Quote of the Day
By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
John Maynard Keynes
From Claim-Check Money to Paper Currency
That’s not waste in the wheelbarrow. Each and every one of those bricks is made up of pieces of paper and every piece of paper in every brick in that barrow is a bank note. Real, tangible, fungible, legal tender. Those men must be rich, you must be thinking… except they aren’t. In fact it is the picture of poor men. For these men live in Germany, the Weimar Republic, during a time of the great hyperinflation. Those children playing with blocks of money are not the offspring of uber-rich, profligate parents. Nay, dear reader, they too are the poor children of the Weimar Republic’s inflationary calamity. They have all the currency in the world, and not a shred of money to buy anything with.
How did Germany get to this place? Well, it seems fitting on the Queen’s 90th birthday to talk about one of her relatives: cousin Wilhelm (first cousin, once removed). Aka Emperor Wilhelm II and leader of the German Reich. I’ve told the story of how we got from Anne, the Queen of Great Britain to cousin Wilhelm II, so let me tell you we get from Wilhelm II to that wheelbarrow full of trash… err, sorry, I mean currency.
You remember previously how we said Lydia’s caveman economists were able to derive a new transaction method. Rather than carrying precious (but heavy) metals like gold and silver with them they could transact receipts or “claim-checks” for the metal. There was no risk of the Pebble Hyperinflation of 100,000 BC because the notes were directly linked to (exchangeable for) the precious metal, which had only limited supply.
It’s hard to be a virtuous monetary authority under constant political pressure (as all monetary authorities are). The short-termist remedy to print away one’s political pain is apparently a temptation too alluring for even the most saintly and righteous. And so, right up through the centuries this claim-check-to-precious-metal principle was regarded a good method to control the wayward monetarists our dear Mr Milton Keynes was referring to in our quote of the day. It did not matter what the paper currency was pegged to, so long as it satisfied the definition of Money: portable, fungible, divisible, durable, store of value. In practice, Gold was used nearly every time. Paper monies which were a claim-check on a tangible amount of gold were said to be on the “Gold Standard”.
The Birth of the Weimar Republic
Really, Germany’s* economic problems began when Queen Victoria’s eldest grandson, Wilhelm II. abandoned the Gold Standard to the Deutsche Mark. When Wilhelm’s friend Archduke Franz Ferdinand of Austria was assassinated in Sarajevo by secretive Serbian military forces called The Black Hand, Wilhelm’s German Empire, along with the rest of Europe was, seemingly incredulously, sucked into a massive conflict which (even more incredulously) cascaded into a global war.
When WW1 broke out in 1914, much to the disgust of many prominent German economists at the time, Emperor Wilhelm II decided he would print-and-borrow his way into the war. In economic terms, at least, he was effectively “betting the farm”, “throwing the kitchen sink in” or “swinging for the fences” – choose your metaphor. That is, he was gambling everything, the fabric of the entire economy, on winning the war. Perhaps Wilhelm was uber-confident of the imperious German Navy he had, so attentively, nurtured and invested in. Either way, chips in.
Thus, by the year 1918, following defeat in The Great War, Germany was in a shambolic state, deep in the throes of what would be called “The German Revolution”. This was precipitated by the armed forces themselves – most famously Wilhelm’s beloved German Navy, described in the Kiel Mutiny. The sailors simply refused to battle to the death on the whim of some aloof and distant royalist. It emerged that they had no faith in this Prussian autocratic despotism and it was a mood that swept the country.
Wilhelm was ousted (fled and abdicated) and thus a democratic state (a republic) was elected and brought to govern. Because public anger was so volatile in Berlin (which still had royalist connections), the new-state-forming process was held in a little-known town two or three hundred kilometres South West of Berlin, called Weimar. The newly formed democratic government under the Weimar Constitution thus became known as the Weimar Republic.
The Disintegration of the Prussian Empire
But this did little to ease tensions within Germany. The country was teetering on the edge of dissolution and complete disintegration. The Bavarians tried to create an independent state, The Bavarian Soviet Republic. They failed, of course, but it highlighted how the fractious fever was creating a mess of what was once a unified empire. A mess compounded by a humiliating punishment the Allies, in particular Britain and France, were imposing in the form of steep reparations (money, capital, land-seizures Germany had to pay) signed by the Treaty of Versailles. As an interesting sidebar, keeping our Austrian angle here for a minute, a heavy majority in both Austria and Weimar Germany wished for Austria and Germany to be reunited as a single state, but, of course, this was strictly forbidden by the other European states in one of the key articles under the Treaty of Versailles.
Tensions in Germany grew to boiling point as Germans felt that their economy simply could not pay the reparations without plunging large swathes of the population into poverty or decades of servitude. Just like our famous Roman Emperor, Diocletian, did with his asset requisitions after Nero had inflated the Denarius to near worthlessness, the Germans too resorted to paying repatriations in basic materials such as steel and wood and coal. It’s funny how, when the going gets tough with currencies, even great, sophisticated economies revert back to the exchange of tangible assets or, what caveman economists such as our dear Lydia would call; real money.
But German workers saw their hard-earned money ending up in the hands of their foreign neighbours who they were only recently at war with. The Belgian and French Occupation of Ruhr, was possibly the final straw. Ruhr was the heartbeat of an industrialized Prussia, and therefore of the German Empire, and the consequential outrage of the occupation was now palpable. The link above shows the ominous translated quote from German Newspaper, Deutsche Allgemeine Zeitung, at the time:
France herself has smashed the dictates of Versailles. But Paris must not think that the German fury is an apparition that belongs to the past so completely as the French imagine, or that it needs guns or bayonets to appear once more on the scene. Any great nation that has been driven to despair has always found the ways and means for its revenge.
Germany took the only power it felt within its grasp at the time: it simply stopped turning up to work in what became an official stance of “passive resistance”, but what was actually politically-sponsored brinkmanship in an orchestrated full-blown general strike. The German economy ground to a halt and was now becoming short of manufactured goods as well as money.
This very simple 4 minute video (love the dramatic music!) shows the rise and fall of the Prussian Empire. While it may be unfair to say that all Prussia’s problems were entirely economic, I think it is accurate to say that the decision to slip off the inherent regulation of a Gold Standard to favour the infinitely printable “Flying Fiat Paper” coincidentally demarked the peak of the Prussian Empire almost to the day. How much causality there is between the two, I’ll leave you to make an intelligent judgement. But after dropping the accountability to Gold, it was an immediate and continuous decline to complete annihilation which ultimately dragged with it the newly-formed Weimar Republic.
The Onset of Hyperinflation
Without the regulatory control of money supply, strategic economic blunders were now coming in thick and fast. In a desperate attempt to reassure the striking Ruhr workers, the German government promised to pay workers using the same method it was using to pay repatriations. It was going to simply print more currency… LOADS more currency. The printers were on turbo-drive producing the new currency. A currency which was now a fiat currency, not a ‘claim check’ on anything real with tangible supply.
While the Allies were, obviously, not prepared to take Deutsche Marks for payment. Germany still had to print more and more Deutsche Marks in order to purchase real, hard currency to pay the repatriations. As they printed, the currency would devalue and as it devalued they would have to print more in order to purchase the same hard currency. This cycle was running out of control and fuelling a hyper-inflationary circumstance within the country. What happened next was quite spectacular.
It started out relatively benign: 1 US Dollar was equivalent to 4.2 German Papiermark. I’m not sure what a dollar would have bought our stereotypical housewife, Frau Schmidt, those days – perhaps a bag of groceries, some eggs and bread and a few vegetables. But then, out of nowhere, the same bag of groceries was costing 5 Papiermarks. Before you knew it, the grocery shopping was costing her 10 Papiermarks. Then things started to get absurd, Frau Schmidt’s grocery shop which used to cost just 4.2 Papiermarks was costing 100 Papiermarks, then 1000 Papiermarks before you knew it she was taking money out of the bank, then sprinting to the market store and just chucking handfuls of trash cash, to the tune of millions, at the store owner just to get her eggs and bread. The exchange rate went from 4.2 Papiermark to 4.2 TRILLION Papiermark to the Dollar. You think I’m making this up? Wikipedia does a lovely illustration of how the notes evolved, see here. By the end, the Germans were issuing 100 Trillion Papiermark notes!
I love this article in Germany’s leading news magazine Der Speigel. I quote:
Few people understood what had happened. Even today, three generations later, much of it sounds pretty incredible.
Take for example the family that sold its house to emigrate to America. On arrival at the port of Hamburg, they found that the money wasn’t enough to pay for their crossing — in fact, it didn’t even pay for their tickets back home. Then there was the man who drank two cups of coffee at 5,000 marks each, only to be presented with a bill for 14,000. When he asked why this was he was told he should have ordered the coffees at the same time because the price had gone up in between. And then there’s the story about the couple that took a few hundred million marks to the theater box office hoping to see a show, but discovered it wasn’t nearly enough. Tickets were now a billion marks each.
At the height of the crisis, the inflation rate was in the tens of thousands — per month, that is. And this in the era before the invention of the pocket calculator.
People were taking banknotes and burning them to keep warm because its intrinsic value as plain paper had exceeded its monetary value. Kids were playing with piles of cash on the pavements. Cash became litter, which had to be swept off the street. The fiat currency simply wasn’t worth anything. Banks were taking deposits by the ton only to recycle the paper back into pulp. And once again, people began resorting to tangible caveman capital to transact, as Der Speigel accounts.
Many doctors insisted on being paid not in cash but sausages, eggs, coal, and the like. Because of the constant increase in prices, shops stopped displaying them in their windows. And when the Prussian authorities forced them to do so nonetheless, it drove prices even higher because traders simply took prospective increases into account.
This all sounds rather amusing in hindsight but it was not. It completely levelled the German economy and, in my opinion, was the fault of the over-meddling monetarists. It had to be, nobody else controlled the money supply or its standards. The frustrating thing was, the goods and produce was all there in good supply, there just was no credible money to transact with! To quote again.
Bizarrely enough, goods were no longer in short supply. There was simply no stable currency to buy them with. As the later Chancellor Hans Luther noted in 1923, Germany threatened to “starve with full barns.”
This great Economist article sums up the destructive effect of inflation quite neatly.
HYPERINFLATION is among the worst catastrophes that can befall an economy. It can destroy output and destabilise societies. The hoarding of real assets, such as property and precious metals, wrecks business and financial investment in countries afflicted by it. Business costs soar, as wages and prices have to be increased on an hourly basis, reducing productivity. Foreign investment evaporates as the financial risks of doing business rise. The sudden redistribution of wealth from creditors to debtors can eat at civil society and discredit political institutions. John Maynard Keynes, as early as 1919, recognised the threat inflation posed to modern capitalist societies:
Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency… [he] was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
More importantly, the impact was taken by everyday “Main Street” consumers. Ordinary people took the hit, and they were hit HARD. What was even more demoralising was that hard workers and diligent earners who sought to pay down debts and save nest eggs were obliterated – their savings simply disintegrated. They suffered more than those with massive debt obligations – who fortuitously saw their debts evaporate into thin air. The hyperinflation simply levelled everything and everyone – it left the economic equivalent of a nuclear holocaust. This was a shock that would be etched into German psyche to this day. Is it any wonder that the German public does not like the ECBs “QE to infinity” which is, effectively money printing on a massive scale? In Weimar Germany, the parabolic rise in consumer prices was accompanied, inevitably, by the fall in living standards with diligent, productive workers and savers hit the hardest. The same Der Spiegel article doesn’t hold back in attributing the rise of Nazism in Germany to the hyperinflationary catastrophe. I quote:
It’s no coincidence that Adolf Hitler’s inexorable rise to power began in November 1923, the highpoint of Germany’s inflation, when he organized the abortive Beer Hall Putsch in Munich.
So, admittedly, the first sentence of this post was incorrect. It was waste in the wheelbarrow. And this is what uncontrolled fiat currency inflation can do to a country.
The rest, as they say, is history…
*I use Germany and German Reich/Empire interchangeably – you’ll have to forgive, me dear reader but, frankly, it’s hard to know when to use which. This is where having a more knowledgeable person write your articles will help! But, hopefully, you’ll get the general gist from a financial perspective – which is what I think matters most.