We recently wrote The Case For A Higher Gold Price Based On Monetary History, which describes the analogy between the end of Bretton Woods and a potential end of the current hegemony of the US dollar as a reserve currency. Today we present another case in monetary history: Germany in the 20th century. This case is particularly interesting because it’s often cited as a prime example of hyperinflation. The key question in this case is what the root cause was of the hyperinflation and which measure(s) brought the situation back under control. Ultimately, here at GoldSilverWorlds, we are interested in understanding if there is any link with Gold.
While researching what exactly caused Germany’s hyperinflation of 1923, we’ve found an extremely insightful paper in the scientific directory Citeseerx. The paper is entitled “Germany Monetary History in the First Half of the Twentieth Century” and is written by Robert Hetzel. The document provides an in-depth analysis of Germany’s situation before, during and after the hyperinflationary period. Below are the highlights from the paper; the full version of the document is embedded below.
The hyperinflation had its roots in the World War I. Germany, just like many other countries in the West, gave up the gold standard in 1914 in order to finance the world war. By abandoning its gold standard, a country becomes free to create theoretically unlimited amounts of money, with the only limitation the speed of the printing press. Money creation can serve short term objectives like financing a war, but there are long term effects which can be very nasty and painful mainly for the citizens, making the short term objective unworthy. The quantity of Germany’s monetary base expansion is presented in the chart below (see dotted line). The chart shows as well the rate of inflation. Source: paper page 5.
Interestingly, the chart shows that the monetary base initially grows at a faster pace than inflation. Between 1914 and 1918, the monetary base doubled. Although there was a period of “stabilization” until 1921, “something” triggered the hyperinflation to take off during 1922. Here it becomes “interesting”: the ultimate trigger was the loss of trust in the government’s policy and debt. As foreign capital refused to buy Germany’s debt anymore, the exchange rate depreciated (i.e. currency debasement) and the rate of inflation accelerated considerably. While it was a certainty that inflation would hit, the timing was determined by the loss of confidence. Do you see an analogy with today?
After the hyperinflationary tragedy, Germany abandoned the weak monetary policy and returned to a fixed monetary base. The paper reports the following on page 20: “The currency reform of 1948 ended price controls and introduced the deutsche mark. The ensuing period of strong economic growth (the Wirtschaftswunder) and the resulting monetary stability contrasted with the hyperinflation and subsequent deflation of theWeimar Republic. That contrast bred the presumption that economic and social stability required monetary stability, and this widespread presumption later created popular support for the “stability” policy of the Bundesbank.”
The key takeaway here is that a stable currency, based on a stable monetary base, is the cornerstone and an absolute condition for economic growth, which results in social stability. The most obvious way for a stable monetary base is a gold standard, in whatever form it comes. Now that’s exactly the opposite of what we see in today’s Western world. Just like Germany following 1914, we see governments all over the world monetizing their public and private debt. The only backing is the US dollar as a world reserve currency, which is undergoing truly an explosion in its monetary base. Sadly, the newly created money is used to monetize debts, resulting in a declining impact on the productivity, as seen on the graph. For how long can this reserve currency be trusted? In other words, what is happening with the (perceived) counterparty risk? Is hyperinflation around the corner?
Germany’s case carries as message, as confirmed in the conclusion of the paper: “The end of WorldWar II had left Germany without national institutions. The deutsche mark became the first national symbol of the new Germany. West Germany had the deutsche mark even before it had a flag. Capie and Wood refer to the deutsche mark as “at once a cause and a symbol of Germany’s recovery.” Germans prized the stability of the mark as a symbol of its social stability and economic prosperity. The deutsche mark symbolized everything that Germany did right after the War.”