Germany suffered two currency collapses in the last century, in 1920-23 and 1945-48. The architect of the recovery from the former, Hjalmar Schacht, chose to cooperate with the Nazi successors to the Weimar Republic, and failed. In that of the second, Ludwig Erhard remained true to his free market credentials and succeeded. While they were in different circumstances, comparisons between the two events might give some guidance to politicians faced with similar destruction of their state currencies, which is a growing possibility.
By Alasdair Macleod
Let us assume the next credit crisis is on its way. Given enhanced levels of government debt, it is likely to be more serious than the last one in 2008. Let us also note that it is happening despite the supposed stimulus of low and negative interest rates, when we would expect them to be at their maximum in the credit cycle, and that some $17 trillion of bonds are negative yielding, an unnatural distortion of markets. Let us further assume that McKinsey in their annual banking survey of 2019 are correct when they effectively say that 60% of the world’s banks are consuming their capital before a credit crisis. Add to this a developing recession in Germany that will almost certainly lead to both Deutsche Bank and Commerzbank having to be rescued by the German government. And note the IMF recently warned that $19 trillion in corporate debt is a systemic timebomb, and that collateralised loan obligations and direct exposure to junk held by the US commercial banks is approximately equal to the sum of their equity.
Then we can say with some confidence that a major credit crisis is developing, and that it will almost certainly be far greater than Lehman. We can also say that the money-printing by central banks to rescue both the banking system and government finances will be on a far greater scale, likely to destabilise the purchasing power of government currencies. If that happens, interest rates will then be forced higher as prices for everything begin to rise uncontrollably, irrespective of central bank interest rate policies. And where they depend on budget deficits being covered by additional issues of government stock, Government finances will be in crisis. It will threaten the ending of unbacked currencies based only on the faith and credit of governments whose spending is spiralling out of control.
The factors determining the pace of currency decline
The end of currencies might not be immediate. The lessons from the past tell us that the public can be slow to recognise what is happening to their money and savings. Currency collapses have happened in individual currencies before, but next time it appears it will be a common fate faced by all major currencies. In the past, there have been other sounder currencies available in the foreign exchanges, but with a declining dollar at the centre of it all, the alternatives to a cadre of collapsing currencies are extremely limited. The consequences for populations accustomed to welfare payments and services are bound to be drastic.
It is the interplay between foreign exchanges and domestic valuations that sets the pace for a currency’s decline. The Argentinian peso is a contemporary example of a currency that is still accepted in the foreign exchanges but is discarded as overvalued by its users. The proof is found in the black-market rate at over 70 to the US dollar compared with the foreign exchanges rate of 59.
Unlike the Argentinians who already value their pesos less than foreigners, in the major currencies the delusion of the masses about their frailty is almost absolute, and the learning process about the consequences of creating money out of nothing has yet to begin. The time taken for ordinary people and the foreign exchanges to learn the hard truths about accelerated currency debasement can vary enormously.
But fiat currencies die. Other than today’s currencies that have yet to do so they always have, and any student of money and the exchanges should be able to detect signs of their demise as well. The death of a currency is painful for all those involved. It is a national bankruptcy, but even though it is difficult to see how, nations and their peoples do survive the destruction of their currencies.
Germany experienced it twice in the last century. The first time paved the way for a dictatorship ten years later. The second had a more enduring legacy, making Germany one of the two most economically powerful nations in recent years, at least until the bureaucrats and planners won, folding the deutsche mark into the new euro. For politicians seeking to navigate their way through what is lining up to be the greatest credit crisis since the 1930s, the lessons from the German experience are salutary. In Britain, a new government will be formed by Christmas, and in its early years, it will probably face a global credit and banking crisis, threatening the future of sterling.
Assuming Boris Johnson wins and continues as Prime Minister, we know from his writings that he understands free markets, the importance of price discovery, the evils of excessive government intervention and regulation, and crony capitalism. He is in a minority in these views, though there are powerful figures around him who share them. This was similar to the position of two German nationals, who handled their currency collapses with different outcomes.
If a widespread currency collapse takes sterling with it, the political class will be unable to stop it. Then, will Boris be a Hjalmar Schacht, or a Ludwig Erhardt, both of which saw a collapse of the mark at different times and managed the subsequent recovery. It is an interesting thought.
Germany’s Weimar government
During the Weimar inflation, a weak government went from believing in Knapp’s pre-war Chartalist state theory of money under the previous sovereign regime, which allowed it to print at will, to learning the hard way of its fundamental errors too late to stop it. The whole Western world in this century has embarked on this journey, so Germany’s experience offers some salutary guidance. Just as interesting is how President trump would respond.
Before Hitler came to power in 1933, the post-war Weimar government had continued in office long after the people suffered the great inflation which ended in 1923. The ten years that followed showed that a system of government can survive a monetary catastrophe. Following the inflation, the Weimar government found itself still balancing the demands of the workers with those of industrial cartels, the Marxists and the Capitalists. And when Britain went off the gold standard in 1931 (along with the whole sterling area) the fall in sterling made German export prices suddenly too high in comparison by an estimated 20%. In 1930, Chancellor Brüning had already responded to the developing depression in America by tightening credit and reversing salary increases, so sterling’s devaluation was an extra blow. Combined with Brüning’s deliberate deflationary policies, this led to mass unemployment and the advancement of the Nazi party, which finally took control of the German economy in January 1933 when Hitler was appointed Chancellor.
This set the pattern to dictatorship described by Hayek in his The Road to Serfdom. In future, some nations with collapsed currencies are almost certain to follow a similar course, characterised initially by a weak government subsequently trying to be all things to everyone.
Whatever the character of that government, severe restrictions on the issue of a new, replacement currency will be needed if it is to have any credibility. It is very likely to find ready support from a population desperate to believe it will work, which is why and how Hjalmar Schacht succeeded in late-1923 as Currency Commissioner and President of the Reichsbank.
When he stabilised the mark, his office was a former charwoman’s cupboard. His secretary described his working day, thus:
“He sat on his chair and smoked in his little dark room which smelled of old floor cloths. Did he read letters? No. Did he write letters? No. He telephoned a great deal – to every German or foreign place that had anything to do with money and foreign exchange as well as with the Reichsbank and the Finance Minister. And he smoked. We did not eat much during that time. We usually went home late, often by the last suburban train, travelling third class. Apart from that he did nothing.”[i]
As Germany’s Currency Commissioner, his was a department of only two with a telephone, including his secretary, Fräulein Steffeck, proof that with the right authority, that is all that is needed to implement a national currency policy. As long as it is properly managed, the lesson from the Weimar Republic is that a new state currency can succeed long enough to see a nation through its economic crisis. Germany then entered the “golden years”, a period of economic recovery and growth, admittedly fuelled by bank credit expansion. While Schacht’s basic monetary policy was very successful, politically he drifted towards Nazism, becoming Hitler’s Economy Minister in 1934, though he continued to advocate free markets while criticising Germany’s military spending.
While working from inside the establishment, Schacht’s free market ethos was directly at odds with fascism. German fascism permitted the ownership of private property on condition that the state directed its production. Schacht was both inside the Nazi regime and one of its greatest critics, even implicated in a plot to depose Hitler in 1938. However, his international credibility was too great for Hitler to sack him, but he was eventually dismissed in 1943.
Schacht was a remarkable man, a German patriot trying to do the best for his country at the most difficult of political times. He was exonerated at Nuremberg and completely so at the de-Nazification trial that followed.
He is a forgotten figure today, but having stabilised the economy by introducing and maintaining a sound monetary policy, he provided a brief window leading to Germany’s golden years in the late 1920s, which admittedly must have been fuelled to a large degree by the expansion of bank credit both in Germany and elsewhere. Other, perhaps, than his neglect of monetary expansion through bank credit, his efforts came to nought through events beyond his control. The wake of the Wall Street crash, Chancellor Brüning’s deflationary policies and the additional factor of sterling being driven off the gold standard in 1931 were the events which opened the door to fascism, and the complete destruction of its economy following Germany’s defeat in the Second World War.
Where Schacht failed, following the Second World War another German economist succeeded, and that was Ludwig Erhard.
Erhard’s rise to power
Erhard’s father was of peasant stock, who had moved from the land to Fürth in Northern Bavaria where he established a successful clothing store. Erhard fils had a settled, if unpretentious background with solid entrepreneurial values. Unfortunately, in childhood he suffered infantile paralysis, which forced him to wear orthopaedic shoes for the rest of his life. He was unable to take part in sporting activities, reduced, as it were, to be a spectator. He had few close friends and was either regarded as something of a loner, or having an independent non-collegiate mind.
Two weeks before Hitler was invalided in a gas attack, in September 1918 Erhard was badly wounded nearby by Allied shrapnel, requiring seven operations and not emerging from hospital until the following spring. He was officially invalided with a pension. But it was Hitler who was radicalised, while Erhard continued to have a more balanced positive outlook on life.
Doubtless informed by his father’s success as a small trader, Erhard understood that consumers mattered above all else, at a time when industry cartels dominated the German economy. Economic debates raged between the German historical school, cartel-supporting liberals, Marxists and then the Nazis. But he remained a lonely supporter of free markets, understanding that no form of state planning was able to provide what the markets demanded and set prices realistically.
Throughout his adult life, he held to his minority view. As a war invalid, he was too weak to work in his father’s store, and in 1919 enrolled in a business college in nearby Nuremberg. It was the start of his academic career, during which he developed an interest in money and economics. As an economist, he never became a consensus man. He did not join the liberals, who promoted cartelism and the state, nor did he embrace socialism. He firmly believed in freedom for the ordinary person. He rejected the current fashions of centralisation and state planning.
Unlike Schacht, Erhard did not join the Nazis. He remained apolitical, but he was clear in his personal objectives and always positioned himself to achieve those ends.
At the end of the Second World War, Germany was split into four military administrative zones: Russian, French, American and British. The one of immediate concern to Erhard was the American, under General Lucius D Clay, who had been instructed by the oversight committee (JCS 1067) that the standard of living of the German people should not be permitted to exceed that of their neighbours (an instruction he ended up ignoring). Furthermore, steps were to be taken to ensure Germany could not launch another war, and accordingly the economy was to be decentralised, war-related industries dismantled and business leadership de-Nazified.
Since it covered Southern Germany, the US occupation zone included Bavaria, Erhard’s home state, and he quickly came to the Americans’ attention as one of very few free-market economists untainted by Nazism. Furthermore, General Clay tended towards free markets himself, and Erhard was appointed Economics Minister in the Bavarian Government in September 1945.
The occupation zones were not initially permitted to trade with each other, so Erhard began to agitate for the combination of American and British zones, which eventually happened. In their co-responsibility with the Americans for the new Bizone, the British were very different from the Americans, having centralising and planning tendencies in line with the nationalisation policies of the Atlee government. However, Erhard chipped away at these obstacles, earning the trust and respect of the American military while being barely tolerated by the British military.
In October 1947, a new committee, the Special Office for Money and Credit met with Erhard as its chairman. In this position, he made it clear that he wanted to deregulate and liberalise the economy as soon as possible, in association with the planned currency reform. On 16 June 1948, the currency reform plans were set: every German would receive forty new deutsche marks immediately and a further 20 marks would follow in two months’ time. Five per cent of savings balances in old marks would be deposited therein immediately, and a further five per cent within ninety days. All balances of old marks would be destroyed, amounting to eighty per cent of currency outstanding. Thus, the purchasing power of the mark was to be restored, and the enabling legislation was rushed through two days later. The new deutsche mark became legal tender for the Bizone on 21 June.
Erhard used his powers as Chairman of the VfW (Administration for Economics) to end rationing for most household items, without referring to the British and American authorities. General Sir Brian Robertson, the chief of the British occupation government objected strongly, because Britain still had rationing. General Clay for the Americans sympathised with Erhard in the knowledge that if he had consulted the military authorities first, the British would have vetoed it, so the matter of Erhard exceeding his authority was dropped.
The following week, the Bizonal economy enjoyed a seeming miracle. Goods appeared in the shops, and shopkeepers sold them for a new money with decent purchasing power. The black market disappeared, and workers no longer wasted time away from their jobs trying to obtain goods on the black market. It was the start of the new German economy.
There were short-term problems. Prices rose, while wages were still controlled, but these were transitional. Erhard had to continue the fight to ensure free markets operated, that the consumer had preference over state-directed businesses, and cartels remained abolished. It was a fight that lasted until the late-1950s. But almost alone, surrounded by bureaucrats, planners and other enemies of free markets, he had through dogged determination set Germany on the path to prosperity. It was referred to as the German Miracle, when it was nothing of the sort: it was the German people given a greater degree of economic freedom than ever before. It was what they did with that freedom, which was Erhard’s enduring legacy.
The lessons for today
There must be no doubt that central bankers create the conditions for their own downfall. They are entirely responsible for a cycle of credit expansion and contraction that leads to what is generally referred to as the business cycle, implying the blame for it lies with the animal spirits in free markets. This is incorrect.
The fundamental problem with monetary and credit expansion is it replaces random market action, the non-cyclical case, with coordinated action. All production and consumption are stimulated at the same time by monetary expansion. Instead of Schumpeter’s creative destruction occurring randomly over time, it is amplified and bunched into a cyclical crisis. Furthermore, through the dollar and the G20 forum, all central banks now expand money and credit at the same time, ensuring the inevitable crisis will be both everywhere and magnified even further through common trade relationships. It is also the nature of the beast for successive credit cycles to become increasingly destabilising, because the distortions created by monetary policy in previous crises are never allowed to wash out of the system.
One cannot say with certainty that the forthcoming credit crisis will destroy government currencies, but the indications are that the monetary and bank credit expansions of the US dollar likely to be undertaken in an attempt to prevent the developing recession turning into a slump will be so large that they will undermine its purchasing power. In the Eurozone, monetary expansion so far has been more subdued, but that is because it has mainly been taken up by governments and not their non-financial private sectors. And Japan’s monetary expansion has almost all gone into savers accounts and been loaned to the government. China has set in train a directed monetary expansion greatest of all the other major currencies.
It will be a miracle if a widespread monetary disaster does not ensue. But contrary to the views of doom-mongers and preppers, life will go on. The key to the situation following the event will be whether free markets are properly embraced. A re-elected President Trump and Prime Minister Johnson might care to draw on the lessons from Germany in the twentieth century, which showed how not to do it, and then how to provide a lasting legacy for their nations and themselves.
[i] Adam Fergusson: When Money Dies: The Nightmare of the Weimar Collapse, Chapter 13.
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