The Organization for Economic Cooperation and
Development, which endeavors to achieve international coordination of
government policies, recently expressed alarm about the ever
accelerating rates of inflation. It called the pace of monetary
depreciation "unacceptably high" and warned about the inherent dangers
of a major business depression as a result of rampant inflation. In
fact, many European economists are convinced that "the Western world is
at the threshhold of a runaway inflation of the Latin-American type.
During the 1950's we had grown accustomed to a creeping
depreciation of currencies at an average rate of 2 per cent a year.
During the 1960's the rate had climbed to 4 and 5 per cent; last year it
reached 6 per cent, which is well beyond the creeping pace. And, if we
project the depreciation growth rates of the 1960's to the 1970's, we
must brace ourselves for inflation of 10 to 20 per cent annually.
We need not here analyze many political and social
aspects of this ominous development in the Western world. But we should
like to review the history of the greatest inflation of the century, the
German hyperinflation of the early 1920's, and the ideological causes
that brought it about. For history is the glass through which we may
behold the deeds and errors, the foibles and misfortunes of mankind.
The German inflation, too, began with a creeping rate
of one and two per cent. When World War I broke out, the central bank
(Reichsbank) immediately suspended redeemability of its notes in order
to prevent a run on its gold reserves. Then it offered assistance to the
central government toward financing the war effort. As taxes are always
unpopular the government preferred to borrow huge amounts of money to
cover its budgetary deficits. And the central bank assisted every issue
of new treasury obligations by discounting much of it. Thus, a large
percentage of government debt found its way into the vaults of the
Reichsbank and an equivalent amount of printing-press money into the
peoples' cash holdings. As in other belligerent countries, the central
bank was monetizing the growing government debt.
By the end of the war, the amount of money in
circulation had risen fourfold and prices some 140 per cent. Yet, the
German mark had suffered no more than the British pound, was somewhat
weaker than the American dollar, but stronger than the French franc.
Five years later, in December 1923, the Reichsbank had issued 496.5
quintillion marks each of which had fallen to one trillionth of its 1914
gold value.1
How stupendous! Practically every item of trade was
costing trillions of marks. The American dollar was quoted at 4.2
trillion marks, the American penny at 42 billion marks. How could a
European nation that prided itself on its high levels of education and
scholarly knowledge suffer such a thorough destruction of its money? Who
would inflict on a great nation such evil which had ominous economic,
social, and political ramifications not only for Germany but for the
whole world? Was it the victors of World War I who, in diabolical
revenge, devastated the vanquished country through ruinous financial
manipulation and plunder?
Every mark was printed by Germans and issued by a
central bank that was governed by Germans under a government that was
purely German. It was German political parties, such as the Socialists,
the Catholic Centre Party, and the Democrats, forming various coalition
governments, that were solely responsible for governmental policies. Of
course, admission of responsibility for any calamity cannot be expected
from any political party.
The reasoning that led these parties to inflate the
national currency at such astronomical rates is not only interesting for
economic historians, but also exposes the rationale of monetary
destruction. The doctrines and theories that led to the German monetary
destruction have been applied with similar consequences in many other
countries, and underlie the rampant inflation throughout the Western
world today.
Four erroneous doctrines or theories guided the German
monetary authorities in those baleful years.
No Inflation in Germany
The most amazing economic sophism
advanced by eminent fianciers, politicians, and economists endeavored to
show that there was neither monetary nor credit inflation in Germany.
These experts readily admitted that the nominal amount of paper money
issued was indeed enormous. But the real value of total currency in
circulation, that is, the total value in terms of gold or goods prices,
they argued, was much lower than before the war and low relative to that
of other industrial countries.
The Minister of Finance, celebrated economist
Helfferich, repeatedly assured his nation that there was no inflation in
Germany since the total value of currency in circulation, when measured
in gold, was covered by the gold reserves in the Reichsbank at a much
higher ratio than before the war.2
The President of the Reichsbank Havenstein
categorically denied that the Central Bank had inflated the German
currency. He was convinced that it followed a restrictive policy since
its portfolio was worth, in gold marks, less than half its 1913
holdings.
Professor Julius Wolf wrote in the summer of 1922: "In
proportion to the need, less money circulates in Germany now than before
the war. This statement may cause surprise, but it is correct. The
circulation is now 15 to 20 times that of pre-war days, whilst prices
have risen 40 to 50 times." Similarly, Professor Elster reassured his
people: "However enormous may be the apparent rise in the circulation in
1922, actually the figures show a deeline."3
The Statistical Bureau of the German Government even
calculated the real values of the per capita circulation in various
countries. It, too, concluded that there was a shortage of currency in
Germany, but a great deal of inflation abroad.
Of course, this fantastic conclusion drawn by monetary
authorities and experts bore ominous consequences for millions of
people. Through devious sophisms, it simply denied individual
responsibility for the disaster and thus removed all limits to the
issuance of more paper money.
GOLD VALUE OF MONIES IN
CIRCULATION
|
Gold Marks Per Person |
|
1920 |
1922 |
| Germany |
87.63 |
17.92 |
| England |
84.40 |
110.73 |
| France |
180.05 |
229.90 |
| Switzerland |
89.49 |
103.33 |
| U.S.A. |
101.35 |
97.66 |
SOURCE: Wirtschaft und Statistik, 1923 No I
(To arrive
at U.S. dollar amountss these figures should be divided by 4.2.)
The source of this momentous error probably lies in
failure to understand one of the most important determinants of money
value: the attitude of people toward money. For one reason or another,
people may vary their cash holdings. An increase in cash holdings by
many people tends to raise the exchange value of money; reduction in
cash holdings tends to lower it. Now, in order to radically change their
cash holdings, individuals must have cogent reasons. They naturally
enlarge their holdings whenever they anticipate rising money value as,
for instance, in a depression. And they reduce their holdings whenever
they expect declining money value. In the German hyperinflation, they
reduced their holdings to an absolute minimum and finally avoided any
possession at all. It is obvious that goods prices must then rise faster
and the value of money depreciate faster than the rate of money
creation. And if the value of individual cash holdings declines faster
than the rate of money printing, the value of the total stock of money
must also depreciate faster than this rate.
This is so well understood that even the mathematical
economists emphasize the money "velocity" in their equations and
calculations of money value.4 But the German monetary
authorities were unaware of such basic principles of human action.
For Health, Education, Welfare, and Full Employment
Immediately
after the war, the German government, under the leadership of the
Socialist party, embarked upon heavy expenditures for health, education,
and welfare. This added to the already heavy load on the Treasury for
demobilization expenses, the demands by the Armistice, the disorders of
the revolution, staggering deficits of the nationalized industries,
especially the railroads, postal services, telephone, and telegraph. The
resources made available by the creation of new money were apparently
unlimited! A number of measures for the nationalization of certain
industries (e.g., coal, electrical, and potash industries) were
introduced, but failed to become law. The eight-hour day was enacted,
and labor unions were given many legal immunities and privileges. In
fact, a system of labor councils was set up which authorized the workers
in each enterprise to elect representatives who shared in the management
of the company!
While government expenditures rose by leaps and bounds,
the revenue suffered a gradual decline; in October 1923, only 0.8 per
cent of government expenses were covered by tax revenues. For the period
from 1914 to 1923 scarcely 15 per cent of the expenses were covered by
means of taxes. In the final phase of the inflation the German
government experienced a complete atrophy of the fiscal system.
The depreciation of the currency brought about the
destruction of taxable wealth in the form of mortgages and bonds,
annuities and pensions, which in turn reduced government revenue. It is
true, some speculators reaped spectacular profits from the depreciation
' but they easily evaded the tax collector. Moreover, the fiscal
policies of the Socialist government were openly hostile toward capital
and frequently endeavored to impose confiscatory capital levies upon all
wealth. Secretary of the Treasury Erzberger even vowed that "in the
future Germany, the rich should be no more." Consequently a massive
"flight of capital" from Germany developed as all classes of savers
invested their money in foreign bank accounts, currencies, bills,
securities, and the like. Much taxable wealth was removed from the grip
of tax collectors.
Furthermore, the rapid depreciation of currency greatly
reduced all tax liabilities during the time interval between the taxable
transaction and the date of tax payment. The taxpayer usually paid a sum
the real value of which was greatly reduced by inflation. Nevertheless,
government expenditure accelerated, while revenue in terms of real value
continued to decline. The growing deficits then were met with even
larger quantities of printing press money, which in turn generated ever
larger deficits. The German monetary authorities were trapped in a
vicious circle from which they had neither the political courage nor the
financial know-how to extricate themselves.
The leading monetary authority, Dr. Helfferich, even
warned his people against the dire consequences of monetary
stabilization. "To follow the good counsel of stopping the printing of
notes would mean refusing to economic life the circulating medium
necessary for transactions, payments of salaries and wages, and so on;
it would mean that in a very short time the entire public, and above all
the Reich, could no longer pay merchants, employees, or workers. In a
few weeks, besides the printing of notes, factories, mines, railways and
post office, national and local government, in short, all national and
economic life would be stopped."5
The Balance of Payments and the Treaty of Versailles
Throughout
the period of the inflation the most popular explanation of the monetary
depreciation laid the blame on an unfavorable balance of payments, which
in turn was blamed on the payment of reparations and other burdens
imposed by the Treaty of Versailles. To most German writers and
politicians, the government deficits and the paper inflation were not
the cause, but the consequences, of the external depreciation of the
mark.
The wide popularity of this explanation, which charged
the victorious allies with full responsibility for the German disaster,
bore ominous implications for the future. Its simplicity appealed to the
masses of economically ignorant people whose chauvinism and nationalism
always make the idea of foreign intrigue and conspiracy so palatable.
The intellectual and political leaders who actively propagated the
doctrine were sowing the seeds for the whirlwind they ultimately reaped
a decade later.
During those baleful years, Germany procured
gratuitously from abroad large quantities of raw materials and
foodstuffs. According to various authoritative estimates, foreign
individuals and banks bought at least 60 billion paper marks which the
Reichsbank had floated abroad at an average price of 1/4 gold mark for a
paper mark. The depreciation of the mark to one trillionth of its
earlier value repudiated these foreign claims to German goods. Thus,
foreigners suffered losses of some 15 billion gold marks, or some $3.5
billion U.S. dollars, which was eight times more than Germany had paid
in foreign exchange on account of reparations.
Even if it had been true that excessive burdens were
thrust on Germany by the Allies, there was no need for any monetary
depreciation. The two phenomena are entirely independent. If excessive
burdens are thrust upon a government, whether they be foreign or
domestic, government must raise taxes, or borrow some funds, or curtail
other expenditures. Excessive reparation payments may necessitate higher
taxes on the populace, or large loans that reduce the supply of savings
for industry and commerce, or painful cuts in government service and
employment. The standard of living of the people thus burdened will
probably be depressed -unless the reduction of bureaucracy should
release new productive energy. But the value of money is not affected by
the reparation burden unless economic productivity is impaired by the
fund raising.
Once government has achieved the necessary budgetary
surplus, the payment of reparations is a simple matter of exchange. The
Treasury buys the necessary gold or foreign exchange from its central
bank and delivers it to the recipient government. The loss of gold or
foreign exchange then necessitates a corresponding reduction of central
bank money, which in turn tends to depress the prices of goods. The
lowered prices encourage more exports while they discourage imports,
that is, generate what is commonly called a "favorable balance of
payments" or new influx of gold and foreign exchange. In short, there
can be no shortage of gold or foreign exchange as long as the central
bank refrains from inflation and monetary depreciation.
The German monetary authorities flatly denied this
economic reasoning. Instead, they preferred to lament the excessive
burdens thrust onto Germany and the unfavorable balance of payments
generated thereby. In 1923 they added yet another excuse: the French
occupation of the Ruhr district. The Central Statistical Office put it
this way: "The fundamental cause of the dislocation of the German
monetary system is the disequilibrium of the balance of payments. The
disturbance of the national finances and the inflation are in their turn
the consequences of the depreciation of the currency. The depreciation
of the currency upset the Budget balance, and determined with an
inevitable necessity a divergence between income and expenditure, which
provoked the upheaval."6
Again I quote Dr. Helfferich: "Inflation and the
collapse of the exchange are children of the same parent: the
impossibility of paying the tributes imposed on us. The problem of
restoring the circulation is not a technical or banking problem; it is,
in the last analysis, the problem of the equilibrium between the burden
and the capacity of the German economy for supporting this
burden."7
Even American economists echoed the German theory.
Professor John H. Williams presented this causal order: "Reparation
payments, depreciating exchanges, rising import and export prices,
rising domestic prices, consequent budgeting deficits, and at the same
time an increased demand for bank credit; and finally increased
note-issue."8 And Professor James W. Angell contended that
"the reality of the type of analysis which runs from the balance of
payments and the exchanges to general prices and the increased issue of
paper seems to be definitely established."9
Speculators Did It
When all other explanations are exhausted,
modern government usually falls back on the speculator who is held
responsible for all economic and social evils. What the witch was to
medieval man, the capitalist is to socialists and communists, the
speculator is to most politicians and statesmen: the embodiment of evil.
He is said to be imbued with ruthless and fickle selfishness that is
capable of wrecking the national economy, governmental plans, and, in
the case of the German inflation, the national currency. No matter how
blatantly contradictory this explanation may be, it is most popular with
government authorities in search of a convenient explanation for the
failure of their own policies.
The same German officials who denied the very existence
of inflation lamented the depreciation caused by speculators. Or they
blamed the Allied reparation burdens and simultaneously denounced
speculators for the depreciation. Dr. Havenstein, the President of the
Reichsbank, embracing every conceivable theory that might clear his own
policies of blame, also pointed at the speculators. Before a
parliamentary committee, he testified: "On the 28th of March began the
attack on the foreign exchange market. In very numerous classes of the
German economy, from that day onward, thought was all for personal
interests and not for the needs of the country."
In a chorus, the newspapers repeated the charge:
"According to all appearances the fall of the mark did not have its
origin in the New York exchange, from which it may be concluded that in
Germany there was active speculation directed toward the continual rise
of the dollar.... We are witnessing a rapid increase in the number of
those who speculate on the fall of the mark and who are acquiring vested
interests in a continual depreciation.... The enormous speculation on
the rise of the American dollar is an open secret. People who, having
regard to their age, their inexperience, and their lack of
responsibility, do not deserve support, have nevertheless secured the
help of financiers, who are thinking exclusively of their own immediate
interests. . . . Those who have studied seriously the conditions of the
money market state that the movement against the German mark remained on
the whole independent of foreign markets for more than six months. It is
the German bears, helped by the inaction of the Reichsbank, who have
forced the collapse in the exchange."
In its broadest sense, speculation is every economic
action that makes provision for an uncertain future. The student who
studies aeronautical engineering speculates on the future demand for his
services. The businessman who enlarges his inventory speculates on a
profitable market in the future. The housewife who hoards sugar
speculates on the availability of sugar in the future. The buyer or
seller of goods or securities hopes to make a profit from future changes
in prices. All such actions reflect a natural motivation of free men to
improve their material well-being or, at least, to avert losses.
When speculators observe or anticipate more inflation
and monetary depreciation, they naturally endeavor to sell the
depreciating currency and buy goods or foreign exchange that do not
depreciate. They are preserving their working capital. Thus, they are
promoting not only their own interests but also those of society which
benefits from the preservation of productive capital. The government
that is actively destroying the currency is injuring the national
interest; successful speculators are safeguarding it. Surely, the
speculators who sold German marks and bought U.S. dollars proved to be
right in the end.
The Current Dilemma in the Light of the German Experience
The
world-wide inflation that is engulfing the free world now springs from
similar doctrines and theories. It is true, there is no Treaty of
Versailles and no reparation payments that can be blamed for the
inflation. But in many countries of Central and Western Europe the
responsibility for monetary depreciation is squarely laid on American
balance of payments deficits that are flooding those countries with U.
S. dollars. While European monetary authorities are actively inflating
and depreciating their own currencies - although at a slower rate than
their American counterparts - they are pointing at the U.S . balance of
payments as the ultimate cause of their currency depreciation. As in the
German hyperinflation foreign intrigue and artifice are said to be at
work again.
And again the speculators are charged for a share of
the blame. American investors who buy foreign securities or make direct
foreign investments are said to be largely responsible for the outflow
of U.S. funds and loss of gold, which is creating an unfavorable balance
of payments and weakening the U.S. dollar. Moreover, Americans who
prefer foreign products over home-made products, or choose to travel
abroad rather than stay at home are decried as selfish and unpatriotic.
Numerous regulations imposed by the very monetary authorities who
perpetrate the inflation aim to prevent speculation in order to save the
dollar.
The specious argument that denies the presence of any
inflation in terms of purchasing power or gold value may be expected to
emerge in later phases of the inflation when monetary authorities will
desperately seek any argument that promises to hold them blameless.
The most popular contemporary doctrine that advocates
inflation and credit expansion pleads its case in terms of economic boom
and full employment. Our economic order which is laboring under heavy
government intervention and restriction is a stop-and-go system with
alternating booms and busts. The booms are generated by heavy budgetary
deficits and monetization of government debt. The busts inevitably
follow the booms as soon as stabilization is attempted or the rate of
inflation is temporarily slowed in order to prevent a hyperinflation.
Under the sway of the "new economics" of Lord Keynes and his American
disciples, our monetary authorities inflate and depreciate to finance
the boom, and then "reinflate" when the economy falters, to prevent
massive unemployment. Inflation is the modern panacea for political,
social, and economic evils most of which were created by the inflation
itself. In truth, it is a savory poison that slowly kills not only the
patients who take it but also the doctors who prescribe it.
At the time of the original publication, Dr. Sennholz
headed the Department of Economics at Grove City College and is a
noted writer and lecturer for freedom.
1 According to the British and German systems of
numeration, the billion is a million of millions, a trillion a million
of billions, and each higher denomination (e.g. quadrillion,
quintillion, sextillion, etc.) is a million times the one preceding. In
the American system, the billion is a thousand millions, and each higher
denomination is a thousand times the preceding. It must also be noted
that a billion in the U.S. system is called milliard in the British and
German systems. In German and British texts the sentence would thus
read: "Five years later in December 1923 the Reichsbank had issued 496.5
trillion marks each of which had fallen to one billionth of its 1914
gold value."
2 Das Geld, 1923, p. 646.
3 Von der Mark zur Reichsmark, 1928, p. 167.
4 Cf. my essay on "The Value of Money" in THE FREEMAN,
Nov. 1969
5 Das Geld, p. 650
6 DeutschlandsWirtschaftslage, March 1923, p. 24.
7 "Die Autonomic der Reichsbank" in Bdrsen-Courier of
Apr. 4, 1922
8 "German Foreign Trade and the Reparations Payments"
(Quarterly Journal of Economics, 1922, p. 503).
9 The Theory of International Prices, 1926, p. 195.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
October, 1970, Vol. 20, No. 10.
Yourname@libertyhaven.com
