9/6/13 - reader request: fixing hyperinflation

In today's selection - Lords of Finance: The Bankers Who Broke the World by Liaquat Ahamed. How to solve hyperinflation. Recently, we ran a selection on how countries create hyperinflation -- by printing vast quantities of paper money a la Germany in 1923 ( 8/30/13). Due to numerous reader requests, today's selection will be on how Germany solved its hyperinflation problem in 1924. In theory, the solution to hyperinflation is simple: stop printing money. However, money is printed because the government is running a deficit, so the government must simultaneously cut its expenses -- government services, entitlements, or debt service -- or raise revenues to rid itself of the need to print money. (Which expenses are cut has significant class consequences: generally, reducing service or entitlement expenses is the preferred solution for the establishment, while for the broad population restructuring debt and preserving services and entitlements is preferred):

"The plan was to introduce a totally new currency, the Rentenmark, to be backed not by gold but by land. The bank issuing the new currency was granted a 'mortgage' on all agricultural and industrial property, on which it could impose an annual levy of 5 percent -- in effect, a tax on commercial real estate. 

"Despite his new position [as currency commissioner in charge of the new Rentenmark], Hjalmar Schacht was as skeptical about the new plan's chances of success as almost everyone else in Germany. From the very first, he had scoffed at the idea of a land-based currency as a pure confidence trick; currencies had to be backed by a highly liquid, easily transferable, internationally acceptable asset, such as gold. ...

"During the debate on the various currency reform plans, Schacht had forthrightly argued for gold as the foundation for a new currency. While no one could challenge the theoretical basis of his logic, the fatal difficulty had been that Germany simply did not have enough gold for the job. Before the war, the country had had a circulating currency of $1.5 billion, backed by just under $1 billion in gold. After five years of reparations and currency collapse, less than $150 million in gold remained. ... 

"The most important, perhaps defining, characteristic of the new currency was not that it theoretically rested on land, but that the amount to be issued was to be rigidly fixed at 2.4 billion Rentenmarks, equivalent to around $600 million.  Grasping that the key to its credibility was to keep it sufficiently scarce, Schacht was determined to ensure that the amount in circulation did not exceed its statutory ceiling under any circumstances.  And though he encountered considerable political pressure to relent from his cabinet colleagues, he stuck to his position.  He was obstinate, almost brutal, about turning down loan requests from everyone -- government agencies, municipalities, banks, or big industrialists. ...

"When the new currency was introduced on November 15,1923, Germany found itself in the curious position of having two official currencies -- the old Reichsmark and the new Rentenmark -- circulating side by side, issued by two uniquely parallel central banks. ...

"The Reichsmark became so worthless that the government was able to buy back its many trillions of debt, valued at $30 billion when first issued, for only 190 million Rentenmarks, equivalent to about $45 million. ...

"On November 26, the Reichsmark was trading at 11 trillion to the dollar in Cologne. Then the strangest thing began to happen. The exchange rate began to reverse itself. By December 10, it was back at 4.2 trillion to the dollar. Within a few days prices stabilized. ...

"Now this spiral reversed itself. As prices began to hold and then fall, it became profitable to hang on to cash. Farmers, their confidence in money restored, began bringing produce to market, food reappeared in the shops, and those interminable queues began to melt away. Lord d'Abernon, the British ambassador, wrote of the 'astonishing appeasement and relief brought about by a touch of the magical wand of 'Currency Stability .... The economic détente has brought in its train political pacification -- dictatorships and putsches are no longer discussed, and even the extreme parties have ceased, for the moment, from troubling.'

"Not all of this was Schacht's doing. [Chancellor Gustav] Stresemann and his cabinet colleagues backed the Rentenmark with a series of budgetary measures, suspending all subsidy payments to workers in the Ruhr, firing a quarter of the government workforce, and indexing all taxes to inflation, thus eliminating the incentive for taxpayers to delay payment. By January 1924, the budget was balanced. But it was Schacht who received the prime credit, feted in the press as 'The Wizard' or the 'Miracle Man.' "


Liaquat Ahamed


Lords of Finance




Copyright 2009 by Liaquat Ahamed


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