A Few History

GERMANY AND ITS PHOBIA OF PRICE INCREASES: HYPERINFLATION IN THE WEIMAR REPUBLIC Monthly Strategy Report April 2014 Pedro Sastre Head of Market Strategy G & FI IN NA K N N C A BEST E B ASSET & R L WEALTH E A V B MANAGEMENT I E O SPAIN W L 1 G 2013 A S W A R D Monthly Strategy Report. April 2014 GERMANY AND ITS PHOBIA OF PRICE INCREASES: HYPERINFLATION IN THE WEIMAR REPUBLIC “In the words of the ECB, the Eurozone faces a period of easing inflation. This easing of inflation, with occasional price drops in some of the region’s economies, fuels the threat of deflation and threatens the budding economic recovery. Germany is aware of the situation and the statements from the President of the Bundesbank, Jens Weidman, point to a certain degree of German permissiveness in taking measures that might lead to inflation. Not without bitterness, as history reminds us”. A 100 billion mark note. 1924 Hyperinflation in the Weimar Republic The phobia of the Bundesbank in particular, and the average German in general, and the call for tight control of prices is something that may at first glance be surprising. In the words of the ECB, we are experiencing a “period of slowdown in inflation of prices”, where the inflation forecasts remain well anchored and yet Germany continues to warn of the terrible consequences of a hypothetical uncontrolled rise in prices. Why? Perhaps we need to take a look at the not so distant past to understand such obstinacy... The period of hyperinflation, or the process in which prices skyrocket and the currency devalues, was experienced by Germany in the interwar period, known as the Weimar Republic. While it was not an isolated process in Europe, the hyperinflation experienced in Germany was a conflation of all possible negative factors: runaway price increases in parallel with a rise in interest rates, sharp changes in the exchange rate, and, eventually, the abandonment of the currency as a unit of exchange. But let’s get back to history. The First World War was nearing its end and the German empire had financed its needs during the war with enormous issues of paper money, the Papiermark, without gold backing or any possibility of conversion into the precious metal. This was something which, at the time, was not the established procedure; until the beginning of the war, the gold standard had been in place in Germany and any issue of paper needed to be backed up to be considered guaranteed. The monetary consequence of the war was the abandonment of the currency that had until then governed the German Empire, the Golden Mark or Goldmark. At the end of the Great War, the Treaty of Versailles required Germany to pay reparations for the damage caused by the war. It was very heavy, although not stifling, compensation and established the payment amounts and terms. The abandonment of the Goldmark, mentioned above, brought with it the maintenance of Papiermark use, with a surprisingly stable exchange rate against the dollar until mid-1921, of approx. 60 marks to the dollar. The scenario was aggravated in mid-1921, with London’s ultimatum demanding war reparations. The amount was set at 2,000,000,000 gold marks per year, an extremely difficult sum to return and the Monthly Strategy Report. April 2014 payment of which began in the summer of 1921. The output of “good” marks, i.e. those backed by gold, joined the growing issue of “bad” paper marks, with the latter used to finance the daily needs of the country. This led to an astronomical increase in the circulation of paper money in the country, and the spiralling devaluation of the mark. Hyperinflation started in the same year 1921 with a sharp fall in the exchange rate from the aforementioned 60 marks/$ to 320 marks/dollar. The total amount of reparations jumped to 132 billion gold marks, impossible to cover with its already depleted gold reserves. In a desperate attempt, the Weimar Republic began purchasing currency by paying in bonds from the public treasury and commercial paper, which did nothing but exacerbate the loss of value of the Papiermark. The process was compounded even further when the victorious powers, aware of the accelerated depreciation of the mark, began to demand payment of reparations in natural resources, especially iron, coal and wood. Failure to agree in subsequent conventions between the victorious power creditors and Germany regarding the amount of reparations was the final straw that led to uncontrolled price increases and sharp devaluation of the mark, which in 1922 stood at 8,000 marks to the dollar. The result: the ruin of German middle class savers, who saw the savings that they had deposited in banks evaporate. Without access to foreign currencies to protect themselves with against inflation and without access to basic foodstuffs after the cost of living multiplied over sixteen times, bartering began to emerge, although without much success in many cases due to the high degree of industrialization in the country. Then came the Notgeld, or “necessity money”, representing either sums of money or essentials. In any case, it was not a great success as the depreciation of the mark and the rise in prices remained major problems requiring a solution. Let’s look at a few practical examples: a loaf of bread that cost 163 marks in 1922 skyrocketed to 1,500,000 in September of the following year and cost 200,000,000 in November later on that year. The price of one egg in 1923 was equal to the cost of five million eggs ten years before. Finance Ministry officials were paid part of their salary in potatoes and restaurants stopped printing menus with prices because between the time when the food was ordered and the bills were paid, prices had already changed. At corporate level, we find that in late 1923 the automobile manufacturer Daimler was worth about $980 m according to the exchange rate, while a car cost $3 m. In short: the entire company was worth just 327 cars. The interest rate was around 5% in 1922 (similar levels to rates at the start of the war), but by the end of November 1923 it exceeded 900%. Furthermore, if in 1922 unemployment was non-existent, one year later it touched 30%, as shown in the following graph. Source: “The economics of inflation: a study of currency depreciation in post-war Germany”, 2003. Monthly Strategy Report. April 2014 This already very difficult scenario deteriorated further when France and Belgium invaded the Ruhr valley between January 1923 and August 1925. The reason was the clear inability of the Republic, headed by Friedrich Ebert, to handle the financial compensation imposed by the Allies after their defeat in the war. The payment of compensation would now be made in iron, coal and steel after all. It should be noted that the occupation caused surges of sympathy for Germany, which had no recourse at the League of Nations (the precursor to the United Nations), since, if the Treaty of Versailles was considered valid, the occupation was legal. Hyperinflation peaked in November 1923, at which time a new currency took shape: the Rentenmark. The government relied on this new fixed value currency, putting an end to the issue of banknotes. The solution proposed by Hjalmar Schacht, President of the Central Bank at the time, consisted of imposing a legal mortgage on the land and industrial goods existing in the country, which would back the new currency, for a total value of 3.2 billion Rentenmark. This conversion stopped the issue of more paper money without collateral, solving the problem of the lack of gold as a guarantee and finally allowing the beginning of the end of hyperinflation. After a transition period in which the Rentenmark was the official currency, in August 1924 the Reichsmark became the new legal currency in Germany, emerging with the same value as the Rentenmark. However, both currencies co-existed until the final disappearance of the Rentenmark in 1948. This historic event, which occurred more than 90 years ago, lives on in the collective Teutonic memory. It also partly explains the behaviour of the most powerful monetary institutions of the Eurozone: the ECB and the Bundesbank. The question we must ask ourselves is: will Germany be able to break free of the ghosts of its past and take a step forward with a view to a definitive recovery of the European economy?.

Load more