The Prodigal Greek

The Greek crisis through a different prism

A little bit about Germany

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Historical events often have such gravity and impact that leave lasting scars on a nation and shape a country’s beliefs and policies for decades.

Germany throughout this eurozone crisis has been heavily criticised on a number of decisions, reluctance to adopt different policy mixes or deployment of alternative solutions to avert the contagion of the crisis from the euro periphery to the core.  However, taking a closer look at one of Germany’s most destructive periods, both for economy and society, and the years that followed, one can easily identify parallels and interpret why the modern-day German leadership is standing firm, almost stubborn, in its beliefs for the resolution of this crisis.

The German hyperinflation of the early 1920s is probably the most famous hyperinflation in history and the most damaging ever to hit an advanced economy.

In 1913, the value of all currency circulating in Germany was 6 billion marks. Ten years later, in October 1923, 6 billion marks were barely enough to buy a 1 Kg loaf of rye bread in Berlin. A month later, the price of the same loaf of bread was 428 billion marks.

The post war inflation in Germany was caused by the combination of war reparations and the government’s refusal to balance its budget. The Treaty of Versailles (1919) had established that Germany was to indemnify the Allies for the war losses and had created a Reparations Commission to assess the amount. In 1921 the commission assessed the war damage at 132 billion gold marks (£6.6bil, an amount equal to half of Britain’s GDP) and laid down a time schedule for payments.

The resulting government deficits were financed initially by borrowing, but when the deficits persisted and even increased in size by rising prices, the German public refused to take up more government securities and the government was forced to print money to cover its excess expenditure. These only added to the quantity of money in circulation and led to even higher prices. Eventually, the expanding money supply and rising prices by depreciating the value of the mark caused it to be spent even more rapidly. From the combined forces of large quantities of money and the mark being spent faster and faster, runaway inflation was inevitably developed.

The price of a daily newspaper rose from 0.30 marks in January 1921 to 1 mark in May 1922, to 8 marks in October 1922, to 100 marks in February 1923, and to 1000 marks in September 1923. In the fall of 1923, prices took off, by 17 November 1923, in less than two months; the price of the daily news paper was 70 million marks.

In 1923, prices in Germany increased an average of 500% per month. Workers were paid twice a day and were given half hour breaks to run to the shop for purchases before their money halved in value yet again.  In restaurants, a waiter would stand up on a table every thirty minutes to call out the new prices.

In the final stages of this hyperinflation the rise in prices left the increase in quantity of money far behind and this shortage of money gave the German government the opportunity to bring inflation under control. A new Rentenmark, introduced late in 1923, was quickly taken up by a public long inconvenienced by the lack of a stable currency. This enabled the government to issue new money to cover its expenditures while at the same time taking steps to balance its budget through spending cuts – the number of government employees was cut by one-third – and tax increases. At the same time, the new central bank, the Rentenbank, replaced the old central bank and was committed to not financing the government by printing money.

The stabilisation of the mark was completed with the receipt of an international loan under the Dawes Plan of 1924.

The Dawes Plan was the outcome of a reconsideration, a form of debt restructuring, of the whole German reparations problem that had inevitably followed the collapse of the mark and Germany’s default on its reparations payments in 1922.  In response to this default, France and Belgium occupied Germany’s industrial heartland with a heavy cost on the economy.

In the grip of  inflation, Germany was in no position to meet her obligations. Under the Dawes arrangements, reparations resumed and the first payment was made possible by an international loan which also enabled Germany to introduce a new currency, the Reichsmark. Foreign countries now became interested in the reconstruction of Germany and the rest of the 1920s both the government and private firms were able to borrow sums abroad. The country’s economic situation was stabilised.

This massive foreign borrowing, however, led to the precarious financial situation in Germany in the late 1920s when one last attempt was made to resolve the issues of the reparations. Under the Young Plan in 1929 the reparations figure and the period of payments were revised, a form of debt restructuring and reprofiling, the annual payments were scaled down to £100mil and the payments termination in 1987-88. The new agreement took effect in April 1930 supported by a $300mil loan. But with the onset of the depression, Germany was quickly engulfed in a financial crisis which led to a moratorium of payments in June 1931 and, in the following year, their complete abandonment, another default.

Linked with the problem of German reparations was the repayment of inter-allied war debts. Since many of the allied countries came to regard German reparations payments as the means of paying back their American debts, there developed a chain of debt payments starting in Germany and ending in the United States.

For these debt payments to be made two things needed to happen: large sums of marks had to be extracted annually by the German people through heavy taxation and these sums had to be transferred regularly in other currencies, and ultimately a large proportion into dollars.  For a number of reasons this transfer process never worked efficiently and the problem of reparations and inter-allied war debts was not settled until Germany started receiving large sums of foreign capital, mainly from the United States. The chain of repayments then started to function smoothly, but when this foreign lending to Germany ceased in the late 1920s the transfer payments also stopped and with it the repayment of the inter-allied war debts, a contagion that caused multiple defaults in debt payments. The United States only received $2.6 out of the original $12bil debt from the Allies.

Excessive budget deficits, fiscal irresponsibility, abuse of the central bank’s authority and functions and heavy external debt led to a traumatic experience for Germany and the Germans. Millions saw their life savings disappear and social cohesion was damaged.

In the current crisis Germany is reliving her worst nightmare with the scars of the past shaping the strategy in the present.  Iron fiscal discipline seems to be, in a monotone, the basic principle behind Germany’s proposed road to catharsis and German politicians further stand firm in their refusal to allow the ECB come to the rescue of any troubled country, act as a traditional central bank with government securities or become the lender of last resort.

However, modern German leadership should take a different view on the lessons of the past. Policies that destroy the social cohesion of a country and politics that hurt the pride of a nation can create the conditions for the formation of social and political teratomas.

As much as it was not the main reason for its rise, it was the anger of those that had lost it all during the 1920s that fed the growth of Nazism.


The Growth of the International Economy 1820 – 2000, A.G. Kenwood and A.L. Lougheed

Macroeconomics, N. Gregory Mankiw

Macroeconomics, Olivier Blanchard

The Economist, Millenium issue: German hyperinflation, Loads of Money


Written by Yiannis Mouzakis

November 17, 2011 at 2:41 am

Posted in Economico

Tagged with , , ,

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