The German inflation of 1914–1923 had an inconspicuous beginning, a creeping rate of one to two percent. On the first day of the war, the German Reichsbank, like the other central banks of the belligerent powers, suspended redeemability of its notes in order to prevent a run on its gold reserves.
Like all the other banks, it offered assistance to the central government in financing the war effort. Since taxes are always unpopular, the German government preferred to borrow the needed amounts of money rather than raise its taxes substantially. To this end it was readily assisted by the Reichsbank, which discounted most treasury obligations.
A growing percentage of government debt thus found its way into the vaults of the central bank and an equivalent amount of printing press money into people’s cash holdings. In short, the central bank was monetizing the growing government debt.
By the end of the war the amount of money in circulation had risen fourfold and prices some 140 percent. Yet the German mark had suffered no more than the British pound, was somewhat weaker than the American dollar but stronger than the French franc. Five years later, in December 1923, the Reichsbank had issued 496.5 quintillion marks, each of which had fallen to one-trillionth of its 1914 gold value.1
How stupendous! Practically every economic good and service was costing trillions of marks. The American dollar was quoted at 4.2 trillion marks, the American penny at 42 billion marks. How could a European nation that prided itself on its high levels of education and scholarly knowledge suffer such a thorough destruction of its money? Who would inflict on a great nation such evil which had ominous economic, social, and political ramifications not only for Germany but for the whole world? Was it the victors of World War I who, in diabolical revenge, devastated the vanquished country through ruinous financial manipulation and plunder? Every mark was printed by Germans and issued by a central bank that was governed by Germans under a government that was purely German. It was German political parties, such as the Socialists, the Catholic Centre Party, and the Democrats, forming various coalition governments, that were solely responsible for the policies they conducted. Of course, admission of responsibility for any calamity cannot be expected from any political party.
The reasoning that led these parties to inflate the national currency at such astronomical rates is not only interesting for economic historians, but also very revealing of the rationale for monetary destruction. The doctrines and theories that led to the German monetary destruction have since then caused destruction in many other countries. In fact, they may be at work right now all over the western world. In our judgment, four erroneous doctrines or theories guided the German monetary authorities in those baleful years.
No Inflation in Germany
The most amazing economic sophism that was advanced by eminent financiers, politicians, and economists endeavored to show that there was neither monetary nor credit inflation in Germany. These experts readily admitted that the nominal amount of paper money issued was indeed enormous. But the real value of all currency in circulation, that is, the gold value in terms of gold or goods prices, they argued, was much lower than before the war or than that of other industrial countries.
Minister of Finance and celebrated economist Helfferich repeatedly assured his nation that there was no inflation in Germany since the total value of currency in circulation, when measured in gold, was covered by the gold reserves in the Reichsbank at a much higher ratio than before the war.2 President of the Reichsbank Havenstein categorically denied that the central bank had inflated the German currency. He was convinced that it followed a restrictive policy since its portfolio was worth, in gold marks, less than half its 1913 holdings.
Professor Julius Wolf wrote in the summer of 1922: « 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 40–50times. »3 Similarly Professor Elster reassured his people that « however enormous may be the apparent rise in the circulation in 1922, actually the figures show a decline. »4
The Statistical Bureau of the German government even calculated the real values of the per capita circulation in various countries. It, too, concluded that there was a shortage of currency in Germany, but a great deal of inflation abroad.
Source: Wirtschaft und Statistjk, 1923, No. 1.
(To arrive at US dollar amounts these figures should be divided by 4.2)
Of course, this fantastic conclusion drawn by monetary authorities and experts bore ominous consequences for millions of people. Through devious sophisms it simply removed the cause of disaster from individual responsibility and thus also all limits to the issuance of more paper money.
The source of this momentous error probably lies in the ignorance of one of the most important determinants of money value, which is the very attitude of people toward money. For one reason or another people may vary their cash holdings. An increase in cash holdings by many people tends to raise the exchange value of money; reduction in cash holdings tends to lower it. Now in order to change radically their cash holdings, individuals must have cogent reasons. They naturally enlarge their holdings whenever they anticipate rising money value as, for instance, in a depression. And they reduce their holdings whenever they expect declining money value. In the German hyperinflation they reduced their holdings to an absolute minimum and finally avoided any possession at all. It is obvious that goods prices must then rise faster and the value of money depreciate faster than the rate of money creation. If the value of individual cash holdings declines faster than the rate of money printing, the value of the total stock of money must also depreciate faster than this rate. This is so well understood that even the mathematical economists emphasize the money « velocity » in their equations and calculations of money value.5 But the German monetary authorities were unaware of such basic principles of human action.
For Health, Education, Welfare, and Full Employment
Immediately after the war the German government, under the leadership of the Socialist Party, embarked upon heavy expenditures for health, education, and welfare. The demands on the treasury were extremely heavy anyway because of demobilization expenses, the demands of the Armistice, the disorders of the revolution, and the staggering deficits of the nationalized industries, especially the railroads, postal services, telephone, and telegraph. Public administration by the new men raised to power by the revolution, nevertheless, was extravagant, as the resources made available by the creation of new money were apparently unlimited. A number of measures for the nationalization of certain industries (e.g., the coal, electrical, and potash industries) were introduced, but failed to become law. The eight-hour day was enacted, and labor unions were given many legal immunities and privileges. In fact, a system of labor councils was set up which authorized the workers in each enterprise to elect representatives who shared in the management of the company! While government expenditures rose by leaps and bounds, the revenue suffered a gradual decline until, in October 1923, only 0.8 percent of government expenses were covered by tax revenues. For the period from 1914 to 1923 scarcely fifteen percent of the expenses were covered by means of taxes. In the final phase of the inflation the German government experienced a complete atrophy of the fiscal system.
The depreciation of the currency brought about the destruction of taxable wealth in the form of mortgages, bonds, annuities, and pensions, which in turn reduced government revenue. Some speculators reaped spectacular profits from the depreciation, but they easily evaded the tax collector. Moreover, the fiscal policies of the socialist government were openly hostile toward capital and frequently endeavored to impose confiscatory capital levies upon all wealth. Secretary of the Treasury Erzberger even vowed that « in the future Germany the rich should be no more. »6 Consequently a massive « flight of capital » from Germany developed as all classes of savers invested their money in foreign bank accounts, currencies bills, securities, etc. Much taxable wealth was removed from the grasp of tax collectors.
Finally, the rapid depreciation of currency greatly reduced all tax liabilities during the time interval between the taxable transaction and the date of tax payment. The taxpayer usually paid a sum whose real value was greatly reduced by inflation. Nevertheless, government expenditure accelerated while revenue in terms of real value continued to decline. The growing deficits then were met with even larger quantities of printing press money, which in turn generated ever larger deficits. The German monetary authorities, in fact, were trapped in a vicious circle from which they did not know how, nor have the courage, to extricate themselves.
The leading monetary authority, Dr. Helfferich, even warned his people against the dire consequences of monetary stabilization.
To follow the good counsel of stopping the printing of notes would mean refusing to economic life the circulating medium necessary for transactions, payments of salaries and wages, etc. It would mean that in a very short time the entire public, and above all the Reich, could no longer pay merchants, employees, or workers. In a few weeks, besides the printing of notes, factories, mines, railways, and post offices, national and local government, in short, all national and economic life would be stopped.7
The Balance of Payments and the Treaty of Versailles
Throughout the period of the inflation the most popular explanation of the monetary depreciation laid the blame on an unfavorable balance of payments, which in turn was blamed on the payment of reparations and other burdens imposed by the Treaty of Versailles. To most German writers and politicians, the government deficits and the paper inflation were not the causes but the consequences of the external depreciation of the mark.
The wide popularity of this explanation which charged the victorious allies with full responsibility for the German disaster bore ominous implications for the future. Its simplicity made it appealing to the masses of economically ignorant people whose chauvinism and nationalism always make the idea of foreign intrigue and conspiracy so palatable. The intellectual and political leaders who actively propagated the doctrine were sowing the seeds for the whirlwind they reaped a decade later.
During those baleful years, Germany actually procured gratuitously from abroad large quantities of raw materials and foodstuffs. According to various authoritative estimates, foreign individuals and banks bought at least sixty billion paper marks which the Reichsbank had floated abroad at an average price of one-fourth gold mark for a paper mark. The depreciation of the mark to one-trillionth of its earlier value repudiated these foreign claims to German goods. Thus foreigners suffered losses of some fifteen billion gold marks, or some $3.5 billion US dollars, which was eight times more than Germany had paid in foreign exchange on account of reparations.
But even if it had been true that excessive burdens had been thrust on Germany by the Allies, there was no need for any monetary depreciation. Both phenomena are entirely independent. If excessive burdens are placed on a government, whether they be foreign or domestic, that government must raise taxes, or borrow some funds, or curtail other expenditures. Excessive reparation payments may necessitate greatly higher taxes on the populace, or large loans that reduce the supply of savings for industry and commerce, or painful cuts in government service and employment. The standards of living of the people thus burdened will probably be depressed — unless the reduction of bureaucracy should release new productive energy. But the value of money is not affected by the reparation burden unless economic productivity is impaired by the fund-raising.
Once government has achieved the necessary budgetary surplus the payment of reparations is a simple matter of exchange. The treasury buys the necessary gold or foreign exchange from its central bank and delivers it to the recipient government. The loss of gold or foreign exchange then necessitates a corresponding reduction of central bank money, which in turn tends to depress goods prices. Lower goods prices encourage more exports while they discourage imports, that is, generate what is commonly called a « favorable balance of payments » or new influx of gold and foreign exchange. In short, there can be no shortage of gold or foreign exchange as long as the central bank refrains from inflation and monetary depreciation. The German monetary authorities flatly denied this economic reasoning. Instead, they preferred to lament about the excessive burdens thrust onto Germany and the unfavorable balance of payments generated thereby. In 1923 they added yet another factor: the French occupation of the Ruhr district. The Central Statistical Office put it this way:
The fundamental cause of the dislocation of the German monetary system is the disequilibrium of the balance of payments. The disturbance of the national finances and the inflation are in their turn the consequences of the depreciation of the currency. The depreciation of the currency upset the Budget balance, and determined with an inevitable necessity a divergence between income and expenditure, which provoked the upheaval.8
Again I quote Dr. Helfferich:
Inflation and the collapse of the exchange are children of the same parent: the impossibility of paying the tributes imposed on us. The problem of restoring the circulation is not a technical or banking problem; it is, in the last analysis, the problem of the equilibrium between the burden and the capacity of the German economy for supporting this burden.9
Even American economists echoed the German theory. Professor Williams presented this causal order: « Reparation payments, depreciating exchanges, rising import and export prices, rising domestic prices, consequent budgeting deficits, and at the same time an increased demand for bank credit; and finally increased note-issue. »10 Professor Angell contended that « The reality of the type of analysis which runs from the balance of payments and the exchanges to general prices and the increased issue of paper seems to be definitely established. »11
Speculators Did It
When all other explanations are exhausted, modern governments usually fall back on the speculator, who is held responsible for all economic and social evils. What the witch was to medieval man, what the capitalist is to socialists and communists, the speculator is to most politicians and statesmen: the embodiment of evil. He is said to be imbued with ruthless and fickle selfishness that is capable of wrecking the national economy, government plans, and, in the case of German inflation, the national currency. No matter how blatantly contradictory this explanation may be, it is most popular with government authorities in search of a convenient explanation for the failure of their own policies.
The same German officials who denied the very existence of inflation lamented the depreciation caused by speculators, or they blamed the Allied reparation burdens and simultaneously denounced speculators for the depreciation. Dr. Havenstein, the President of the Reichsbank, embracing every conceivable theory that exculpated his policies, also pointed at the speculators. Before a parliamentary committee he testified: « On the 28th of March began the attack on the foreign exchange market. In very numerous classes of the German economy, from that day onwards, thought was all for personal interests and not for the needs of the country. »12
In a chorus the newspapers chanted the charge:
According to all appearances the fall of the mark did not have its origin in the New York exchange, from which it may be concluded that in Germany there was active speculation directed towards the continual rise of the dollar.
We are witnessing a rapid increase in the number of those who speculate on the fall of the mark and who are acquiring vested interests in a continual depreciation.
The enormous speculation on the rise of the American dollar is an open secret. People who, having regard to their age, their inexperience, and their lack of responsibility, do not deserve support, have nevertheless secured the help of financiers, who are thinking exclusively of their own immediate interests.
Those who have studied seriously the conditions of the money market state that the movement against the German mark remained on the whole independent of foreign markets for more than six months. It is the German bears, helped by the inaction of the Reichsbank, who have forced the collapse in the exchange.13
In its broadest sense speculation is present in every economic action that makes provision for an uncertain future. The student who studies aeronautical engineering speculates on the future demand for his services. The businessman who enlarges his inventory speculates on a profitable market in the future. The housewife who hoards sugar speculates on the availability of sugar in the future. The buyer or seller of goods or securities hopes to make a profit from future changes in prices. All such actions reflect a natural motivation of free men to improve their material well-being or, at least, to avert losses.
When speculators observe or anticipate more inflation and monetary depreciation they naturally endeavor to sell the depreciating currency and buy goods or foreign exchange that do not depreciate. They are preserving their working capital. Thus they are promoting not only their own interests but also those of society, which benefits from the preservation of productive capital. The government that is actively destroying the currency is injuring the national interest — successful speculators are safeguarding it. Surely the speculators who sold German marks and bought US dollars were proved to be right in the end.
The worldwide inflation that is engulfing the western world now springs from similar doctrines and theories. There is no Treaty of Versailles and no reparation payments that can be blamed for the present inflation. But in many countries of Central and Western Europe the responsibility for monetary depreciation is squarely laid on American balance-of-payments deficits that are flooding those countries with US dollars. While European monetary authorities are actively inflating and depreciating their own currencies — although at slower rates than their American counterparts — they are pointing at the US balance of payments as the ultimate cause of their currency depreciation. As in the German hyperinflation, foreign intrigue and artifice are said to be at work again.
American officials and politicians are quick to lay the blame for US difficulties on foreign intrigue, especially that of « the Arabs. » Since the formation of the oil producers’ cartel and the significant boost in oil prices, US balance-of-payments deficits and the dollar weakness in foreign exchange markets are charged explicitly to the Arab countries. Lest any suspicion should fall on the US monetary authorities, the American people themselves come in for some of the blame. Their use of « excessive » quantities of foreign oil is said to contribute to the balance-of-payments deficits and the dollar weakness. Therefore, our political leaders and economic authorities are debating the desirability of special taxes that would reduce the consumption of foreign oil. After the Arab blow at economic well-being the US government is readying its blow for the sake of financial stability.
Again the speculators are charged for a share of the blame American investors who buy foreign securities or make direct foreign investments are said to be largely responsible for the outflow of US funds and the loss of gold, which is creating an unfavorable balance of payments and weakening the dollar. Moreover, Americans who prefer foreign products over homemade products or choose to travel abroad rather than stay at home are decried as selfish and unpatriotic. Numerous regulations imposed by the very monetary authorities who perpetrate the inflation aim to prevent speculation in order to save the dollar.
The specious argument that denies the presence of any inflation in terms of purchasing power or gold value has, in our judgment, not yet been raised. But it must be expected to emerge in later phases of the inflation when our authorities will be desperate for any argument that promises to exculpate them.