"Lessons From the Weimar Republic"

Sydney M. Williams

Thought of the Day

“Lessons From the Weimar Republic”

October 22, 2010

The story of Germany’s dazzlingly descent into destructive hyperinflation in the early 1920s was vividly retold by Art Cashin of UBS a little over a week ago in one of his daily “Cashin’s Comments”. Mr. Cashin wrote: “At the start of World War I the exchange rate had been a mere 4.2 marks to the dollar…[Nine years later], by late November 1923, you would need 4.2 trillion marks to get one dollar.” In the previous twelve months, the rate of inflation had soared by a factor of 2000.

Art Cashin uses the example of a loaf of bread, which, in dollar terms, cost $0.13 a loaf in 1914. Four years later, after the war, that same loaf cost $0.19. In the middle of 1922, it cost $3.50 and by the end of the year it cost $700.00. Eleven months later, in mid November 1923, that same loaf cost $100 billion.

The German people largely blamed the cause of the hyperinflation on two factors: the debilitating reparations that the Allies demanded of Germany, and on bankers and speculators. There is little dispute that the total level of reparations was punitive, to say the least. The 132 billion gold marks demanded would be roughly equivalent to $6 trillion in today’s dollars, an amount roughly two times Germany’s current annual GDP. The terms of the Armistice called for annual payments of 2 billion gold marks, plus 26% of the value of their exports.

John Steinbeck once wrote that people have a need, especially in times of stress, to find a cause for their problems. The German people were no different. Anti-Semitism rose, as people looked for someone to blame (other than themselves); Jewish bankers became an easy and visible target, setting the stage for Hitler and National Socialism.

But the real cause of the inflation was simpler; it was the excessive printing of money. Germany was inundated with debt. Many of the buyers were foreign, most of whom recalled Germany’s glorious past and could not conceivably foresee her despicable future. Inflating one’s way out of debt is tempting. In the early months many businesses accepted inflation and quickly learned to adapt – borrowing marks, speculating in foreign exchange, and converting money into hard assets, goods and fixed plant.

But the problem with inflation is that it is insidious. Savers are penalized. It is seductive; it often starts modestly and then can accelerate geometrically, entrapping the people.

In the United States, we had a taste of inflation in the late 1970s. Fortunately, President Carter nominated Paul Volcker to be Chairman of the Federal Reserve, and then President Reagan gave him the reins he needed to stop inflation, inducing a recession, but saving the country from something far worse.

The story of Germany’s exodus from the clutches of hyperinflation is fascinating in its simplicity. On November 12th, 1923 Hjalmar Schacht became currency commissioner. On the 16th, the Rentenmark was introduced on the basis of one Rentenmark for one trillion Reichsbank marks. Rentenmarks were introduced slowly and backed by hard assets. Since the Rentenmark, at this point, was not legal tender, the new Rentenbank refused credit to government and speculators who could not borrow Rentenmarks, for there were few around. However, the discounting of trade bills was allowed and the amount of Rentenmarks gradually expanded, but in a controlled manner.

On November 20th Reichsbank president Rudolf Havenstein died and Hjalmar Schacht was named president. By November 30th there were 500 million Rentenmarks in circulation. By January 1, 1924 the number had increased to a billion and to 1.8 billion by July. The old Reichsbank marks continued to depreciate. Nevertheless, the currency had stabilized and by August 1924, everyone was able to convert their old Reichsbank marks on the basis of a trillion for one.

However, the ground had been laid for the emergence of National Socialism. It would take another ten years before Hitler took control of the government, buried the Weimar Republic and assumed dictatorial powers granted him by the Third Reich. In 1938, Hitler and his minions began a military campaign that ultimately cost 70 million people their lives – thirty million of them civilians.

We should never forget those ravages of inflation ninety years ago, its social as well as its financial consequences and how easily it can slip under the tent virtually undetected. When debt becomes overwhelming (and many of its owners non nationals), the easy path is to keep rates low, continue to print money and let the currency slide. Among the things we learn from reading history is that things are often not what they seem. Perception and reality become blurred. Actions (and inaction) have consequences. History helps us to understand how people respond to events, to try to anticipate behavior.

Thomas M. Hoenig, President of the Federal Reserve of Kansas City gave a speech ten days ago in Denver in which he questioned the need for another round of quantitative easing. He worries that it could lead to a commitment to keep funds rates too low and the Fed’s balance sheet too large. “The natural tendency”, he said, “will be to maintain an accommodative policy for too long.” He worried that inflation expectations might become unanchored. As regards to the current policy of zero rates, he said: “Zero rates distort market functioning…zero rates lead to a search for yield and, ultimately, the mispricing of risk; zero rates subsidize borrowers at the expense of savers.” Words to ponder.

The financial crisis we experienced two years ago continues to reverberate. We entered new territory and, while the system appears to have stabilized, commonsense suggests prudency. Those in emerging countries – those not subject to the legacy constraints of developed nations – are competing for goods and services; they are also competing for jobs. Their elevation to consumers means opportunity for some, but pain for others. Those, like numerous politicians, union members and others, who believe that the world will remain as it was will be disappointed. Shrinking debt at home and expanding competition from abroad will be painful for those who are incapable of adapting. The lessons from the Weimar Republic are worth remembering.