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The Quintessential Inflation - The Great Weimar Inflation

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From the Archives : Originally published April 13th, 2008
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Category : Fundamental

The "Weimar Inflation". Much has been spoken about it, but few really appreciate key points, motives and reasoning. It seems that it was just excessive money, but in reality it was a constant shortage! The critical role of the velocity of money is also not understood in these situations, nor today. It was portrayed and possibly constructed as a financial accident, but linking the scene to that day's politics shows another picture!

In understanding today's environment and the prospects for "Stagflation" and the battle to export "Deflation", understanding the Weimar Republic's hyperinflation is one of the critical lessons for Investors today.

The Quintessential Inflation - The Great Weimar Inflation - Germany the Early Twenties

Julian D. W. Phillips

History as written, is written not by those who make history, but usually by those who observe it. Sad to say they may be possessed of less information than needed to give an accurate picture. Some facts of history become evident later when observers perceive the full picture in the results achieved well after the event. It will be so that the facts they present may be accurate, but their presentation may lack proportions and mixture that gives the true picture. In this Article we are going to re-look at the collapse of the German Currency in the post- first world war years as occurred in the Weimar Republic.

With the benefit of hindsight and the experience of similar albeit moderate repeats of the evil of inflation we can see that this collapse was not a financial accident in the hands of the inexperienced and incompetent German government, but clearly a deliberate "accident", which achieved a desired and effective result in financial terms, despite the dreadful seeds laid by it that led to the Second World war. It was the only recourse a defeated government to the imposition of greedy, rapacious conquerors masquerading as oppressive creditors, seeking financial revenge and further grabbing of the spoils of war.. It serves as the most dramatic example of Inflation in history.

Since then it has been used as a useful tool to give the appearance of wealth where none was, and a most useful tool in later decades of the century to achieve short term goals. Do not think for one moment that it will be repeated exactly as it occurred then. The world has learned how to use it in a way to postpone its effects, in the pretence that the effects are not necessarily pernicious. Today, by re-examining this period through the eyes we now have, we can see features to this disaster that were not understood or even perceived by the less street-smart observers of that day.

Indeed, since then, the world has come to understand the phenomena of Inflation and deflation and their hybrid - stagflation. They have been used as tools to achieve Political as well as Monetary objectives and over long periods of apparent growth, giving fluidity to such economic growth, globalisation, Imperialistic widening of multi-national synergies. The impression of increasing wealth, and general prosperity have made these processes tenable, indeed welcomed. With such benefits, who could reasonably object to the pervasive processes that, in reality, undermined the very foundations of long-term stability. The postponing of the painful process of re-establishing monetary stability, is a temptation far too hard for a government to resist, until they can reap the rewards of political kudos when they resolve a crisis, without the unpopularity that attends the solution of mere problems.

We ask you, the reader, to ponder over these events looking at the ingredients and observing their presence today. We have no doubt that you will add to the observation we make, these events being structural events whose offshoots can manifest themselves in so many ways. The ingredients of a beautiful meal they, of themselves, will not make the final dish, but their quantities, preparation and presentation will give you the final dish. And mark well, just who the Chefs are - they decide just what you will eat!. So it was just after the First World War.

This analogy is not simply for the decoration of this Article, but an attempt to persuade our readers to stop isolating economic, monetary or markets world from the broader spectrum of the integrated and interdependent world we live in. We have to stop being myopic, to take off our blinkers and integrate political and other features into the biggest picture, as far as the public facts will allow us, to identify the true picture of power. Only when we can place these into proper "synch" will we be able to understand the events that occurred in the past and perceive those that lie ahead.

The Weimar Republic, on the surface, looked as though it could have been accidental, or an act of irresponsibility by the Monetary Officials involved, indeed the commentator to which we will refer constantly, the Right Hon. Viscount D'Abernon [with thanks to Euromoney], who was a commentator of the day, wrote: -

"The evils through which Germany had to pass might have been avoided had proper measures been taken in time. Their was more ignorance than malevolence in their currency blunders, more recklessness than malicious intent. Had a full, accurate and impartial narrative existed of the currency adventures in France between 1790 and 1800, it is not impossible that both Germany and France would have avoided many of the mistakes that have caused them recent trouble. Although the German crisis is only three years old, similar errors of currency policy are today being committed in other countries.

"With the benefit of hindsight and the final objectives achieved, we would disagree with this conclusion, saying that the entire process of the financial bankruptcy of Germany in 1919-23 was a costly but effective way of resolving and removing the punishment the Allies had imposed on Germany at the end of the war - namely that they should carry the cost of the entire war - including the Allies costs. Such a punishment would have endured decades longer, were it not for this relatively short term expedient. The recovery of the German currency and economy, from 1923 to 1926, provided sufficient evidence of this fact. The social ramifications inside Germany, such as the financial destruction of the middle and upper classes of the thrifty and prudent was a price the nation felt had to pay. After all, the interests of the State always outweigh those of its citizens, even in Financial conflict! The social damage quickly laid the seed of the Second World War.

France handled it inflationary objectives better as the figures demonstrate below. Lessons had clearly been learned.

The development of the Inflation crisis was true to standard type. Result followed cause in the financial world, in accordance with what should have been theoretical expectation. Nothing occurred which could not be explained by known law, or which could not have been anticipated from a knowledge of what previously occurred elsewhere. The case was, however, at once normal and also abnormal; normal in its truth to type, abnormal in its violence and magnitude. The crisis was indeed, unprecedented in severity among modern industrial states. "It may, therefore be said to belong at once to those examples which are suitable for a text-book, and to those tales of wonder and adventure which owe their interest to the extravagance of the fact recounted. "The climax of the inflation was reached in the Autumn of 1923, when the German exchange had fallen to one billionth [i.e. the British billion - one million-millionth] of its original value, and the German Mark was no longer accepted in payment by the population, when grave political trouble and the rapid process of dismemberment of the Reich threatened.

To emphasise our point that this was a political expedient, please note that the progress of recovery since Autumn of 1923 to 1926 was remarkable; by November 16th 1926 the replacement currency had been firmly established - the budget in equilibrium and Germany's financial world was working on normal lines, it was thought at the time, towards prosperity.

The prime cause of the catastrophic fall in the German Mark? - Demands for Reparation payments, involving forced public expenditure, without regard to the effect of these payments on State Finance. Please be aware, though that it would be incorrect to say that Reparation demands made inflation inevitable, inflation had been resorted to in Germany during the war years. Reparation demands, whilst they were not an initial cause, were an aggravating one. We leave it up to the reader to conclude that it had been realised that inflation served political causes well, both during and after the war, but for entirely different reasons.

It was and is our contention that inflation was seen as a useful tool, even back there, despite the crudeness of its impact. We would further contend that whilst the consequences of an ill-regulated issue of bank notes was inadequately appreciated, once realised was allowed to continue, as the "greater" political objective was appreciated, thoroughly.

History has taught governments well, as we see from the "controlled" inflation of the last few decades. We therefore have no doubt, whatsoever, that inflation will be attempted again, should deflation pose the obvious political threat, it may well do should it spread from Japan and accelerate in Germany and develop solidly in the U.S.A.

The question will be, are the controlling authorities capable of co-ordinating control of it to the extent needed, in the partially developed "world" economy we have now? Secondly, do they have effective mechanisms to control the mercurial money supply in a deflationary climate via the use of inflation to counter it, without the dreadful collateral damaged suffered then? The signs are there for this looming battle in these early years of the 21st Century.

After the autumn of 1923 saw the stabilisation of the currency, recovery commenced directly unrestrained issues stopped. But until the death of Dr Havenstein and the appointment of Dr. Schacht in his place as President of the Reichbank, accompanied by the nomination of Dr. Luther as Minister of Finance, there was no effective financial check, nor the indication among responsible officials of any correct diagnosis of the position or of any willpower capable of dealing with the crisis. Dr Havenstein, then President of the Reichbank, speaking before the Reichsrat on August 7th 1923 [the pound sterling then stood at 15 million paper marks.] said: "The Reichsbank today issues 20 thousand milliards of new money daily. The note issue at present amounts to 63, 000 milliards: in a few days, therefore, we shall be able to issue in one day two thirds of the total circulation." This declaration elicited no protest and excited no public disapproval.

It is of significance to note that the principal feature of Germany in 1923 [the climactic year of inflation] was that industry enjoyed the illusion of fortune, while living in a state whose finance and currency were completely disorganised. The ledgers of German industry showed enormous paper-mark profits, but in the end it was realised that the paper it had gained was worthless! At the same time an analogous process was followed regarding reparations. Cash on delivery was demanded; the only basis which allowed a permanent flow of profits and cash flow.

Stability in purchasing power was treated with scant regard. Yes, the Reparation Commission made constant efforts to induce the German Government to institute a radical reform of taxation and currency, but they were never prepared to give the German Government a long enough breathing space to enable them to carry through such a programme. Indeed, one wonders if it would have suited the German Government to have been able to implement such reforms.

Theory has it that budgetary deficits and currency instability are to some extent cause and effect; the greater the gap in the budget, the greater the necessity of finding the means to fill the gap. Today, we still have the same formula, but if you can moderate inflation and give a semblance of stability, one can enjoy the "benefits of inflation for far longer. However, the 'day of reckoning' inevitably arrives.

In Germany in 1923, the normal resources of taxation, having been found insufficient, one administration after another was compelled to resort to abnormal [or indeed illegitimate] resources, i.e. each attempted to meet current necessities via the printing press! The general public did not appreciate the extravagance of the Havenstein statement above, nor apparently did the German financial and industrial leaders, so commentators at the time believed. However, we would argue that the benefits to the nation from the easing of the repayment burden of Reparations was sufficiently overwhelming as to make the negative impacts tolerable [except to those who suffered directly]. Indeed, the ignorance bred of myopia and in accord with the principles of economic thought prevailing at the time, the amount of internal currency in circulation had little influence on its external value. The latter was determined, so they wondrously contended, mainly by the passivity or activity of the trade balance.

With such a paucity of theoretical advice, sufficient to fool all of the people in the critical time, the German Government acted on the principle that, as there was an admitted monetary scarcity, the only way to cure it was to increase the circulation. The results were remarkably (see Table 1) swift when the size of the reparation debt was considered. The elimination of an intolerable internationally enforced debt, within four years, was a feat of ill-considered genius.

In resorting to the printing press, the German government diminished the value of, not only each individual unit but of the aggregate total circulation. It was generally realised only later that the sole way to increase the value of the circulating medium was to raise the value of the units by the strict limitation of output and by subjecting the issues to clearly specified conditions.

The pre-war circulation in Germany was approximately equal to 300 million pounds sterling, whereas from August 1923, until the period of stabilisation the whole Reichsbank and authorised government issues could have been bought up, on the basis of GOLD for a figure of 10 million pounds! The more notes the Reichsbank issued, the less the aggregate exchange value of the notes in circulation became. Quality, or value in the world market, decreased more rapidly than quantity could be increase; and this, although every effort was made to stimulate note output. France underwent a similar, albeit more moderate development [see Table 2]

How did Germany carry on business under such extraordinary conditions? The theory was twofold: -

  • The velocity of circulation of the currency increased enormously.
  • The currency gap was filled by tokens (Notegeld) issued by various public administrations and by private persons, alongside the limited use of foreign banknotes. The velocity of notes played an important part.

24hGold - The Quintessential I...True the population of Germany had diminished by 10 million; territories had been taken away, while business had contracted. On the other hand, payment by cheque had ceased to exist and there was a flight from the Mark. Notes were held no longer than could be helped as they were turned into goods or exchanged against foreign currency.
In practice the degeneration of the Mark had a dramatic impact: -

  • Workers had to be paid once or twice daily. Scenes of workers running to the gates of the factory, giving their pay to spouses, who put it in prams then ran to the shops to spend it, as fast as possible, on, literally anything.
  • One man went into a restaurant, next to a bank [who kept in touch with the exchange rate], bought a cup of coffee which by the time he had finished it had doubled in price.
  • One woman went to the shop, and for some reason put down her bag, full of money, outside the shop. When she returned she found the money on the pavement but the bag gone.

On July 17th 1922 a law was passed [amended on October the 26th 1923, permission to issue emergency tokens was granted by the Minister of Finance - if a real emergency was recognised to exist, e.g. if the Reichsbank was unable to satisfy the demands of industry for the payment of wages. As a condition of such issues it was stipulated that an asset had to be deposited in the Reichskreditgesellschaft [a semi-official Reich banking institution] in favour of the Minister of Finance; if and when the tokens were called in, this deposit was released. But over and above these authorised issues, the whole country was inundated with unauthorized Notegeld, without any pretence of cover at all, whose amount in January 1924 was estimated at 159.6 million Gold Marks.

24hGold - The Quintessential I...The evil of this inflation was aggravated by the extraordinary credit policy of the Central Bank of Issue. According to the terms of the Bank Law of 1875, the Reichsbank note-issue was covered up to one-third by gold and for the other two-thirds by discounted bills of not more than three months' date guaranteed by at least two persons of known solvency. Now it should be known that Treasury bills did not fall under this category and could not then be used as backing for the note-issue. At the outbreak of the first World War, because of the realisation of possible abnormal currency needs, an Act was passed whereby Treasury bills were put on the same footing as trade bills of exchange. From then on the Reichsbank was able to hold them against note-issues. The first stage of inflation [the Helfferich stage] had begun. But it was nothing compared to the Havenstein stage [Table 3].

No effective measures were taken by the Reichsbank to put an end to such excessive credit issues. To illustrate the situation at the time, we refer to the decision taken by the Central Committee of the bank on August 2nd 1923 were Havenstein stated that it was not the duty of a Central Bank of issue to make the rate of interest, but to follow the market rate. He consequently proposed to raise the Bank rate from 18% to 30%. It is regrettable that Havenstein did not draw the proper conclusion from his premise, for the current market rates being 3-4% a week, the bank rate should have been raised to nearer 200%. But the interesting point is that the members of the Committee did not support the President's motion, not because the rate proposed was not high enough, but because they were opposed to any increase in the Bank rate at all. Indeed, throughout 1921, 1922 and the first half of 1923, a majority of the banking world were either in favour of increased note issues, or regarded such issues as inevitable. They were hostile to any departure from the Havenstein policy. Rudolf Havenstein, President of the Reichsbank, is said to have remarked in 1922 that he needed a new suit, but was not going to order it until prices fell. Presumably, he never got his new suit; he died on November 20 1923 - the day the mark sank to its lowest on the Berlin Exchange. Of course had he done so at the beginning of 1920 and it cost 10 pounds sterling or 1,848 Marks, he would have been able to sell it for 18,000,000,000,000.0 Marks, were he to achieve his cost price at the sale.

24hGold - The Quintessential I...Perhaps most unfortunate of all was the fact that the Capitalist class, which finally lost all its savings through inflation, was at no time hostile to the steps which led to this loss. Temporary gain, or the illusion of it, obscured the inevitable final disaster. This class, including the landed class suffered tremendous collateral damage. On the one hand, those who were most familiar with business dealings were able to take advantage of the situation, ensuring ownership of the production process from basic raw materials through to final retail sales, so removing the constant dangers of monetary degradation until the profits had been achieved and translated into more goods or foreign currencies. On the other hand, many of the landed classes found themselves dispossessed of lands and estates held for many generations. Thus the seeds of the dreadful policies of the Hitler era, including the war itself as well as the anti-Semitic policies, were laid in the social disruptions resulting from hyper-inflation. Now we turn to another cause of the Mark disaster, enforced State expenditure. On the budget side the main troubles were: - (a} From 1920 onwards Germany was called upon to make Reparation payments, without regard to the question whether such payments could be obtained either from existing or possible tax revenues or from loan operations of the State, which would divert to its uses the real, not fictitious, savings of the people During 1923, the year of supreme disaster, Germany, through political circumstances not within her own control, made public expenditure on a colossal scale in the Ruhr. The initial inactivity of the Reparation Commission between January 10th 1920 and April 30 1921, was reflected in the relative calm of the mark Exchange during that period. It is true that the general trend of the Mark was weak, but not disastrously so at that stage. Indeed, the year 1920 and the first quarter of 1921 were periods of comparative stability.

Article 233 of the Treaty of Versailles provided that the findings of the Reparation Commission in regard to the amount of damages inflicted by Germany in the war had to be concluded and notified to the German Government on or before May 1st 1921. The Reparation Commission fixed the sum at 132 billion gold marks (6,600 million). An inter-allied conference met in London in May 1921, and determined the schedule of payments tat the German Government had to meet. An important provision of the so-called London Ultimatum laid down that Germany must pay a sum in cash of 1 billion Gold Marks (50 million pounds sterling) before the end of August 1921. That payment was duly met, but the German Government had to borrow about two thirds from the firm of Mendelssohn and Company, repayable before the end of the year. This operation is likewise reflected in the Exchange Rates.

The year of 1922 led the short path to disaster. The Committee of Guarantees, set up under the Authority of the London Conference, instituted a system of ten-day cash payments, each of 31 million Gold Marks (1,1550,000 pounds sterling). This system was continued under the decisions of Annes Conference (January 1922) until it became impossible to find the money. By the beginning of May the German Government had asked for a Moratorium. After a great deal of fruitless discussion, it was finally decided in August of 1922, that Germany should make out future Reich's Treasury Bills to the order of the Belgian Government, which were afterwards paid out of the Gold Reserves of the Reichsbank. The average monthly rates of exchange for 1922 are in Table 7. It must be noted that throughout these early reparation years the Reparation Commission constantly draw to the attention of the German Government to the necessity of covering their budgetary deficits, but the German Government were either unable or unwilling, or a combination of both, to give effect to reforms on the necessary scale.

The Reparation Commission, clearly not in a position to either understand or counter this effective destruction of Germany's debt, did not give a sufficiently large inducement to the German government to renounce their policy. It was only realised that this was needed once a collapse had taken place. The collapse was complete and precipitated the postponement of reparations until the currency was effectively stabilised. The fact that reparations were being paid, not out of tax surpluses, but out of the unrestrained printing of notes - a process inevitably destructive of the financial capacity of the debtor [unless repayment can be effected in freshly printed and debauched notes - was therefore partly responsible for the Mark's disaster. However, a larger responsibility must be attributed to the weakness of the Reich's financial system and its tolerance of the wild currency policy of the Reichsbank.

During 1923 the Ruhr Territory was occupied by Franco-Belgian troops; a foreign administration seized the customs and levied other imposts. Not only was a valuable economic area from Germany, but important revenues were destroyed or diverted to foreign treasuries - destruction occurring to a larger extent than diversion.

The only surprising feature of this hyper-inflation was that it was not undertaken quicker and more completely so as to eliminate the Reparation requirements as speedily as possible in the face of the rapacious greed of the conquering forces. Hence it was to be expected that - in order to support passive resistance - the Reich elected to make colossal payments in aid of its citizens in the Ruhr, with a disastrous effect on the budget and Mark Exchange rate.

24hGold - The Quintessential I...Throughout the inflation period no real budgeting was done; the Government lived on borrowings, open credits being available at the Reichsbank against Treasury Bills. It was an era of unrestricted and unlimited Floating debt!

We will not discuss the process of recovery here, which was effective and quick. Needless to say the establishment of the "Rentenmark" - the currency based on land - and therefore limited in printability - [so believed at the time] was the means of expanding money supply, in a less pernicious manner, was established, a feat which commenced today's system of skyscraper like paper money, based on such a small foundation of reality. Remember 9-11?

By : Julian D. W. Phillips

Gold/Silver Forecaster – Global Watch

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Julian Philips' history in the financial world goes back to 1970, after leaving the British Army having been an Officer in the Light Infantry, serving in Malaya, Mauritius, and Belfast. After a brief period in Timber Management, Julian joined the London Stock Exchange, qualifying as a member. He specialised from the beginning in currencies, gold and the "Dollar Premium". At the time, the gold / currency world exploded into action after the floating of the $ and the Pound Sterling. He wrote on gold and the $ premium in magazines, Accountancy and The International Currency Review. Julian moved to South Africa, where he was appointed a Macro economist for the Electricity Supply Commission, guiding currency decisions on the multi-Billion foreign Loan Portfolio, before joining Chase Manhattan the the U.K. Merchant Bank, Hill Samuel, in Johannesburg, specialising in gold. He moved to Capetown, where establishing the Fund Management department of the Board of Executors. Julian returned to the 'Gold World' over two years ago and established "Gold - Authentic Money" and now contributing to "Global Watch - The Gold Forecaster".
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