QE2: History Lessons From Germany

This terrible tale of the ravages of inflation rings warning bells for less virulent forms of deficit financing.
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By Adam Fergusson, author of When Money Dies



) -- Through the printing press, the Weimar Republic conducted the most extreme policy of quantitative easing in history. The German mark, 4 to the $1 before World War I, stood at 20 when it ended. Gathering momentum, it eventually plunged in November 1923 to 4 trillion to the $1.

At that point the nominal value of the ocean of circulating paper reached 93 quintillion (a figure with 18 noughts). The mark was dead. Such headlong debauchery of a currency in an advanced economy teaches us something today.

Then as now, the objective was to reduce unemployment and thus avoid unrest and political unpopularity. Revolution was in the air. A defeated army was disbanding. Dr. Rudolf Havenstein, president of the independent Reichsbank, made it his task to supply industry with all the credits and the government with all the wages and salaries needed for national recovery and survival.

Havenstein pursued it relentlessly, convinced that his titanic money-printing triumphs had no connection with the depreciation which accompanied, and later anticipated, them. Unchallenged, he blamed that on the economic crisis, international speculators, the fear of Bolshevism, the social disorganisation of a truncated country (the Treaty of Versailles had cost a defeated Germany all her colonies, Alsace-Lorraine and the industries of Upper Silesia), the Allied blockade, the massive war reparations payable in gold and in kind, and finally, in the spring of 1923, on the Franco-Belgian invasion of the Ruhr to retrieve those payments. The Kaiser's regime, which had hoped in 1914 to pay for a short war not with taxes but the spoils of victory, had certainly left its Socialist successor a baleful legacy.

As a way of ensuring full employment, printing money was successful from the start. And what a success! Private industry, much of it converting from a war footing, expanded rapidly and happily to mop up the limitless credit the Reichsbank and the currency-issuing regional banks made available. Exports boomed, for with such low manufacturing costs they undercut all competition (and in 1920 contributed to a slump in France and Britain, and afterwards to the beggaring of France and other neighbors).

Shipbuilders in Hamburg, automobile makers, steelworks in the Ruhr -- all flourished. Profits were outrageous. New enterprises sprouted: as inflation speeded up, the loans which had launched them could be repaid with trivial amounts of foreign earnings or the price of a tram ticket. Often these foreign earnings, if not hoarded abroad, were invested in new factory buildings which produced nothing but boosted the construction industry enormously.

The public sector also ballooned: the pre-war railway personnel of 700,000 expanded to 1.1 million; the post and telegraph services added 120,000 staff, for the authorities never lacked money for wages however high they rose. The taxation system stopped functioning usefully: by the time tax was due it was hardly worth collecting, and anyway, so far had morale and morals fallen, tax evasion had almost become a civic duty.

National and state governments intervened sporadically to regulate prices, rail fares, currency dealing, hoarding and even gluttony -- but most rules were ignored. Every chance to establish a new stable currency while Germany still had enough gold was missed, through ineptitude or lack of political courage. However, by the summer of 1922, unemployment had practically disappeared.

Meanwhile, trust in money evaporated. Everyone hurried to get rid of it, accelerating the velocity of its circulation and stoking inflation further. People sought goods of intrinsic value. Gold or foreign currencies were the most favored (though it was illegal to hold them). Speculation on the stock exchange was rife, for some the only way of making a living. Prices of industrial shares soared as the mark declined, the exchange so busy that it opened only three days a week. Those with no money to risk, and too young or old to work, shivered and starved.

Corruption was general, even where it had previously been unknown. From theft and prostitution to riots and political assassinations, crime became common. There were militaristic and secessionist outbreaks. As foreigners swarmed in over the frontiers to take advantage of the exchange rates, hapless townspeople, hungering for the food which farmers refused to sell for worthless paper, went into the country to seize it.

The outcome was disastrous for all -- except profiteers with foreign bank accounts; except farmers and landowners whose heavy borrowings and mortgages were reduced to nothing; except some industrialists and financiers whose responsible comprehension of events let them survive the storm. As Germany's internal debts were swept away, creditors were ruined.

The rentier classes who depended on savings or pensions, and anyone on a fixed income, were soon in penury, their possessions sold. Barter often took over from purchase. By law rents could not be raised, which allowed employers to pay low wages and impoverished landlords in a country where renting was the norm. The professional classes -- lawyers, doctors, scientists, professors -- found little demand for their services. In due course, the trade unions, no longer able to strike for higher wages (often uncertain what to ask for, so fast became the mark's fall from day to day), went to the wall, too.

Stabilization came only when the abyss was plumbed. At the end of 1923, Germany no longer faced the false choice between unemployment and bankruptcy, for she had both. When the new Rentenmark, equal to one old gold mark, was introduced and trusted, food flowed into the towns and cities again. Many could not afford it.

This terrible tale of the ravages of inflation rings warning bells for less virulent forms of deficit financing.

It emphasizes, first, governmental predilection for the quick fix of printing money. With the banknotes of the Mississippi Bubble, the


of the French Revolution or the paper promises of Weimar, the addiction grew, each extra dose of the drug irresistible because circumstances seem exceptional. Will QE2 be the last of the series?

It shows how readily confidence in money evaporates; and the public's distress when virtues like thrift and honesty become folly. Is it plausible for a bank to concern itself with employment (surely a government's worry) as well as financial stability?

It explains how inflation casts its shadow before it. Havenstein continually proclaimed his intentions, with inevitable results. The mere prediction of QE2 by the


, and talk of an inflation target, sent the dollar tumbling across the world, with knock-on effects on every commodity and currency.

It warns how fighting an internal crisis with the two-edged sword of cheap money may be interpreted as malevolence by foreign trading partners.

Worried by growing inflation, the Bank of England is this week having second thoughts about its QE2. Although main-street banks have released little of the GBP200 billion QE1 into Britain's wider economy, there are signs of its recovery. It is an interesting contrast to a Federal Reserve worried about deflation.

Both countries have low interest rates and few choices for economic stimulation. Nevertheless, lack of alternative seems poor justification for a neo-Keynesean measure whose effectiveness is evidentially so opaque and when the risks of unintended consequences across the world are so disturbing. While economic opinion is divided, confused taxpayers must understandably fear that more fuel may be being poured into a tank already full, threatening a costly, futile and dangerous global spillage.

Adam Fergusson has been a member of the European Parliament, a special adviser at the Foreign Office, a consultant on European affairs for international industry and commerce, and a political adviser during Margaret Thatcher's government.


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