milton Friedman's book, Dollars and Deficits.
Friedman notes that after the Russian revolution, the Bolsheviks introduced a
new currency. They printed huge amounts of it and soon it became almost
worthless. At the same time some of the older Czarist
currency still circulated and maintained its value in terms of goods. It
appreciated enormously in terms of the new money. Why? This money was not
redeemable. Nobody expected the Czarist government
to return. Why did this currency hold up? "Because," says Friedman,
"there was nobody to print any more of it."
Effects of Inflation on Business
As inflation proceeded, people rushed to buy goods and get rid of
their depreciated money. For similar reasons, businessmen hastened to buy
machinery, to build new factories, to buy huge stocks of coal, steel and
other raw materials. Those who had access to credit borrowed heavily for
these purposes, and inflation wiped out their debt. There was a tremendous
conversion of working capital into fixed investments. Business was booming
and unemployment virtually vanished until the last stages of the inflation.
Farmers got rid of currency by heavy purchases of equipment, and later
many were left holding large supplies of useless machinery. Shipbuilding was
expanded beyond all market needs. Marginal mines were opened leading to
serious overproduction later on. But while basic industries prospered, there
was a severe depression in consumer goods industries such as textiles, meat,
beer, sugar and tobacco. Too many workers and persons on fixed incomes had
lost their purchasing power.
There was a tremendous move toward concentration of industry. Large
firms or combinations found it much easier to raise prices, to obtain raw
materials and above all to obtain bank credit. Also, they could issue "notgeld" or emergency money which more and more came
to replace the paper mark as a medium of exchange. Some of these new
industrial combinations were rational and efficient, but many were purely
speculative operations. A new breed of financier arose.
Earlier the great German industrial leaders--men like Krupp, Thyssen and Siemens--had developed basic new ideas in
technology or in organization. But now the rising stars were those of shrewd
speculators and manipulators geared to quick trading and to jumping from deal
to deal and from company to company. The most successful were those who saw
the trend of events early, who borrowed to the hilt and bought up goods,
shares and companies at bargain prices. Conglomerates sprung up forty years
before the heyday of the conglomerate movement in the U.S. Perhaps the
biggest operator of the day, Hugo Stinnes, formed a
giant conglomerate including companies in oil, coal, steel, shipyards,
electrical works, insurance, newspapers and hotels. He died in 1924, just
before his empire fell apart in the cold winds of the stabilization period.
Most of these new mushroom combinations and conglomerates were speculative
bubbles which were only able to survive as long as they benefited from ongoing inflation.
Beneath the surface of prosperity there was enormous waste and
inefficiency. Much of the new capital plant proved inefficient or unneeded.
Middlemen multiplied like locusts, and more and more time and energy went to
speculation and to endless paperwork generated by currency fluctuations, new
tax law regulations and labor disputes. Speculation
caused banks to multiply; there were 100,000 bank
workers in 1913 and 375,000
in 1923. Labor became much
less productive. Workmen were pre-occupied with their own problems of trading,
getting wage boosts, and staying ahead of inflation. With paper wages rising
rapidly and full employment, they were less inclined to work hard. Despite
the surface boom, net production was really much less than before the war.
Bewildering fluctuations in costs prices and wages made it impossible
to allocate resources and production rationally. More and more, the
businessman became a speculator in goods and currencies. However, very few
businesses failed, since their debts were constantly wiped out by inflation.
Bankruptcies had run to 815 per month in 1913; by late 1923 they were 10 per
Finally, however, in the last stages of the inflation, the economy
began to collapse. Retailers could not get goods or else could not sell at a
profit. The money they received was depreciating too fast. Farmers stopped
selling their produce. More and more stores became empty. Now unemployment
began to soar.
Some economists argued that inflation may have helped Germany by
stimulating the building of capital plant and the rationalization of
industry. But much of this investment proved to have no value except in the
dream world of inflation. Most of the inflation combinations fell apart after
stabilization. On the whole, much energy and wealth was wasted in unproductive
channels--speculation, paperwork and unprofitable equipment. The working
capital of industry was largely dissipated, making that much harder the
eventual process of economic rebuilding and rationalization.
Stabilization--The Rentenmark Miracle
In November 1923, a
currency reform was undertaken. A new bank, the Rentenbank,
was created to issue a new currency--the Rentenmark.
This money was exchangeable for bonds supposedly backed up by land and
industrial plant A total of 2.4 billion Rentenmarks
was created, and each Rentenmark was valued at one
trillion old paper marks. From that moment on the depreciation stopped--the Rentenmarks held their value; even the old paper marks
held stable. Inflation ceased.
What was the secret of the "miracle of the Rentenmark"?
After all, the new currency was not redeemable in anything. Its backing by
real property was a fiction, since there was no way by which property could
be foreclosed or distributed. Further, there we have the government
distributing a vast new supply of money--2.4 billion trillion in terms of the
old mark. Ought that not have led to a new wild
To understand this, we must recall that the real value of the money
circulating in late 1923 was small--equal to a mere 168 million pre-war gold
marks. The continued depreciation at this point was due to utter lack of
confidence--to the belief that the printing presses would run indefinitely.
But actually there was a great shortage of and need for money. New money
could be introduced without price inflation if only people had confidence in
it. How was confidence developed?
First, the government announced that the new currency would be "wertbestaendig"--stable in value. In their hunger
for usable money people accepted this, at least until it should be proven
false. Then the property backing seemed to give the currency value. True, the
Assignats of the French Revolution, backed by fixed
property, had depreciated, but still the backing helped.
Second, and certainly most important, the government limited strictly
the amount of Rentenmarks which could be issued and
it halted the issue and discounting of notes and the creation of paper marks.
Finally, after April 1924, the Reichsbank stopped
the expansion of credit to businesses which had been stimulating inflation.
Businessmen were required to repay loans in gold marks, equal to the original
value of the loan. Thereafter, incentive was gone to borrow except for
In August 1924 the reform was completed by introduction of a new Reichsmark, equal in value to the Rentenmark.
The Reichsmark has a 30% gold backing. It was not
redeemable in gold, but the government undertook to support it by buying in
the foreign exchange markets as necessary. Drastic new taxes were imposed,
and with the inflation ended, tax receipts increased impressively. In
1924-1925 the government had a surplus.
After the stabilization, most companies found that they were
critically short of working capital. Their funds had been dissipated or
converted into goods and plant, and cash was very short. They could no longer
rely on a stream of incoming capital at the cost of bond holders and workers.
Taxes were again a serious burden, as were wage agreements that had been made
under the inflation.
In other ways the business climate changed. Now there was a huge
demand for consumer goods, but the capital goods industries which had so overexpanded in the inflation were depressed. Huge stocks
of coal, steel and other materials which had been accumulated were a drug on the market. Agriculture and building,
Many of the speculative and conglomerate companies which had been
formed in the inflation were unable to survive. They failed, or split up into
their original components. In 1923 there had been only 263 bankruptcies; in
1924 there were 6,033. Most of the great inflation speculators were ruined or
faded from the business scene. However, strong, well-organized companies like
Krupp and Thyssen which had resisted overexpansion
and speculation were able to weather the stabilization period and to thrive.
How Investments Fared
At the start it is important to understand how hard it was to obtain
real income during the inflation. Professionals, skilled workers and others
used to enjoying good income found their real salaries disastrously cut.
Those who depended on savings, pensions or investment income for a living
faced a terrible situation.
Interest from bonds or savings deposits soon depreciated to where they
had no real value. Stocks paid meager dividends or
none at all; corporate managements needed the money for working capital, or
used it for capital building and speculation. Owners of rental property fared
no better; the government froze rents, which soon meant that tenants were
occupying premises virtually rent-free. Dipping into capital led to big
losses, since cash, bonds and even stocks quickly shrunk drastically in
value. The urgent need for income had important effects on the true prices of
various types of property and investments.
Cash: Money held in cash lost value rapidly and soon
became completely worthless. Of all investment forms, this was the most
Bank Deposits: In theory, bank deposits became as worthless as
cash. However, after the stabilization the government decreed partial
reimbursement, and sums in the range of 15-30% of the original deposit value
were repaid. Naturally, however, the great majority of depositors withdrew
their funds at some time during the inflation, after much of the value had
been lost, and exchanged them for goods. Few Germans held money in deposits
through the entire period.
Bonds, Mortgages: As usual in an inflation,
bonds and mortgages fell in value even faster than cash. After the
stabilization, some restitution was provided by law. Holders of government
bonds were reimbursed to the extent of 2.5% of the original bond values.
Mortgage holders also received some repayment, while a 1925 law provided for
15-25% reimbursement of corporate bondholders, though the payment was delayed
for some years. Here again, few investors held bonds or mortgages throughout
the entire period; most holders got rid of them for whatever pittance they
would bring during the inflation.
Real Estate: Farmers and holders of urban property seemed to
benefit if their property was mortgaged; the inflation soon wiped out the
mortgage debt. However, they received no income, as noted above, since rents
were frozen. After the stabilization, heavy new taxes and the urgent need for
cash forced most holders to remortgage their
property, often more heavily than originally, so that their gains were
illusory. Still, those who held real estate throughout managed to save the
capital thus invested. However, those who sold during the inflation (often
through desperate need for cash) fared poorly. Because it brought no income, real
estate sold at extremely low real price levels during inflation.
Foreign Exchange: Those who held funds in dollars, pounds or other
stable currencies, or in gold,
saved their capital. The government set up rigid exchange controls as the
inflation proceeded. As usual under such conditions, a black market
flourished. The ones who fared best were the
small minority who had the foresight to exchange marks into foreign money or
gold very early, before new laws made this difficult and before the mark lost
too much value.
Personal Property: Capital was preserved
by those who early changed it into objects of lasting value--rare coins,
stamps, jewelry, works of art, antiques--or into
merchandise such as clothing, fabrics, etc. Of course, most people did not
understand the advantage of accumulating such property until the inflation
was well along. By that time the prices of all goods had risen so much that
they seemed outrageously bad bargains. In the event, however, cash proved an
even worse bargain.
Common Stocks: In an inflation, common
stocks are generally considered a desirable hedge to protect against or even
to profit from the rise in prices. In practice, it is not so simple. In this
country stock prices have been known to fall violently just when inflation was
most evident (1946, 1957, 1966, 1969). Market
fluctuations--the rise of exciting new speculative stocks, waves of fear or
greed--all make it much too easy to buy or to sell at the wrong time or to go
into the wrong stocks.
Getting down to specifics, we can say that those who bought a
well-diversified list of stocks in solid, well-established companies quite
early in the inflation and who held on throughout the period and also through
the stabilization crisis saved much or all of their capital. However, there
were many pitfalls along the wayside for the greedy, the fearful and the
over-clever. Those who did best were investors with a certain unemotional,
stolid character, a basic confidence that strong, well-managed companies
would come through, and an immunity to excitement,
anxiety and speculative temptations.
Many very sharp but brief advances and declines in the market led to
widespread speculation, and well-intentioned investors often wound up as
traders. Naturally most of them did as badly as amateur speculators generally
do. Many decided that speculation was the only sensible approach; when the
entire economy and financial structure was visibly crumbling, who could wait
patiently with confidence in the long-range value of anything?
Could it Happen Here?
Since 1939 the general price levels have gone up some 200% in this
country. Much of this inflation was due to the government generating large
amounts of money to pay for three wars. You can be absolutely certain that if
we are involved in any further wars for big increases in military spending,
there will be new inflationary surges. Modem governments do not dare to
impose the taxes needed to pay for war. They find it much easier politically
to inflate instead.
The most recent wave of inflation, which got underway in 1965, was
triggered by enormous expansion in spending for the Vietnam war. The
government ran deficits as big as $25 billion, and much of this debt was
monetized by a process similar to that by which the Reichsbank
monetized the German government's debt. The main
difference is that the newly generated money shows up mainly as bank deposits
instead of printed currency. Since bank demand deposits are in fact money,
convertible into currency and usable for any type of purchase, the net result
is the same.
At the same time that Vietnam war spending mushroomed, our government
undertook a vast program of expensive social welfare spending. It was argued
that this country could afford guns and butter. The result was an inflation
which already has imposed a 20% capital tax on all savings held as cash,
bonds, insurance and on pension payments and other fixed income.
Now, in March 1970, the government and the Federal Reserve have been
fighting for a year to check the inflation. Thus far, they have succeeded in
slowing down the economy, but prices have continued rising as fast as ever.
The reason is simple. Inflation has developed momentum. Many people,
especially businessmen, have no faith that the government will stick to its
policy. They look for more boom and inflation ahead. Hence, they have
continued to get rid of money as fast as possible and convert it into goods,
machinery and factory buildings. Even though our manufacturing plant is
already in excess in needs and is being utilized at only 82% of capacity, the
building boom continues. The reasons are precisely those which led to this behavior in the German inflation.
The late 1960s also saw the rise of a new breed of financial
speculator. Huge conglomerates were organized, often with heavy borrowing,
taking advantage of inflationary trends. Although their stocks soared in
1967-1968, even a hint of possible deflation and a cooler economy led to
drastic declines of 60-80% in 1969. Many reported serious losses or sharply
lower earnings. We believe that many of these companies could not survive a
period of recession and deflation. Further, some bankruptcies in a few huge,
prominent speculative companies could set off a chain reaction and a
financial crash. And that is where the great danger of a wild inflation lies.
Today the public expects and demands that the government must maintain
prosperity and full employment. If a very severe business slump developed,
Washington would have no choice at all--it would have to spend huge sums for
relief, public works, to pay off mortgages, etc. Yet at the same time tax
payments would drop sharply as business profits disappeared. Taxes could
hardly be raised under such circumstances. What would the President do? Turn
on the printing presses? What else could he do? [Editor's note: As a
reminder, after this report was written, the redeemability
of the dollar for gold was terminated in 1971, two Oil Crises struck in 1973
and 1979, and massive Cold War expenditures characterized the 1980's.]
Ironically enough, we think that all this could be triggered by the
anti-inflation campaign. It may prove all too successful. The money managers
in Washington are aiming at a mild cooling down in business. This would
reduce spending and investment, and hopefully would slow down the rate of
price escalation. We think that it may work for a while and to a degree.
Unhappily it poses tremendous danger.
During the last several years of inflationary boom, debt has gone far
too high. Government, individuals and especially businesses have borrowed and
spent without limit. In an inflationary period, this makes sense. At the same
time liquidity is at an all-time low. Cash and government bills are less than
20% of the current liabilities of business against a normal 40-50% (and 90%
right after the war).
The danger is that some of the especially vulnerable businesses will
get into deep trouble and that the trouble will spread. In 1954, 1958 and
1960 the economy could stand a moderate recession without its
escalating into something worse. In 1970 this may no longer be the case. The
trend toward illiquidity and dangerously high debt has proceeded for twenty
years, and other figures indicate that the breaking point is near. It might
come very soon, or not for many months or even a year or two. Who can tell
just when some stray breeze will cause a rickety house of cards to collapse?
Once a snowballing financial and economic deflation gets underway, it
could develop with breathtaking speed. Soon the
government, instead of worrying about inflation, would be using desperation
measures to halt the collapse, even if it had to run budgetary deficits of
100 billion or more. In the short run, in a pragmatic sense, Washington would
simply feel that it was tackling an overriding emergency, relieving hardship,
etc. In the long term, what it would be doing was to inflate up to the point
where most of the huge debt burden was wiped out, and a fresh start could be
made. Of course, this would be at the expense of millions of savers who would
lose most of their capital. Hopefully the expropriation would be less drastic
than it was in Germany.
Reprinted from The Nightmare German Inflation by Scientific
Market Analysis, 1970.
(Editor's note: By the end of the 1970's, double digit
inflation had ravaged the American financial landscape. This forecast by
Scientific Market Analysis was not only accurate, it was prescient, and the
conclusions drawn enduring. Only the very strict monetary policies of the
Federal Reserve Bank during the 1980's kept the nation from sliding into the
hyperinflationary abyss, and those years became a period of relative calm.
The profligate fiscal policies of the United States government, however, continue
unabated. The overall national debt has grown to enormous proportions. The defense build-ups of the Reagan and Bush administrations,
coupled with the unbridled growth of entitlements --- financed to a large
degree with government debt---have set the stage for a new round of
inflation. Few believe that the Congress or the President possesses the
political will to stop the spending. As argued by Scientific Market Analysis
in this report, sooner or later, the deficits will translate to inflation,
and sooner or later, the Federal Reserve Bank will find it nigh impossible to
continue pulling rabbits out of the hat. Whether or not the inflationary
tendency of the American economy will cross the line to hyperinflation is
primarily a matter of politics---a reality few of us welcome. For the United
States to escape the fate of 1924 Germany, we must alter our ways and soon. MK)
Copyright 1999 USAGOLD / Centennial Precious Metals, Inc. All
Rights Reserved. No further reproduction without permission.
Michael J. Kosares
USAGold - Centennial Precious Metals, Inc.