Originally posted March 20, 2020.
The world’s most extraordinary episode of hyperinflation happened between 1919 and 1922 in post-World War I Germany.
To get the full picture of the events that led to rapid inflation by Germany’s post-World War I ruling regime, the so-called Weimar Republic, you have to go back to the Franco-Prussian War, in 1870. Prussia, a sort of proto-Germany, won the war quickly, taking only about six months to defeat France.
Prussia paid for the war by taking on debt, and the short duration of hostilities and decisive victory made it relatively easy for the new Germany (created out of the unification of Prussia with other German-speaking lands shortly after the war) to repay the debt.
Germans remembered that when they entered World War I to help Austria-Hungary fight the Triple Entente, an alliance of France, the UK, and Russia. The Germans assumed this new war would be fast, and that they would win. Both those assumptions turned out to be wrong.
To finance the new war, the Germans again took on debt. The war turned out to be long, bloody, and expensive, chewing up 50% of German production capacity.
After the war, Germany was loaded with debt. Additionally, the countries of the Triple Entente, especially France, demanded reparations to pay for the costs incurred. They demanded 132 billion gold marks (marks backed by gold). A huge sum. Payments from 1919 to 1922 were about 10% of Germany’s national income, or about as much as Germany’s entire pre-war government budget.
Germany Ran Huge Deficits
To keep the country operating post-war, the government began running huge deficits around 50%, and sometimes even more. Germany’s leaders chose to fund the deficits by selling debt to the national bank, the Reichsbank. The plan lowered foreign confidence in the Weimar government’s ability to pay its debts.
As a result, foreign investment crashed, and the value of the mark, Germany’s currency, sank. Thus began the first round of inflation. At the time, the German government levied its taxes in nominal terms. Inflation started rising so fast that when the government levied a tax, the value of the money demanded was much lower by the time it was actually collected. Revenues couldn’t keep up with rising costs, leading to even higher deficits.
In 1920 the Germans offered the Entente a plan to pay the war reparations at a rate of 2.24 billion marks a year. The proposal would have eventually balanced Germany’s budget, but the Entente demurred. Instead, they demanded 4 billion marks each year and threatened military occupation of Germany’s Ruhr region, its industrial heartland, if the Germans didn’t comply.
The Germans were left with no choice but to pay. However, they couldn’t easily tax their people any more than they already were, leaving revenue further behind spending. Germany’s creditworthiness declined again, spurring on inflation even more. To make matters worse, the Entente took Upper Silesia from Germany and gave it to Poland, subtracting some of Germany;’s GDP in the process.
German Foreign Minister Walther Rathenau, a Jew, was assassinated in 1922 by anti-Semitic radicals. Rathenau had been a much-respected figure in German economics, and his death shook confidence in Germany’s ability to manage its economy. The murder caused capital flight, and soon hyperinflation began, driving the value of the mark even lower.
At this point, Germany began printing money with gusto. The government decided to sacrifice the value of the mark to provide businesses with the liquidity they needed. Thomas Piketty explained this period of rapid money printing in his book, The Economics of Inflation, writing (my emphasis in bold):
But in the summer of 1922 the Reichsbank began to supply directly to commerce and industry the financial means, the need of which, in that period of credit crisis, was urgently felt. To mitigate this crisis the Reichsbank insistently counselled the business classes to have recourse to the creation of commercial bills,* which it declared itself ready to discount at a much lower rate than the rate of the depreciation of the mark, and even than the rates charged by private banks.
Indeed the official discount rate was 6 per cent at the end of July 1922; it was raised to 7 per cent at the end of August; to 8 per cent on September 21st; 10 per cent on November 13th; 12 per cent on January 18th, 1923; and 18 per cent in the last week of April 1923. It is enough to compare these rates with the increase in the dollar rate (a gold mark was worth 160 paper marks at the end of July 1922; 411 paper marks at the end of August, 1,822 at the end of November; and 7,100 at the end of April 1923) to be convinced that the policy of the Reichsbank could not but give a strong stimulus to the demand for credit and to the inflation.
To facilitate the money printing, the Reichsbank was running 1,783 printing machines by 1923. The mark’s value compared to gold, and gold-backed currencies like the dollar (at the time), plummeted.
Ultimately, France occupied the Ruhr after the Germans failed to make required coal deliveries dictated by the reparations package. In retaliation to France’s aggressive move, coal and steelworkers in the region went on strike, sending the entire country grinding to a halt. The Weimar government felt it needed to keep paying the workers to prevent the union members from starting a Bolshevik revolution, so they printed even more money, sending inflation skyrocketing even moe than before.
By November 1923, the mark was trading at 4,200 billion to one dollar. That’s when the government finally decided to peg its value to the dollar, ending the hyperinflation. Before the war, the mark-dollar exchange rate had been 4.2 to 1. And as recentty as 1922 it had been 1,500 to 1. It then took less than a year for the mark’s strength to fall from 1,500 to 1, to 4,200 billion to 1.
In the end, Germany’s decision to take on debt to start a war, and subsequently to run deep deficits to pay for it, destroyed the country’s economy. The price of gold soared in Germany during its hyperinflation. Those few Germans who still owned any gold (the government had strongly encouraged them to turn it in to bolster the Reichsbank) owned an asset that had held its value despite the inflation.
Gold, along with silver, tends to maintain its value in the face of inflation. That ability can act as an insurance policy in investment portfolios that own gold. With governments around the world today using higher deficits and the devaluation of currencies to fund spending, prudent investors should own precious metals in their portfolio today.