Hyperinflation in the Weimar Republic
In order to pay the large costs of the First World War, Germany suspended the convertibility of its currency into gold when that war broke out. Unlike France, which imposed its first income tax to pay for the war, the German Kaiser and Parliament decided without opposition to fund the war entirely by borrowing, a decision criticized by financial experts like Hjalmar Schacht even before hyperinflation broke out. The result was that the exchange rate of the Mark against the US dollar fell steadily throughout the war from 4.2 to 8.91 Marks per dollar. The Treaty of Versailles, further accelerated the decline in the value of the Mark, so that by the end of 1919 more than 6.7 paper Marks were required to buy one US dollar.
German currency was relatively stable at about 60 Marks per US Dollar during the first half of 1921. Because the Western theatre was mostly in France and Belgium, Germany had come out of the war with most of its industrial power intact, a healthy economy, and in a better position to become the dominant force on the European continent. However the "London ultimatum" in May 1921 demanded reparations in gold or foreign currency to be paid in annual installments of 2,000,000,000 (2 billion) goldmarks plus 26 percent of the value of Germany's exports.
The first payment was made when due in June 1921. That was the beginning of an increasingly rapid devaluation of the Mark which fell to less than one third of a cent by November 1921 (approx. 330 Marks per US Dollar). The total reparations demanded was 132,000,000,000 (132 billion) gold marks, of which Germany only had to pay 50 billion marks (a sum less than what they had offered to pay).
Because reparations were required to be repaid in hard currency and not the rapidly depreciating Papiermark, one strategy Germany employed was the mass printing of bank notes to buy foreign currency which was in turn used to pay reparations. This greatly exacerbated the inflation rates of the paper mark.
Beginning in August 1921, Germany began to purchase foreign currency with Marks at any price, but that only increased the speed at which the Mark declined in value. The lower the Mark sank on foreign exchanges, the more marks were required to buy the foreign currency demanded by the Reparations Commission.
During the first half of 1922, the Mark stabilized at about 320 Marks per Dollar. This was accompanied by international reparations conferences, including one in June 1922 organized by U.S. investment banker J. P. Morgan, Jr. When these meetings produced no workable solution, the inflation changed to hyperinflation and the Mark fell to 800 Marks per Dollar by December 1922. The cost-of-living index was 41 in June 1922 and 685 in December, a 15-fold increase.
In January 1923 French and Belgian troops occupied the Ruhr, the industrial region of Germany in the Ruhr valley to ensure that the reparations were paid in goods, such as coal from the Ruhr and other industrial zones of Germany. Because the Mark was practically worthless, it became impossible for Germany to buy foreign exchange or gold using paper Marks. Instead, reparations were paid in goods. Inflation was exacerbated when workers in the Ruhr went on a general strike, and the German government printed more money in order to continue paying them for "passively resisting."
By November 1923, the American dollar was worth 4,210,500,000,000 German marks.
As a result of hyperinflation, there were news accounts of individuals in Germany suffering from a compulsion called zero stroke, a condition where the person has a "desire to write endless rows of [zeros] and engage in computations more involved than the most difficult problems in logarithms."
When a new currency, the Rentenmark, replaced the worthless Reichsbank marks on November 16, 1923 and 12 zeros were cut from prices, prices in the new currency remained stable. The German people regarded this stable currency as a miracle because they had heard such claims of stability before with the Notgeld (emergency money) that rapidly devalued as an additional source of inflation. The usual explanation was that the Rentenmarks were issued in a fixed amount and were backed by hard assets such as agricultural land and industrial assets, but what happened was more complex than that, as summarized in the following description.
In August 1923, Karl Helfferich proposed a plan to issue a new currency (Roggenmark) backed by mortgage bonds indexed to market prices (in paper Marks) of rye grain. His plan was rejected because of the greatly fluctuating price of rye in paper Marks. The Agriculture Minister Hans Luther proposed a different plan which substituted gold for rye and a new currency, the Rentenmark, backed by bonds indexed to market prices (in paper Marks) of gold.
The gold bonds were defined at the rate of 2790 gold Marks per kilogram of gold, which was the same definition as the pre-war goldmarks. The rentenmarks were not redeemable in gold, but were only indexed to the gold bonds. This rentenmark plan was adopted in monetary reform decrees on October 13–15, 1923 that set up a new bank, the Rentenbank controlled by Hans Luther who had become the new Finance Minister.
After November 12, 1923, when Hjalmar Schacht became currency commissioner, the Reichsbank, the old central bank, was not allowed to discount any further government Treasury bills, which meant the corresponding issue of paper marks also ceased. Discounting of commercial trade bills was allowed and the amount of Rentenmarks expanded, but the issue was strictly controlled to conform to current commercial and government transactions. The new Rentenbank refused credit to the government and to speculators who were not able to borrow Rentenmarks, because Rentenmarks were not legal tender. When Reichsbank president Rudolf Havenstein died on November 20, 1923, Schacht was appointed president of the Reichsbank. By November 30, 1923, there were 500 million Rentenmarks in circulation, which increased to 1 billion by January 1, 1924, and again to 1.8 billion Rentenmarks by July 1924. Meanwhile, the old paper Marks continued in circulation. The total paper Marks increased to 1.2 sextillion (or 1,200,000,000,000,000,000,000) in July 1924 and continued to fall in value to one third of their conversion value in Rentenmarks.
The monetary law of August 30, 1924 permitted exchange of each old paper 1 trillion Mark note for one new Reichsmark, equivalent in value to one Rentenmark.
Eventually, some debts were reinstated to compensate in part those who had been creditors. A decree of 1925 reinstated some mortgages at 25% of face value in the new Reichsmark (effectively 25,000,000,000 times their value in old marks) if they had been held 5 years or more. Similarly some government bonds were reinstated at 2-1/2% of face - to be paid after reparations were paid. Mortgage debt was reinstated at much higher percentages than government bonds. Reinstatement of some debts, combined with a resumption of effective taxation in a still-devastated economy, triggered a wave of corporate bankruptcies.
One of the important issues of the stabilization of a hyperinflation is the revaluation. In its customary sense it refers to the raising of the exchange rate of one national currency against other currencies. It also means revalorization – the restoration of the value of a currency depreciated by inflation. The German government had the choice either by means of a revaluation law to finish the hyperinflation quickly or to allow sprawling and the political and violent disturbances on the streets. The German Government argued in detail that the interests of creditors and debtors had to be fair and balanced. Neither the living standard price index nor the share price index or the property price index (for this time, however, not existing) were judged as relevant. The calculation of the conversion relation was considerably judged to the dollar index as well as to the wholesale price index. In principle the German government followed the line of market-oriented reasoning that the dollar index and the wholesale price index would roughly indicate the true price level in general over the period of high inflation and hyperinflation. In addition the revaluation was bound on the exchange rate Mark and North American Dollar, based on the Berlin Bourse to obtain the value of the Goldmark.
The Law on the Revaluation of Mortgages and other Claims of 16 July 1925 (Gesetz über die Aufwertung von Hypotheken und anderen Ansprüchen or Aufwertungsgesetze, a.k.a. the Revaluation Act 1925) finally included only the relation of paper mark to gold mark for the period from 1 January 1918 to 30 November 1923 and the following days. This led to the fact which was given up the A Mark is worth a Mark principle recognized till then (nominal value principle) because of the galloping inflation. This law was challenged in the Supreme Court of the German Reich (Reichsgericht). The 5th Senate of the German Supreme Court (Reichsgericht) ruled on 4 November 1925 that the Revaluation Act 1925 was constitutional, even when weighed against the "Bill of Rights and Duties of Germans" (articles 109, 134, 152, and 153 of the Constitution). This case was precedence-setting for the issue of judicial review in German jurisprudence.
The hyperinflation episode in the Weimar Republic in the early 1920s was not the first hyperinflation, nor was it the first one in Europe, or even the most extreme inflation in history (the Hungarian pengő and Zimbabwean dollar have both been more inflated). However, as the most prominent case following the emergence of economics as a scholarly discipline, the Weimar hyperinflation drew interest in a way that previous instances had not. Many of the dramatic and unusual economic behaviors now associated with hyperinflation were first documented systematically in Germany: order-of-magnitude increases in prices and interest rates, redenomination of the currency, consumer flight from cash to hard assets, and the rapid expansion of industries that produced those assets. German monetary economics was then highly influenced by Chartalism and the German Historical School, and this conditioned the way the hyperinflation was then usually analyzed.
John Maynard Keynes described the situation in The Economic Consequences of the Peace: "The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance."
It was during this period of hyperinflation that French and British economic experts began to claim that Germany destroyed its economy with the purpose of avoiding reparations, but both governments had conflicting views on how to handle the situation. The French declared that Germany should keep paying reparations, while Britain sought to grant a moratorium that would allow for its financial reconstruction.
Reparations accounted for about one third of the German deficit from 1920 to 1923, and were therefore cited by the German government as one of the main causes of hyperinflation. Other causes cited included bankers and speculators (particularly foreign). The inflation reached its peak by November 1923, but ended when a new currency (the Rentenmark) was introduced. In order to make way for the new currency, banks "turned the marks over to junk dealers by the ton" to be recycled as paper.
Although the inflation ended with the introduction of the Rentenmark and the Weimar Republic continued for a decade afterwards, hyperinflation is widely believed to have contributed to the Nazi takeover of Germany and Adolf Hitler's rise to power. Adolf Hitler himself in his book, Mein Kampf, makes many references to the German debt and the negative consequences that brought about the inevitability of "national socialism". Some economists, however, point out that Hitler's rise was immediately preceded by the 1931 economic crisis, which, while also being partially triggered by Germany's debt, was, unlike the hyperinflation crisis of 1923, characterized by massive deflation created by a government austerity program. Keynesian economist Paul Krugman concurred that the "1923 hyperinflation didn’t bring Hitler to power; it was the Brüning deflation and depression." The inflation also raised doubts about the competence of liberal institutions, especially amongst a middle class who had held cash savings and bonds. It also produced resentment of bankers and speculators, whom the government and the press blamed for the inflation crisis. Some antisemitic Germans called the hyperinflated Weimar banknotes "Jew confetti".
Later German monetary policy showed far greater concern for maintaining a sound currency, a concern that even affected Germany's attitude in resolving the European sovereign debt crisis from 2009 onwards.
The hyperinflated, worthless Marks became widely collected abroad. The Los Angeles Times estimated in 1924 that more of the decommissioned notes were spread about the United States than existed in Germany.
The cause of the immense acceleration of prices that occurred during the German hyperinflation of 1922–23 seemed unclear and unpredictable to those who lived through it, but in retrospect was relatively simple. The Treaty of Versailles imposed a huge debt on Germany that could be paid only in gold or foreign currency. With its gold depleted, the German government attempted to buy foreign currency with German currency, an action equivalent to selling German currency in exchange for payment in foreign currency, but the resulting increase in the supply of German marks on the market caused the German Mark to fall rapidly in value, which greatly increased the number of Marks needed to buy more foreign currency. This caused German prices of goods to rise rapidly, increasing the cost of operating the German government, which could not be financed by raising taxes because those taxes would be payable in the ever-less-valuable German currency. The alternative was some combination of running a budget deficit and simply creating more money, each of which increased the supply of German currency on the market and reduced that currency's price. When the German people realized that their money was rapidly losing value, they tried to spend it quickly. This increase in monetary velocity caused still more rapid increase in prices, creating a vicious cycle. This placed the government and banks between two unacceptable alternatives: if they stopped the inflation this would cause immediate bankruptcies, unemployment, strikes, hunger, violence, collapse of civil order, insurrection, and revolution. If they continued the inflation they would default on their foreign debt. The attempts to avoid both unemployment and insolvency ultimately failed when Germany had both.
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