Inflation And Hyperinflation After World War 1
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Published: Tue, 18 Apr 2017
Germany went into hyperinflation after the First World War 1. One of the origins of the hyper inflation lay in the war and one of the keys lie in the role of the bond market during war. All the warring countries issued war bonds during the war, persuading a lot of the national people who had never previously purchased government bonds that it was their patriotic duty to do so. However, unlike Britain, France, Italy and Russia, Germany did not access to the international bond market during the war. While the Entente powers could sell bonds in the United States or throughout the capital-rich British Empire, the Central powers (Germany, Austria and Hungary) were dependent on their own resources. Berlin and Vienne were important financial places, but compared with London, Paris and New York, they did not have depth. As a result, the sale of war bonds in Germany became gradually more difficult than the Entente powers, as the appetite of domestic investors became sated. Much sooner, and to a much greater extent than in Britain, the German government had to the Reichs bank for short-term funding. The growth of the volume of Treasury bills in the Reichs bank’s hands was a sign of inflation, because, unlike the sale of war bonds to the general public, exchanging these bills for banknotes increased the money supply. Before the war, Reichs bank functioned as the normal central bank ( issuing banknotes and the central bank for private banks and so on ) and had independence from others. However, after World War 1 occurred, because German government raised much war money, Reichs bank was handled by the government and lost independence. In other words, this freed the government to finance the war money with usual effect: price rose. By the end of 1918, the Mark had fallen more than 50 % against dollars.
At 1918 German was defeated and surrendered to the enemy. After World War 1 in 1919, the Peace Treaty was held at Versailles. German lost their colonies and gave France, Belgium, Poland and Lithuania a part of their territory in the Peace Treaty. Furthermore, victorious nations forced 20 billion ‘gold marks` as reparations on German. In 1921, the total indemnity was finally fixed with a huge debt with a nominal capital value of 132 billion gold marks, equal to more than three times national income. Facing this situation, the Germans found themselves saddled. Although not all this new debt was immediately interest bearing, the scheduled reparations payments accounted for more than a third of all Reich expenditure in 1921 and 1922. Although Germany paid a part of reparations with gold, German’s funds became a shortage because of an out flow of gold. As German government faced this problem, German government made Reichs bank discount treasury bills. As a result, much paper money began to appear in German. No investor who contemplated Germany’s position in the summer of 1921 could have felt optimistic and such foreign capital as did flow into the country after the war was speculative or hot money which soon departed when the going got tough.
The domestic politic also related to monetary crisis. The Weimar tax system was feeble, not least because the new regime lacked legitimacy among higher income groups who declined to pay the taxes imposed on them. At the same time, public money was spent recklessly, particularly on generous wage settlement for public sector unions. The combination of insufficient taxation and excessive spending created enormous deficits in 1919 and 1920, before the victors had even presented their reparation bills. The deficit in 1923, when Germany had suspended reparations payments, was even larger. Moreover, those in charge of Weimar economic policy in the early 1920s felt they had little incentive to stabilize German fiscal and monetary policy, even when an opportunity presented itself in the middle of 1920. A common calculation among Germany’s financial elites was that runaway currency depreciation would force the Allied powers into revising the reparations settlement, since the effect would be to cheapen German export relative to American, British, and French manufactures. It was true, as far as it went, that the downward slide of the mark boosted German export. What the Germans overlooked was that the inflation-induced boom of 1920-22, at a time when the US and UK economics were in the depth of a post war recession, caused an even bigger surge in imports, thus negating the economic pressure they had hoped to exert. One of the heart of the German hyper inflation was miscalculation. When the French cottoned on to the insincerity of official German pledges to fulfill their reparations commitments, they draw the conclusion that reparations would have to be collected by force and invaded the industrial Ruhr region. This occupation led to the growth of the unemployed, so inflation rate accelerate because of lack of goods. The unemployed reacted by proclaiming a general strike. After they proclaimed, the German government determined to give the unemployed 40 million mark per a day. As a result, the deficit of the German government more and more increased, so this related to Reichs bank printing much more money.
Relationship between expectations of inflation and money supply is also important. Expectation of greater inflation should have increased the share of debt monetized. The greater the expected inflation, the less investors should have reduced their nominal portfolios to the minimum needed for transactions. There are two indicators of expectations: the velocity of circulation of money and the forward discount of the mark in foreign exchange market. Up through 1922 both indicators correlate highly with the share of debt monetized. During 1923, inflationary expectations and the share of debt monetized were both at historically high levels, but their wide fluctuations reveal no systematic relationship. Even in periods when inflation rate greatly exceeded the nominal return on debt, substantial portions of the total debt remained unmonetized. Most often, firms held the debt in the form of treasury bills, via deposits at their banks. Although such behavior did not maximize expected profits, firms were averse to the risk and the illegality of balancing real assets like inventory or foreign exchange against nominal fixed obligations like the payment of taxed withheld from workers or the redemption of script paid to suppliers and workers.
Next, I want to refer to whether the other aspects of Reichsbank’s policies were important in determining the money supply. First, the Reichsbank frequently intervened in the foreign exchange market. The two most important intervention episodes were in the spring of 1920, when the Reichsbank stepped in to halt the appreciation of the mark, and in early 1923, when for almost three months the Reichsbank totally arrested the previous precipitous fall of the mark. Although statistical tests reveal no shift in the money supply function at these times, the intervention of 1923 deserves comment because of its obvious impact on inflation. A month after the invasion of the Ruhr region, the Reichsbank intervened and defended the mark’s foreign exchange value. Inflation, money growth, government deficits and the indicators of inflationary expectations all fell. It was the smaller deficits and more optimistic expectations, not the exchange market intervention that caused the slower money growth. However, it was the Reichsbank’s intervention that improved expectations and lowered the deficit by temporarily stopping inflation. Why could an intervention have even temporary success, when its eventual failure was inevitable? At first even the Reichsbank expected the stabilization to last no more than four weeks; in fact, it lasted twelve. The answer involves the uncertainty about how long the stabilization would last and the risk aversion of most market participants. Given its long-run infeasibility, the stability could last only as long as market participants believed that the stability would last a little longer. If only a few market participants with limited financial resources dared to speculate against the mark, the Reichsbank could defeat them, render their effort unprofitable and sustain the stabilization. At first the efforts of the Reichsbank to stabilize were easy, because even a stabilization that was expected to be temporary increased people’s willingness to keep marks in their pockets. This assisted in the stabilization process by actually bringing price down. The fall of prices raised the real value of the outstanding debt and money supply, However, and this undermined the creativity of the Reichsbank’s threat to defeat any run on the mark. Furthermore, after the real values of the holdings of nominal assets reached their equilibrium levels for a state of temporary stability, inflation had to resume at least at the rate of growth of the nominal money supply. Then, confident that the non-speculators would be following them rather than the Reichsbank, the speculators could make their runs on the central bank, as they did on April 18, after which the Reichsbank let the mark resume its fall. In short, exchange market intervention could have a short-run impact on the course of the inflation without altering the underlying process that determined the money supply.
A second possible complication to Reichsbank policy was that until May 1921 a law required one third of the Reichsbank’s liabilities to be backed with some asset like gold, which limited the number of treasury bills the bank could hold. The Reichsbank found a way around this constraint, however, because it could count its holdings of Loan Bureau notes as part of the one third cover. In order to unload enough treasury bills so as not to exceed two thirds of its assets, the Reichsbank resorted to the subterfuge of selling some to a Prussian state bank, which then borrowed against them at the Loan Bureau. The Loan Bureau notes thus created were then bought by the Reichsbank and held as part of the one third cover for the Reichsbank notes in circulation. The effect of the seehandlung-Loan Bureau-Reichsbank connection was, in other words, to guarantee that one way or another the central bank system would monetize whatever government and private debt the private sector did not wish to hold. Statistical evidence confirms the notion that the one third cover law and its repeal in May 1921 made no difference in determining the aggregate money supply.
Since the private sector decided which portion of the total debt to monetize, qualitative changes in private credit market conditions also might have caused structural shifts in the money supply. One type of change related to whether the average inflation rate was above or below the discount rate at the Reichsbank. Before February 1920 and after June 1921 the inflation rate was higher, but there appeared to be no structural shift of the money supply function at these points in time. In summer 1922 a cluster of changes in the private credit market occurred, foremost of which were the decisions by foreign bankers not to give Germany long-term loans, the change of the forward exchange rate on the mark from a premium to a discount, the end of short-term foreign lending and the Reichsbank’s discounting of large volumes of commercial bills. Although some claim that Reichsbank policy shifted then, it was fundamentally more of a change in what the privte sector was asking the Reichsbank to do so. Only after July 1922, when private lenders were not offering cheaper credit than the Reichsbank, did corporate borrowers turn to the latter in large numbers. Statistical tests do not reveal a shift at this time in the parameters in the money supply function.
Summer 1923 was another time of many changes in the credit market. Large increases in real government borrowing and decreased use of paper marks in transactions combined with the counterpoints of tax reforms and Reichsbank efforts to have the commercial bills they discounted specified in gold rather than in paper marks. Although the inflation rate reached hundreds of percent per month, expectations in the goods and forward exchange markets became somewhat more optimistic. There was, however, no corresponding willingness to hold more debt relative to money.
Last, there is an opinion that a plot of foreign businessman also influenced the money supply of the Reichsbank. J.P.Morgan who was a American businessman influenced Reichs bank to print more money. In 1916 in the middle of World War 1, the force of German was equal to that of the allied powers. The number of the war dead in Britain and France was more than that of German, so Britain and France wanted to negotiate with German to end World War 1. Because J. P. Morgan lent much money to France and Britain, he hoped that German should be defeated at World War 1. A few months later, he got America, which was isolationism country, to take part in World War 1. As a result, German became a defeated country. The Allied Powers which won World War 1 forced 132 billion Mark on German as reparation of World War 1. Committee of reparation was established by mainly businessman of Wall Street to collect reparation. Reichsbank was kept watch by committee of reparation. At this very moment, Reichs bank became under the Allied Powers, so what did Reichs bank do? To our dismay, Reichs bank started discounting bills of private sector. In the second half of this year, the discount rate became more than five hundred times. What does this mean? For example, someone write a bill of a billion Mark so, get factories. A few months later, because the price of mark fall to one – billion, when he settles an account, he can essentially get factories at 1 mark. In this way Capitalists who had much money monopolized many factories in astronomical rise of price. The other side, the middle classes could not follow astronomical rise of price, so they went bankrupt one after another. Then German bank got their equipment. Thus, J.P.Morgan and Jewish capitalists exploited Reichs bank as an Aladdin’s lamp, so they got many factories in the whole of German.
This paper refer to that the Reichsbank related to money supply, from 1914 to 1923. The central point of Reichsbank’s policy is passivity. I think the Reichsbank was made print money by government, foreign businessman and so on, so it could not be avoided.
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