Hyperinflation in the Weimar Republic
Hyperinflation in the Weimar Republic
A warning for the not-so-distant future (Free)
Hyperinflation is one of the most destructive forces ever created by a man. Technically, it’s defined as a monthly increase in the consumer price index of over 50 percent. In practice, this means that, for example, the price of jeans rises at least by half every single month.
Hyperinflation destroys the public's faith in money, but also their faith in important civil society structures. This is why it's so destructive. People lose trust not just in money as a store of value, but also in the institutions they have trusted to govern and protect their livelihoods and well-being. This includes the banking system, the state and its public institutions as well as, possibly, even democracy itself. This breeds anarchy and other extreme movements. This is exactly what the hyperinflation in the Weimar Republic gave birth to.
The hyperinflation that hit the republic of Germany between June 1921 and July 1924 was not the first of its kind, but it occurred in one of the most developed economies at a time, when economics, more precisely macroeconomics, was making its big leap as a scholarly discipline. Although the hyperinflation occurred almost a hundred years ago, it still bears important lessons for today. Most importantly, its main lessons: how hyperinflation is born, who it hurts and where it leads to have been confirmed in several countries around the globe after Weimar.
Hyperinflation in Weimar's Republic is a prime example of the consequences of combining monetary and fiscal policies inappropriately. It explains why most economists until very recently so fiercely objected to any government financing from the central bank. It carries a warning we all should heed.
From a peace treaty to a hyperinflation
Germany had lost the First World War, which led to a deluge of war reparations from the winners, most notably from France and the Great-Britain, which for their part were burdened by the claims of the U.S. The Treaty of Versailles, a peacy agreement between Germany and the allied powers, demanded heavy reparations payed mostly in gold marks or in a foreign currency. The London Ultimatum, given in May 1919, set the final bill for Germany to soul-wrecking 250 percent of her GDP paid mostly in gold marks. To make matters worse, Germany had financed the war by borrowing heavily from abroad. So, at the end of the Great War, Germany was already deeply indebted to foreign investors.
Alas, the Weimar Republic faced an overwhelming national debt burden with economic structures in a dire need of a reform. The massive war reparations also led to a joint "tax revolt', where ordinary citizens deferred the submission of their returns and authorities delayed demands for arrears. Politicians decided that instead of painful reforms, austerity and a likely sovereign default, they would try to uphold national demand and production by social spending, which meant monetizing the budget deficits of the Republic from the central bank (Reichsbank).
A monetization typically proceeds as follows. The central bank buys the debt, bonds, issued by the finance ministry. Government then uses this money to increase or to sustain its consumption. The debt bought by the central bank then either remains in the balance sheet of the central bank ad infinitum, or the central bank nullifies it creating a loss. To cover the loss, the central bank issues new currency notes (physical or nowadays digital) in circulation to increase its revenue. This process results to a notable increase in the currency in circulation.
Yet, the main channel leading to the major increase in currency in circulation runs through the government. When the government uses this "debt" from the central bank to sustain or increase its consumption and investments, this newly created money enters the economy through goverment spending. Government effectively becomes the guarantor of jobs and profits of different industries with money created form "thin air". This is essentially what the Weimar Republic did. Instead of letting the economy to implode, and correct itself, it used newly created money to provide employment and investments to keep the economy afloat.
If production possibilities are limited at the same time, due to, e.g., damage from a war or due to wide-spread corporate bankruptcies, demand grows faster than production. In practice, there is more money chasing fewer products, and prices start to rise very rapidly. Moreover, politicians and bureaucrats tend not to be very skilled in efficient managing of businesses and they let views of the public to interfere their decisions (the very essence of being a 'politician'). This leads to unproductive and wasteful investments and thus to falling productivity.
When there’s more money in circulation with respect to production, that is, products and services, prices start to rise fast leading to accelerating inflation. As inflation accelerates, consumers, firms and workers start to expect ever-higher inflation, which, combined with the quickly-increasing supply of money from the central bank destroys public faith in the currency, and a very fast inflation ensues.
A research by Richard Burdekin and Paul Burkett showed that rising wage claims and demand for private credit that followed the monetization were major contributors to the hyperinflation in Weimar's Republic. The wage price index made spectacular leaps before the actual hyperinflation set in. It increased by 700% between November 1918 and March 1920, and by 500% percent between mid-1921 and mid-1922. The rate of inflation was actually much higher than the rate of monetization, implying that the targeted real wage rate of workers was an important factor driving the hyperinflation. This speaks on the importance of containing the expectation of inflation among the populace. When wage pressures (expectations) build to extreme levels, they are very hard to contain, which is the process that led to an extremely fast inflation in Weimar’s Germany.
So, hyperinflation tends to be caused by ordinary people and corporations expecting the purchasing power of currency to fall drastically. Essentially, people lose trust to the currency, and as money is first-and-foremost a product of public acceptance (trust) its value collapses. The example of the Weimar Republic thus shows that while pre-conditions for hyperinflation are 1) reckless central bank lending and 2) stagnant/collapsing production, they are just ‘starters’, developments that push hyperinflation into motion, which is then fed by the collapsing trust to the currency.
The central-bank financed bailout of the Weimar economy did create “full employment” with the unemployment rate hovering under four percent, but labor productivity fell dramatically. Moreover, the purchasing power of money was decimated. The price of gold in Germany reflects this monetary destruction.
The painful stabilization and destructive aftermath
The ravaging inflation was stopped by a combination of massive cutbacks in government spending and credit freezes. A new currency, the Reichsmark backed by gold, was also established.
The inevitable consequence of these actions was a recession, and a forced restructuring of the German economy. The recession was relatively short, but this was mostly due to the 'Dawes Plan', which lowered annual repayment instalments of war reparations and provided the Reich a foreign-currency loan. Belgium and France also withdrew their forces from the Ruhr region, which was the economic strong-hold of Germany. The 'transfer protection clause' of the Dowes plan meant that the claims of the private creditors had priority over reparations, which made Germany able to borrow vast amounts of foreign capital from which a vast part was used to extend services.
However, the hyperinflation sow the seeds to further economic calamity by leaving many German banks and corporations severly under-capitalized. Their failure was central on turning the global recession of early 1930s into the Great Depression (I’ll return to this in more detail in my third instalment on the series on the Great Depression).
The republic was also weak, with the government in desperate need for public support, because the social repercussions of hyperinflation had been high. The main losers in the Weimar hyperinflation were the middle class, pensioners, and professionals, as the purchasing power of their incomes fell, as well as creditors who essentially lost the principal of their debt obligations. The rich often had the means to hedge against ravaging inflation through buying precious metals, usually gold, by making suitable alternative financial investments and by transferring funds to sounder markets or currencies. Large corporations could also raise their prices in accordance with the input prices pressures much more easily than workers or small companies.
The public discontent, created by the hyperinflation, gave birth to several far-right and anarchistic movements. One of these was the National-Sozialistische Deutsche Arbeiterpartei, NSDAP better known as the Nazi Party, and their charismatic leader Adolf Hitler.
The hyperinflation effectively impoverished the friends and supporters of the newly formed republic, i.e., the middle-class, and empowered its enemies, i.e., rich industrialist and the elite, who did not want to lose their power to the masses in the new societal innovation called ‘democracy’. They chose to support a leader, who they thought they could control to ensure a return to an authoritarian rule. The industrialist provided their money, prestige and influence to support the NSDAP and its leader, Adolf Hitler. Lewis Hill, Charles Butler and Stephen Lorenzen conclude that: without the active commitment of the industrial leaders' substantial influence, Hitler's accession to power would probably have been impossible.
The paradox of money printing
The paradoxical feature of debt monetization, and similar schemes, is that they tend to hurt those they are originally aimed at helping the most, while creating a very dangerous societal backlash, the details of which are difficult to foresee. The hyperinflation in Weimar's Republic was the first hyperinflation in a developed country. Essentially, all the following hyperinflation periods, e.g., in Zimbabwe and in Venezuela, have followed similar patterns.
All periods of hyperinflation in history have been associated with debt monetization schemes from the central bank. This is why a government should never rely on the central bank to finance its deficits, whether consumption or investments. Such an action has the potential to grow extremely destructive economic and societal forces, and this is the process we are in the risk of repeating.
Our monetary future (of printing?)
There simply is no other way to avert the collapse of our economies than through massive money printing. I have detailed the reasons for this in my first instalment to the Economic Collapse series.
We at GnS Economics noted in our last Q-Review report (9/2022) that:
The question is, how do contemporary governments, frightened by crisis and the prospect of political instability, stop both the collapse of financial markets and the real economy?
Through massive market intrusion and socialization, naturally.
What would be required is never-before-seen central bank action. The Federal Reserve and other central banks would need to buy not just government bonds (as they have already in QE) but the majority of the universe of financial risk assets, which is estimated to top 400 trillion US dollars. Moreover, central banks would need to provide practically limitless fiscal support for governments to uphold or even increase their consumption and investment activities.
In this scenario, the balance sheets of major central banks would turn into investment vehicles with limitless boundaries. Central bankers would decide which countries and corporations would survive. They would effectively metastasize into Gosbanks (the central bank of the now-defunct Soviet Union) of the world. This would naturally lead to an utter, unrecognizable, global economic dystopia.
With endless central bank printed money pouring into corporations and governments, and governments competing to avoid strong currencies, inflation expectations would assuredly rise, and dramatically. Combined with high levels of corporate bankruptcies, this would create a perfect setup for accelerating inflation or even hyperinflation. Productivity would likely collapse at the same time.[2] Unlike our other, more benign scenarios, in this one society would be driven into anarchy as trust in institutions collapses. Extreme measures, through the introduction of a police state, would be needed to curtail the unrest. Anarchy would provide a breeding ground for extreme political movements, including those of both left and right. The long-run consequences of the “Great Inflation” would be utterly devastating and outside the experience of anyone now alive in the developed West. Thus, we clearly consider this our worst-case scenario.
This is the fate that is inching closer to us every single day as long as the central banks take a larger and larger role in our economies.
The question you should be asking is, what do you think central bankers and governments do, when the collapse commences? Will they let the economy to implode, most likely taking the government and the banking sector with it? Or, do they enact a gargantuan money printing as a last desperate effort to save the system from collapsing leading to a ravaging inflation?
It is of course impossible to know for sure, but I am voting for the latter. In any case, an economic purgatory awaits just around the corner.
Best,
Tuomas
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