[R-G] [BillTottenWeblog] Key Points About Hyperinflation

[Bill Totten]

by Eric deCarbonnel

marketskeptics.com (April 21 2009)

The encyclopedia (Farlex) explains hyperinflation:

My comments are in square brackets [ ... ]

Hyperinflation

Rapid and uncontrolled inflation, or increases in prices, usually
associated with political and/or social instability, as in Germany in
the 1920s.


Inflation during World War One

The hyperinflation that blighted Germany between 1920 and 1923 had its
roots in World War One. Prices rose by 240% between 1914 and 1919. This
figure was equivalent to price rises in France and the UK, but masked
more serious problems in Germany. The Germans had borrowed vast sums to
fund the war. When supplies of funds proved inadequate, the German
central bank, the Reichsbank, simply lent itself money and printed new
banknotes. The currency was not backed by gold after 1914, so there was
no limit on the amount of money that could be printed. The amount of
marks in circulation rose by 300% between 1914 and 1919. This resulted
in limited inflation at the end of the war, but the seeds of later
problems were sown.

Post-war expenditure

The new Social Democratic government of the Weimar Republic had great
plans to improve the conditions of the poor in Germany. Improved
education, welfare, and more jobs were promised. These were expensive
programmes to deliver, more expensive than the government could really
afford in 1919. To finance them the government borrowed more money and
printed more currency. Prices rose by 400% between 1919 and 1920, yet
the German government did little to try to stop the rise. Prices did
actually stabilize after 1920, partly due to improved exchange rates.
Import prices fell by fifty percent. However, the government did not act
to stop future price rises. In fact they simply carried on printing more
money to pay for the price rises. Between 1920 and 1921 the supply of
money increased by fifty percent. At this stage a loaf of bread cost two
marks.


The burden of reparations

The shadow of Germany's defeat in World War One and the reparations
demanded by the Allies hung over Germany throughout this period. Under
the terms of the Treaty of Versailles (1919) following the end of World
War One, Germany was forced to sign a 'War Guilt clause' and pay
reparations (compensation) for the damage Germany had done to the
economies and infrastructure (buildings, communication networks, and
utilities) of the Allies. In 1921 the Allies presented the Germans with
their demands for payment, a sum of GBP 6.6 billion (132 billion gold
marks). Germany was already in financial trouble, and the only way its
government could see to pay the reparations was through the printing of
more money. Without this bill, the German government may have been able
to adopt a more sensible policy and avoid some of the worst effects of
the hyperinflation that followed. As the defeated nation, however, the
Germans had no way to avoid paying the Allied demands.


Attempts to control inflation in 1922

The impact of reparations on the German economy was catastrophic at a
time when social and political upheaval was widespread under Germany's
new democratic constitution. Prices were already rising fast by the
start of 1923. The number of items in the shops stayed the same, but
there was suddenly more money around to spend on them, so prices started
to rise. When the government printed more money to meet the new prices,
the price rises began to become astronomical. In the twelve months
before January 1923 prices rose to more than 75 times their January 1922
levels. A loaf of bread now cost 450 marks. The German government seemed
powerless to stop the inflation. In fact they were making it worse. They
tried to support the value of the mark against foreign currencies by
buying German marks from abroad. By raising the demand for marks they
hoped they would become more valuable and reduce inflation. This was a
total failure, and merely led to the Germans spending much of their
precious gold and foreign currency reserves to buy worthless German
marks. The German government also carried on printing more and more
money to meet the demand, which just led to higher price rises. The
German government also refused to raise the interest rate for borrowing,
which encouraged business people to take out ever larger loans, secure
in the knowledge that they would be able to pay them back with worthless
currency. This further increased the demand for money and meant more had
to be printed. However, at this stage price rises were nowhere near the
levels to be seen in 1923.


Franco-Belgian invasion

With rising debts and an increasingly worthless currency, the Germans
stopped paying the reparation payments demanded by the Allies. The
response of the French and Belgians was to occupy the German industrial
region of the Ruhr in January 1923. They intended to get their
reparations from the German factories and mines in the form of goods and
raw materials. The impact on the German economy was devastating. With
the loss of so much industrial production and income the German economy
faltered. This alone would have led to higher inflation, but the
response of the German government made the situation worse. They
organized strikes in the Ruhr, and paid the striking workers' wages out
of government funds. Of course the government had no money, so simply
printed more cash to pay the workers. The government employed 300 paper
mills 24 hours a day to turn out the currency. As prices rose the
denomination of marks on notes was changed. Notes bearing one figure
were recalled to have a new figure printed on them. The government
believed it had to supply the demands for more cash or the economy would
grind to a halt. By October 1923 the government was printing 120,000
trillion marks a day, yet the demand was eight times the production. The
response of the government was to further increase production to 500,000
trillion marks. As money became worthless so people stopped using it and
began to barter for goods. The economy of Germany seemed to be
collapsing, and the government was simply making the problem worse
rather than solving it.


Effects on the German people

In 1920 a loaf of bread in Germany cost two marks. By June 1923 when the
hyperinflation was in full flow, a loaf of bread in Germany cost
430,000,000,000 marks. Prices rose by the hour. People sitting in bars
or coffee shops found that their second drink could cost twice as much
as their first. Images of the era include children using piles of
banknotes as building blocks or toys, and Germans wallpapering their
houses with banknotes [Anyone dying for a room wallpapered with 100
dollar bills? Give it a year, and you might just be in luck.] Workers
were paid up to three times a day. The wages would be collected in a
wheelbarrow and taken down to the shops to be spent as quickly as
possible, before prices rose any further.

Shopkeepers found it almost impossible to make money. Unless they could
spend their takings on new supplies immediately, they would be unable to
restock their shops with goods. Many shopkeepers simply closed their
doors, or opened as little as possible. Goods became hard to come by.
Farmers refused to bring their produce to the towns as the money they
received was worthless by the time they came to spend it. There were
riots in Berlin and other German cities, and some workers organized
parties to go to the countryside and steal the farmers' produce out of
the ground. Trade unions bargained with employers for regular wage
increases, but these failed to keep pace with rising prices. At first
workers believed they were doing well, but this feeling soon disappeared
as they struggled to support their families. Those who were reliant on
pensions from the government fared very badly. The government failed to
raise benefits fast enough to keep up with price rises and pensioners
struggled to survive. People with investments in bank accounts saw their
value vanish overnight. Any income generated was worthless. Tax receipts
for the government stopped, as people realized that they could reduce
their taxes to virtually nothing to pay if they waited a few months to
pay. With money increasingly worthless, the government lacked the
incentive to collect taxes. By October 1923 just one percent of
government expenditure was covered by taxes. To make up the shortfall
the government simply printed new notes to cover the remaining 99% of
expenditure.

Many Germans gained from the hyperinflation. People with property were
able to ride out the storm, while those with debts or mortgages saw
their value disappear and their debt payments effectively end.
Businesses were able to borrow money, spend it on new machinery, and
then pay back virtually nothing to the banks. Bankruptcies became almost
unknown. In 1913 around 10,000 German firms went out of business due to
their debts. In 1923 the figure was less than 200. The speed with which
Germans had to spend their money meant that demand in the shops was
actually higher than before the period of hyperinflation. In response to
this companies employed more workers, and unemployment effectively ended
by 1923. Banking jobs, for example, rose from 100,000 in 1913 to 375,000
in 1923. Companies opened new factories to supply the high demands of
Germans desperate to part with their cash. The German government also
benefited in at least one way. During World War One the government had
borrowed vast sums to finance the war effort. As the hyperinflation
rose, the government saw its debts being wiped out.


The solution

With Germany on its knees, the government finally acted. A new
centre-right government had been established in August 1923 led by
Gustav Stresemann, a renowned politician of the liberal right-wing
German People's Party. The German government realized eventually that it
would be unable to defeat the French and Belgian invasion, and would
have to accept the agreed reparations. Resistance to the French and
Belgian forces was abandoned. Reparation payments were restarted, and
economic stability was re-established. In November 1923 the government
called a halt to new currency issues of marks. A new currency, the
Rentenmark, backed by land and property was created. The new government
led by Stresemann realized the mistakes made in the past and tried to
solve them. Each Rentenmark was exchangeable for one trillion old marks
with a limit of 2.4 billion Rentenmarks to be issued. The government
also cut its expenditure, partly by sacking around 700,000 employees.
However, reparations remained a problem.

In April 1924 the US government brokered a deal with Streseman known as
the Dawes Plan, a scheme initiated by US republican politician Charles
Dawes to help Germany pay off its enormous war debts. This reduced
Germany's annual payments to more manageable levels, and arranged for
the Germans to receive loans of 800 million gold marks from banks and
businesses in the USA and Europe. In August 1924 the Rentenmark was
replaced with a new Reichsmark of equal value. The new currency had
backing from gold so inspired confidence. Taxes were raised and by 1925
the German government actually had a surplus. The Pact of Locarno (1925)
settled the frontiers between Germany, France, and Belgium.


Long-term impact on Germany

The hyperinflation of the early 1920s had a negative impact on the
democratic stability of the Weimar Republic. Although there was economic
recovery from 1924 to 1929 with the assistance of US loans, confidence
in the democratic politicians who led Germany was shattered [This will
be seen again here in the US]. When the USA demanded its loans back
after the Wall Street Crash of 1929, the German economy collapsed again.
Much of the middle class, many of whom lost everything in the early
1920s, supported the Nazis after 1929 as they had lost all confidence in
the democratic politicians handling of the German economy. The workers
of Germany also abandoned the democrats, moving their support to German
communism. This collapse of support for democracy was not simply the
result of the hyperinflation crisis of the early 1920s, but it had a
major impact on the German people. With the second economic collapse
after 1929 Germans no longer believed that the politicians who had led
them to two economic disasters in the space of ten years were capable of
running Germany. The opportunity for extreme political forces to gain
power was great, with both communist and fascist parties threatening
rebellion. Within four years of the Wall Street crash the destruction of
the democratic dream of 1919 was complete and Adolf Hitler's Nazi state
was in place.

_____


My reaction: This well written article summarizes some key points about
hyperinflation.

1) Hyperinflation begins, always, with budget deficits. Governments
promise more than they can afford, racking up debt. When this
accumulation of debt reaches the breaking point, a loss of confidence
and currency collapse begins.

2) Instead of keeping budget steady in the face of rising prices, most
governments adjust spending upwards to compensate for inflation. This
increasing government spending, paid for with printed currency, is what
makes price rises become astronomical during hyperinflation.

3) In a currency collapse, the government's initial reaction is usually
to support their currencies. For example, the US is supporting the
dollar using currency swaps. These efforts always prove useless,
worsening the eventual collapse by squandering resources and racking up
foreign debt.

4) During currency collapse, governments also refuse to raise interest
rates (because this would make financial system insolvent). These low
interest rates are used to speculate against the currency, making
hyperinflation worse.

5) Shopkeepers/retailers find it almost impossible to make money during
hyperinflation. Rising costs make it impossible to restock shops with
goods. With the US's economy so dependent on retail sector, this is a
nightmare waiting to happen.

6) Many people end up gaining from the hyperinflation:

(a) Those with debts or mortgages see their value disappear and their
debt payments effectively end.

(b) Businesses were able to borrow money, spend it on new machinery, and
then pay back virtually nothing to the banks.

(c) The government's debts are wiped out.

7) Once the government finally finds the resolve needed to stop the
hyperinflation, the steps to stabilize prices are:

(a) Stop printing money and introduce a new currency

(b) Cut expenditure (by laying off hundreds of thousands of government
employees)

(c) Renegotiate (or default on) national debt

(d) Raise taxes

8) Hyperinflation shatters confidence in the politicians and political
institutions. Even more, hyperinflation undermines faith in democracy
itself, which can lead to extremist forms of government (such as facism,
et cetera)


Conclusion: Hyperinflation happens because of irresponsibility at the
national level. Politicians spend more than the nation can afford, and,
when prices start rising, they don't have the political will to take the
steps necessary to stop it.

It will be interesting to see what the long term effects of the dollar's
collapse will have on the US political system. Right now it is too early
to tell what those effects will be.


Here are some past entries on hyperinflation:

What life looks like during hyperinflation
http://www.marketskeptics.com/2008/12/what-life-looks-like-during.html

What Is Hyperinflation?
http://www.marketskeptics.com/2008/12/what-is-hyperinflation.html

Models of Hyperinflation
http://www.marketskeptics.com/2008/12/models-of-hyperinflation.html

How Deflation Creates Hyperinflation
http://www.marketskeptics.com/2008/12/how-deflation-creates-hyperinflation.html

The Dynamics of Inflation and Hyperinflation
http://www.marketskeptics.com/2008/12/dynamics-of-inflation-and.html

The Nightmare German Inflation
http://www.marketskeptics.com/2008/12/nightmare-german-inflation.html


http://www.marketskeptics.com/2009/04/key-points-about-hyperinflation.html

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