Hyperinflation in Germany, 1914-1923

Mises Daily: Friday, October 27, 2006 by Hans F. Sennholz

[This article is excerpted from the book The Age of Inflation.]

The German inflation of 1914–1923 had an inconspicuous beginning, a creeping rate of one to two
percent. On the first day of the war, the German Reichsbank, like the other central banks of the
belligerent powers, suspended redeemability of its notes in order to prevent a run on its gold
reserves.

Like all the other banks, it offered assistance to the central government in financing the war
effort. Since taxes are always unpopular, the German government preferred to borrow the needed
amounts of money rather than raise its taxes substantially. To this end it was readily assisted by
the Reichsbank, which discounted most treasury obligations.

A growing percentage of government debt thus found its way into the vaults of the central bank
and an equivalent amount of printing press money into people's cash holdings. In short, the central
bank was monetizing the growing government debt.

By the end of the war the amount of money in circulation had risen fourfold and prices some 140
percent. Yet the German mark had suffered no more than the British pound, was somewhat
weaker than the American dollar but stronger than the French franc. Five years later, in
December 1923, the Reichsbank had issued 496.5 quintillion marks, each of which had fallen to
one-trillionth of its 1914 gold value.[1]

How stupendous! Practically every economic good and service was costing trillions of marks. The
American dollar was quoted at 4.2 trillion marks, the American penny at 42 billion marks. How
could a European nation that prided itself on its high levels of education and scholarly knowledge
suffer such a thorough destruction of its money? Who would inflict on a great nation such evil
which had ominous economic, social, and political ramifications not only for Germany but for the
whole world? Was it the victors of World War I who, in diabolical revenge, devastated the
vanquished country through ruinous financial manipulation and plunder? Every mark was printed
by Germans and issued by a central bank that was governed by Germans under a government that
was purely German. It was German political parties, such as the Socialists, the Catholic Centre
Party, and the Democrats, forming various coalition governments, that were solely responsible for
the policies they conducted. Of course, admission of responsibility for any calamity cannot be
expected from any political party.

How could a European nation that

prided itself on its high levels of
education and scholarly
knowledge suffer such a thorough
destruction of its money?

The reasoning that led these parties to inflate the national currency at such astronomical rates is
not only interesting for economic historians, but also very revealing of the rationale for monetary
destruction. The doctrines and theories that led to the German monetary destruction have since
then caused destruction in many other countries. In fact, they may be at work right now all over
the western world. In our judgment, four erroneous doctrines or theories guided the German
monetary authorities in those baleful years.

No Inflation in Germany
The most amazing economic sophism that was advanced by eminent financiers, politicians, and
economists endeavored to show that there was neither monetary nor credit inflation in Germany.
These experts readily admitted that the nominal amount of paper money issued was indeed
enormous. But the real value of all currency in circulation, that is, the gold value in terms of gold
or goods prices, they argued, was much lower than before the war or than that of other industrial
countries.
Minister of Finance and celebrated economist Helfferich repeatedly assured his nation that there
was no inflation in Germany since the total value of currency in circulation, when measured in
gold, was covered by the gold reserves in the Reichsbank at a much higher ratio than before the
war.[2] President of the Reichsbank Havenstein categorically denied that the central bank had
inflated the German currency. He was convinced that it followed a restrictive policy since its
portfolio was worth, in gold marks, less than half its 1913 holdings.
Professor Julius Wolf wrote in the summer of 1922: "In proportion to the need, less money
circulates in Germany now than before the war. This statement may cause surprise, but it is
correct. The circulation is now 15–20 times that of pre-war days, whilst prices have risen 40–
50times."[3] Similarly Professor Elster reassured his people that "however enormous may be the
apparent rise in the circulation in 1922, actually the figures show a decline."[4]
The Statistical Bureau of the German government even calculated the real values of the per capita
circulation in various countries. It, too, concluded that there was a shortage of currency in
Germany, but a great deal of inflation abroad.

Gold value of monies in circulation, gold marks per person

1920 1922

Germany 87.63 17.92

England 84.40 110.73

France 180.05 229.90

Switzerland 89.49 103.33

United States of America 101.35 97.66

Source: Wirtschaft und Statistjk, 1923, No. 1.

(To arrive at US dollar amounts these figures should be divided by 4.2)

Of course, this fantastic conclusion drawn by monetary authorities and experts bore ominous
consequences for millions of people. Through devious sophisms it simply removed the cause of
disaster from individual responsibility and thus also all limits to the issuance of more paper
money.

The source of this momentous error probably lies in the ignorance of one of the most important
determinants of money value, which is the very attitude of people toward money. For one reason
or another people may vary their cash holdings. An increase in cash holdings by many people tends
to raise the exchange value of money; reduction in cash holdings tends to lower it. Now in order
to change radically their cash holdings, individuals must have cogent reasons. They naturally
enlarge their holdings whenever they anticipate rising money value as, for instance, in a
depression. And they reduce their holdings whenever they expect declining money value. In the
German hyperinflation they reduced their holdings to an absolute minimum and finally avoided
any possession at all. It is obvious that goods prices must then rise faster and the value of money
depreciate faster than the rate of money creation. If the value of individual cash holdings declines
faster than the rate of money printing, the value of the total stock of money must also depreciate
faster than this rate. This is so well understood that even the mathematical economists emphasize
the money "velocity" in their equations and calculations of money value.[5] But the German
monetary authorities were unaware of such basic principles of human action.
For Health, Education, Welfare, and Full Employment

Immediately after the war the German government, under the leadership of the Socialist Party,
embarked upon heavy expenditures for health, education, and welfare. The demands on the
treasury were extremely heavy anyway because of demobilization expenses, the demands of the
Armistice, the disorders of the revolution, and the staggering deficits of the nationalized
industries, especially the railroads, postal services, telephone, and telegraph. Public
administration by the new men raised to power by the revolution, nevertheless, was extravagant,
as the resources made available by the creation of new money were apparently unlimited. A
number of measures for the nationalization of certain industries (e.g., the coal, electrical, and
potash industries) were introduced, but failed to become law. The eight-hour day was enacted,
and labor unions were given many legal immunities and privileges. In fact, a system of labor
councils was set up which authorized the workers in each enterprise to elect representatives who
shared in the management of the company! While government expenditures rose by leaps and
bounds, the revenue suffered a gradual decline until, in October 1923, only 0.8 percent of
government expenses were covered by tax revenues. For the period from 1914 to 1923 scarcely
fifteen percent of the expenses were covered by means of taxes. In the final phase of the inflation
the German government experienced a complete atrophy of the
fiscal system.

In October 1923, only

The depreciation of the currency brought about the destruction of
0.8% of government
taxable wealth in the form of mortgages, bonds, annuities, and expenses were covered by
pensions, which in turn reduced government revenue. Some tax revenues.
speculators reaped spectacular profits from the depreciation, but
they easily evaded the tax collector. Moreover, the fiscal policies of the socialist government
were openly hostile toward capital and frequently endeavored to impose confiscatory capital
levies upon all wealth. Secretary of the Treasury Erzberger even vowed that "in the future
Germany the rich should be no more."[6] Consequently a massive "flight of capital" from Germany
developed as all classes of savers invested their money in foreign bank accounts, currencies bills,
securities, etc. Much taxable wealth was removed from the grasp of tax collectors.

Finally, the rapid depreciation of currency greatly reduced all tax liabilities during the time
interval between the taxable transaction and the date of tax payment. The taxpayer usually paid
a sum whose real value was greatly reduced by inflation. Nevertheless, government expenditure
accelerated while revenue in terms of real value continued to decline. The growing deficits then
were met with even larger quantities of printing press money, which in turn generated ever larger
deficits. The German monetary authorities, in fact, were trapped in a vicious circle from which
they did not know how, nor have the courage, to extricate themselves.

The leading monetary authority, Dr. Helfferich, even warned his people against the dire
consequences of monetary stabilization.

To follow the good counsel of stopping the printing of notes would mean refusing to economic life
the circulating medium necessary for transactions, payments of salaries and wages, etc. It would
mean that in a very short time the entire public, and above all the Reich, could no longer pay
merchants, employees, or workers. In a few weeks, besides the printing of notes, factories,
mines, railways, and post offices, national and local government, in short, all national and
economic life would be stopped.[7]

The Balance of Payments and the Treaty of Versailles

Throughout the period of the inflation the most popular explanation of the monetary depreciation
laid the blame on an unfavorable balance of payments, which in turn was blamed on the payment
of reparations and other burdens imposed by the Treaty of Versailles. To most German writers and
politicians, the government deficits and the paper inflation were not the causes but the
consequences of the external depreciation of the mark.

The wide popularity of this explanation which charged the victorious allies with full responsibility
for the German disaster bore ominous implications for the future. Its simplicity made it appealing
to the masses of economically ignorant people whose chauvinism and nationalism always make the
idea of foreign intrigue and conspiracy so palatable. The intellectual and political leaders who
actively propagated the doctrine were sowing the seeds for the whirlwind they reaped a decade
later.

The wide popularity of

this explanation which
charged the victorious
allies with full
responsibility for the
German disaster bore
During those baleful years, Germany actually procured gratuitously
ominous implications for
from abroad large quantities of raw materials and foodstuffs.
the future.
According to various authoritative estimates, foreign individuals and
banks bought at least sixty billion paper marks which the Reichsbank
had floated abroad at an average price of one-fourth gold mark for a paper mark. The
depreciation of the mark to one-trillionth of its earlier value repudiated these foreign claims to
German goods. Thus foreigners suffered losses of some fifteen billion gold marks, or some $3.5
billion US dollars, which was eight times more than Germany had paid in foreign exchange on
account of reparations.

But even if it had been true that excessive burdens had been thrust on Germany by the Allies,
there was no need for any monetary depreciation. Both phenomena are entirely independent. If
excessive burdens are placed on a government, whether they be foreign or domestic, that
government must raise taxes, or borrow some funds, or curtail other expenditures. Excessive
reparation payments may necessitate greatly higher taxes on the populace, or large loans that
reduce the supply of savings for industry and commerce, or painful cuts in government service and
employment. The standards of living of the people thus burdened will probably be depressed —
unless the reduction of bureaucracy should release new productive energy. But the value of
money is not affected by the reparation burden unless economic productivity is impaired by the
fund-raising.

Once government has achieved the necessary budgetary surplus the payment of reparations is a
simple matter of exchange. The treasury buys the necessary gold or foreign exchange from its
central bank and delivers it to the recipient government. The loss of gold or foreign exchange
then necessitates a corresponding reduction of central bank money, which in turn tends to depress
goods prices. Lower goods prices encourage more exports while they discourage imports, that is,
generate what is commonly called a "favorable balance of payments" or new influx of gold and
foreign exchange. In short, there can be no shortage of gold or foreign exchange as long as the
central bank refrains from inflation and monetary depreciation. The German monetary authorities
flatly denied this economic reasoning. Instead, they preferred to lament about the excessive
burdens thrust onto Germany and the unfavorable balance of payments generated thereby. In
1923 they added yet another factor: the French occupation of the Ruhr district. The Central
Statistical Office put it this way:

The fundamental cause of the dislocation of the German monetary system is the disequilibrium of
the balance of payments. The disturbance of the national finances and the inflation are in their
turn the consequences of the depreciation of the currency. The depreciation of the currency upset
the Budget balance, and determined with an inevitable necessity a divergence between income and
expenditure, which provoked the upheaval.[8]

Again I quote Dr. Helfferich:

Inflation and the collapse of the exchange are children of the same parent: the impossibility of
paying the tributes imposed on us. The problem of restoring the circulation is not a technical or
banking problem; it is, in the last analysis, the problem of the equilibrium between the burden
and the capacity of the German economy for supporting this burden.[9]

Even American economists echoed the German theory. Professor Williams presented this causal
order: "Reparation payments, depreciating exchanges, rising import and export prices, rising
domestic prices, consequent budgeting deficits, and at the same time an increased demand for
bank credit; and finally increased note-issue."[10] Professor Angell contended that "The reality of
the type of analysis which runs from the balance of payments and the exchanges to general prices
and the increased issue of paper seems to be definitely established."[11]
Speculators Did It

When all other explanations are exhausted, modern governments usually fall back on the
speculator, who is held responsible for all economic and social evils. What the witch was to
medieval man, what the capitalist is to socialists and communists, the speculator is to most
politicians and statesmen: the embodiment of evil. He is said to be imbued with ruthless and
fickle selfishness that is capable of wrecking the national economy, government plans, and, in the
case of German inflation, the national currency. No matter how blatantly contradictory this
explanation may be, it is most popular with government authorities in search of a convenient
explanation for the failure of their own policies.

The same German officials who denied the very existence of inflation lamented the depreciation
caused by speculators, or they blamed the Allied reparation burdens and simultaneously
denounced speculators for the depreciation. Dr. Havenstein, the President of the Reichsbank,
embracing every conceivable theory that exculpated his policies, also pointed at the speculators.
Before a parliamentary committee he testified: "On the 28th of March began the attack on the
foreign exchange market. In very numerous classes of the German economy, from that day
onwards, thought was all for personal interests and not for the needs of the country."[12]

In a chorus the newspapers chanted the charge:

According to all appearances the fall of the mark did not have its origin in the New York exchange,
from which it may be concluded that in Germany there was active speculation directed towards
the continual rise of the dollar.
We are witnessing a rapid increase in the number of those who speculate on the fall of the mark
and who are acquiring vested interests in a continual depreciation.
The enormous speculation on the rise of the American dollar is an open secret. People who,
having regard to their age, their inexperience, and their lack of responsibility, do not deserve
support, have nevertheless secured the help of financiers, who are thinking exclusively of their
own immediate interests.
Those who have studied seriously the conditions of the money market state that the movement
against the German mark remained on the whole independent of foreign markets for more than six
months. It is the German bears, helped by the inaction of the Reichsbank, who have forced the collapse in the
exchange.[13]

In its broadest sense speculation is present in every economic action that makes provision for an
uncertain future. The student who studies aeronautical engineering speculates on the future
demand for his services. The businessman who enlarges his inventory speculates on a profitable
market in the future. The housewife who hoards sugar speculates on the availability of sugar in
the future. The buyer or seller of goods or securities hopes to make a profit from future changes
in prices. All such actions reflect a natural motivation of free men to improve their material well-
being or, at least, to avert losses.

When speculators observe or anticipate more inflation and monetary depreciation they naturally
endeavor to sell the depreciating currency and buy goods or foreign exchange that do not
depreciate. They are preserving their working capital. Thus they are promoting not only their own
interests but also those of society, which benefits from the preservation of productive capital. The
government that is actively destroying the currency is injuring the national interest — successful
speculators are safeguarding it. Surely the speculators who sold German marks and bought US
dollars were proved to be right in the end.

What the witch was to

medieval man, what the
capitalist is to socialists
and communists, the
speculator is to most
The worldwide inflation that is engulfing the western world now
politicians and statesmen:
springs from similar doctrines and theories. There is no Treaty of
the embodiment of evil.
Versailles and no reparation payments that can be blamed for the
present inflation. But in many countries of Central and Western
Europe the responsibility for monetary depreciation is squarely laid on American balance-of-
payments deficits that are flooding those countries with US dollars. While European monetary
authorities are actively inflating and depreciating their own currencies — although at slower rates
than their American counterparts — they are pointing at the US balance of payments as the
ultimate cause of their currency depreciation. As in the German hyperinflation, foreign intrigue
and artifice are said to be at work again.

American officials and politicians are quick to lay the blame for US difficulties on foreign intrigue,
especially that of "the Arabs." Since the formation of the oil producers' cartel and the significant
boost in oil prices, US balance-of-payments deficits and the dollar weakness in foreign exchange
markets are charged explicitly to the Arab countries. Lest any suspicion should fall on the US
monetary authorities, the American people themselves come in for some of the blame. Their use
of "excessive" quantities of foreign oil is said to contribute to the balance-of-payments deficits
and the dollar weakness. Therefore, our political leaders and economic authorities are debating
the desirability of special taxes that would reduce the consumption of foreign oil. After the Arab
blow at economic well-being the US government is readying its blow for the sake of financial
stability.

Again the speculators are charged for a share of the blame

American investors who buy foreign securities or make
direct foreign investments are said to be largely responsible
for the outflow of US funds and the loss of gold, which is
creating an unfavorable balance of payments and
weakening the dollar. Moreover, Americans who prefer
foreign products over homemade products or choose to
travel abroad rather than stay at home are decried as
selfish and unpatriotic. Numerous regulations imposed by
the very monetary authorities who perpetrate the inflation
aim to prevent speculation in order to save the dollar.
$9
The specious argument that denies the presence of any inflation in terms of purchasing power or
gold value has, in our judgment, not yet been raised. But it must be expected to emerge in later
phases of the inflation when our authorities will be desperate for any argument that promises to
exculpate them.

Hans F. Sennholz, Professor Emeritus Grove City College is an Adjunct Scholar of the Mises
Institute. See his articles. Comment on the blog.
This article is excerpted from the book The Age of Inflation.