Posts Tagged ‘German Hyperinflation’

If you want deflation, you would love Germany

Sunday, July 11th, 2010

From our previous article, one of our readers was very indignant at the current state of affairs. As he wrote,

During inflationary times, those who speculated made more money than those who held cash. so you could argue that those who held cash felt the "inflationary pain" but why wasn’t the government pressured politically to do something as they were when they get spooked by deflation?

Then when deflationary times come its the turn of those who held cash to benefit while those who already made their money out of speculation and over leveraging to feel the "deflationary pain", after all they did take too much risk.

I don’t think its fair or right for governments to manipulate the economy to prop up the prices of the investments of the speculators (who helped create all these bubbles in the fist place). Basically that means that they got to make a lot of money out of speculating but they didn’t take any real risk as government will step in to do "something" about the pain.

If the don’t feel the pain they will continue recklessly speculating.

Meanwhile that very same "something" the governments will do to help the speculators avoid pain will probably mean devaluation of the currency one way or another so that once again those who did not speculate and over leverage will feel the pain.

The governments actions will tend to encourage more people to speculate! I would like to see deflation happen, does anybody else feel the same way???

On the first point, why are governments more spooked by deflation than by inflation? The simple reason is that in a democracy, the mob rules. Unfortunately, the mob is heavily indebted as a whole. All we have to do is to look around and see that the culture of debt is deeply ingrained in society. For young people, not only is it fashionable to get into debt, it is very difficult not to get into debt. For example, buying your first home is enough to put you in debt for decades.

The last time governments became spooked by inflation was in 2008 when oil and food prices shot through the roof (see Who is to blame for surging food and oil prices?). If governments continue its policy of doing ?something? about deflation for a sustained period of time, we believe it will be a matter of time before prices of necessities will resume its surge again. As usual, the blame will be put on ?shortages? and ?speculators.?

But not all governments in the world are biased towards inflation. Germany is the exception here. The trauma of the hyperinflation during the Weimar times is seared into the German consciousness. As a result, they will avoid anything that hints of inflation. Unlike the English-speaking countries, politicians in Germany who stick to discipline, austerity, balanced budgets and stand against moral hazards see their popularity go up.

Coincidentally, Germany is also the most important member of the Euro zone. As a result, their attitude towards inflation is being imposed on Europe. In the recent G-20 meeting, the G-20 endorsed a halving of budget deficits by 2013 as the target.

But as George Soros wrote in a recent article,

The situation is eerily reminiscent of the 1930s. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banking system and the economy may not be strong enough to do without fiscal and monetary stimulus.

The Great Depression of the 1930s is one of deflation. In Soros? opinion, the G-20?s endorsement of government de-leveraging has increased the risk of deflation today.

So, in the coming months, we can see why the deflation argument will be gaining the upper hand.

The economics of inflation

Wednesday, May 21st, 2008

Today, we will introduce another great book- The Economics Of Inflation- A Study Of Currency Depreciation In Post War Germany by Costantino Bresciani – Turroni, an economist who lived through the German Hyperinflation of the 1920s. That book was first published in Italian in 1931 and the English edition was first published in 1937. The foreword of this book begins:

THE depreciation of the mark of 1914-23, which is the subject of this work, is one of the outstanding episodes in the history of the twentieth century. Not only by reason of its magnitude but also by reason of its effects, it looms large on our horizon. It was the most colossal thing of its kind in history: and, next probably to the Great War itself, it must bear responsibility for many of the political and economic difficulties of our generation. It destroyed the wealth of the more solid elements in German society: and it left behind a moral and economic disequilibrium, apt breeding ground for the disasters which have followed. Hitler is the foster-child of the inflation. The financial convulsions of the Great Depression were, in part at least, the product of the distortions of the system of international borrowing and lending to which its ravages had given rise. If we are to understand correctly the present position of Europe, we must not neglect the study of the great German inflation. If we are to plan for greater stability in the future, we must learn to avoid the mistakes from which it sprang.

This book was recommended by Marc Faber and serves an excellent example of what can go wrong even in a highly cultured and advanced nation. Although history never repeats itself exactly, it rhymes and provides a grave warning to us today. If you have not already, we recommend that you read out guide, What is inflation and deflation? first before reading the rest of this article.

Now, let us turn our clocks back to Germany after the end of the First World War. For a period of time, the German economy seemed to be prospering- it was the envy of others. As Costantino wrote in Chapter 5,

It was often affirmed that only the inflation made it possible for German industry to continue to produce, there being the exceptional and interesting spectacle of extraordinary activity and prosperity in Germany at a time of general crisis in business in other countries, and especially in some of those who were victorious in the Great War.

To this view others objected that it was a question only of an “apparent prosperity,” which concealed the real and continual loss of capital, the disintegration of productive apparatus, the increasing poverty of many classes of society, and the symptoms of a crisis, which, after having remained latent for a long time, burst forth with unparalleled violence in the last months of 1923.

After the First World War, Germany had to sign the Treaty of Versailles, which required her to pay punishing war reparations. Up till 1919, the German mark fell rapidly and remained stable till the second half of 1921. As Costantino wrote in Chapter 1,

Throughout this period the movement of the mark exchange was analogous to that of the other principal European exchanges, save for a greater amplitude of fluctuation.

But from the second half of 1921 onwards (till 1923), the German mark began a downward spiral and depreciated exponentially (so much so that a diagram of the mark exchange rate with the US dollar was best drawn on a logarithmic scale). It was under this backdrop of a depreciating currency that (Chapter 5):

To that was added the influence of an economic conception, which is widely held in countries with depreciated currencies, that is the myth of “real value” or “intrinsic value.” It was thought that even if for the time being the entirely new equipment was not utilized, it nevertheless always represented an “intrinsic value,” a “substance” as it was called in Germany.

In times of inflation, the Germans hoarded capital equipment in an attempt to preserve the purchasing power of their rapidly depreciating marks. Today, we have a similar parallel- under the depreciating US dollar, prices of oil, gold, silver and commodities (including food and base metals) in general soared due in part to hoarding (see Connecting monetary inflation with speculation) and growing demand from China and India.

The initial effects of inflation in Germany seemed to be prosperity. German engineering industries were greatly stimulated during the fall of the mark. Demands for these capital goods eventually converged on the market for iron and coal, which was a great boon for these industries. There was a continuous reallocation of resources from the consumer goods industries to the capital goods industries. As Costantino quoted Professor Hirsch,

… from 1919 to 1921 an industrial migration occurred with a rapidity which had no precedent in history; more than 200,000 new workers were employed in the mines.”* The highest number was reached towards the end of December 1922.

This expansion resulted in Germany not only reconstructing their industrial capacity after the war, but also greatly enlarge them.

Sadly speaking, monetary inflation always result in distortion that are harmful to society in the long run. In Germany, the distortionary outcome was:

In the acutest phase of the inflation Germany offered the grotesque, and at the same time tragic, spectacle of a people which, rather than produce food, clothes, shoes, and milk for its own babies, was exhausting its energies in the manufacture of machines or the building of factories.

Looking back at history, we find many eerie parallels with today.