Will not waste much time, moving on to the next part of the story. Bear with me for this entire feature will be long, I will make a third part of this and it will end there, hope you will find it interesting.
German Hyperinflation:
This is one famous story that you may have heard. As part of the Versailles treaty, Germany had to cede Alsaces and Lorraine provinces to France, it also had to cut down its army to 100000 and finally agreed to pay $12 billion to the Allies as reparations. However, due to weak coalition governments, country on brink of revolution, large residual expenses from the war i.e. pensions to veterans and war widows and compensation to those who had lost territories, the German fiscal position was precarious. In addition, the democratic governments took up new social obligations like an eight hour workday, insurance for the unemployed, health and welfare for the sick and poor. This led to an even bad fiscal condition on top of which they had to stick to the reparation payment schedule. To finance this gap, the different governments simply resorted to printing money.
Figures again – in 1914, the mark stood at 4.2 to the dollar, by 1920, the mark had fallen to 65 marks to the dollar. Over the next 18 months, the inflation slowed down and foreign currency speculators moved in $2billion into the country since this was Germany, the epitome of discipline and orderliness and it had to perform well right. A series of events in mid 1921 (French intransigence over reparations, political murders by right wing death squads) changed the tide and broke the confidence of public in the mark who abandoned it in droves. As the mark went down, Germany got caught in a downward spiral. Prices rose forty fold during 1922 and the mark fell from 190 to 7600 per dollar. By 1923, the inflation had acquired a momentum of its own and the demand for Germany to print currency was a major logistical operation – 133 printing works with 1783 machines and more than 30 paper mills. In a country awash with paper, the demand for currency could not be met by the official press hence towns and private companies began to print their own notes.
Over the next few months, Germany experienced the single largest destruction of monetary value in human history. By August 1923, a dollar was worth 620,000 marks and by early November, 630 billion – to think this had happened to the third largest economy of the world was what made it horrendous. Basic necessities were priced in billions – a kilo of butter cost 250 billion marks, a kilo of meat cost 180 billion and a simple ride on a Berlin street car, which had cost 1 mark before the war now cost 15 billion.
The impact of all this was that the middle class lost most of its savings and was reduced to penury, discontent rode high in the populace and foreigners made hay by buying major German assets because of the currency rate. For one hundred dollars, a Texan hired the full Berlin Philharmonic orchestra for an evening. This difference in living rankled the Germans and agitated them further against the Versailles Treaty.
Schacht to the rescue:
In stepped Hjalmar Schacht who was made Currency Commissioner by the Government to supersede Von Havenstein who was the Governor of the Reichsbank and ardent supporter of inflation. Schacht convinced the government to launch a new currency the Rentenmark which would be backed by something tangible – Land. The whole idea was to make the currency stable. Schacht waited for the mark to fall to 4.2 trillion to the dollar and then set the conversion rate of Rentenmark to 1 trillion Reischsmarks to 1 Rentenmark. The Reischsmark became so worthless that the government was able to buy back its trillions of debts valued at $30 billion when first issued for 190 million Rentenmarks equivalent to $45 million. This signaled to the world that the new currency was stable and the German public which had simply got rid of cash before now started to began to buy it back. Farmers, their confidence in money restored, began bringing produce to the market, food reappeared in shops and queues began to melt away. The currency was stable and hope was back.
The question of reparations still remained which was solved by a group of Americans led by businessman Charles Dawes. The brain of the group was Owen Young, the chairman of GE and now the president of RCA. The plan mainly laid out that the total figure of $12.5 billion be kept aside, Germany was to pay $250 million in the first year, to be progressively increased to $600 million by the end of the decade. In addition, a loan of $250 million was to be raised to help Germany pay the first installment and kick start the economy. If Germany failed to pay, they would get a year’s break so the currency would not be impacted. The result of all this was that the confidence was back in the German economy and soon, American money began pouring into Germany in form of loans thus swelling its currency reserves and making it increase its interest rates.
The French story:
France was in big fiscal trouble around 1924 with its currency dropping in value. This was mainly due to the short term bonds and loans that had become due for payment, chronic political instability (6 governments in 5 months at one point) and German reparations not coming through any time soon. Another reason was the unearthing of an accounting scandal by the Banque authorities in order to cover up for deficit in revenue by printing money but not showing it on the books. This was a temporary solution but it never stopped and when unearthed amounting to 5 percent of money in circulation. The government refused to raise taxes and the Banque refused to let go of some gold to balance the deficit. This led to confidence dropping in the Franc and the currency slipped from 5 Francs per dollar before the war to 30 francs per dollar. The currency was in balance now but the money was short. French efforts at raising loans came to nought with both UK and US refusing to lend them.
It is at this point that Raymond Poincare took over power in France and appointed Moreau as head of the Banque – the franc was at 50 per dollar. This appointment provided a turnaround in confidence and brought back speculative attentions and financiers’ money to the franc. The Franc started rising and went rapidly up to 25. It is at this time that Moreau decided to cap the rise of the Franc by fixing the rate of the currency. If the franc had risen too high, the value of French goods in the world market would have risen thus making exports uncompetitive and leading to recession. The Franc was kept in control by buying up other currencies with the enormous gold that France had. By mid 1927, waves of French capital that had fled to London or New York came back home with the foreign exchange held by the Banque at $500 million in pounds. At 25 francs to the dollar, French goods were the most competitive in the world and France was back on the Gold standard.
The British story:
Last week, I had mentioned that Montagu Norman not only wanted to return Britain to the Gold standard but also wanted to not devaluate the pound so that it could retain its prime status. Like mentioned before, between devaluation and deflation, Norman chose deflation thus leading to a recession. After 3 years, the currency had come back to within 10% more than the dollar. In 1924, the socialist government fell and brought the Conservatives led by Stanley Baldwin to power. Baldwin appointed Winston Churchill as Chancellor of the Exchequer. Meanwhile, most of the other countries had moved to the Gold Standard and Britain (Norman) was being pushed to join by Benjamin Strong. Keynes opposed this tooth and nail because he believed that joining would join Britain too much with American fortunes since they owned most of the gold. Instead, he recommended devaluating the currency so that British exports could be competitive again. At 10% higher than America, British prices were still too high and this would cause a problem when tethered to the Gold Standard, Britain would lose control over its currency.
The debate raged far and wide and ultimately Churchill called in a conference of a handful of colleagues and intellectuals representing both sides – Keynes being one of them. Everyone agreed that the prices were a bit too high but also that the best time was now since the economy was in good shape (Pound was at 4.3 dollars, though British hold over manufacturing had been lost) and Americans could help Britain with $250 million in loans. Finally, Churchill decided in favor of the Gold Standard, Norman was the Hero of the Hour as he promised to make Churchill the “Golden Chancellor”. The Pound went to Gold and its value was raised to 4.86 i.e. pre-war levels. Because the exchange rate rose, the prices of British goods rose outside as well and the staple export industries of coal, steel and shipbuilding were hit. Strikes resulted and tempers flew. This did not lead to flight of capital because there was continued inflow of capital was because of the high interest rates in London market and escaping the escalating crisis in France.
To keep this “hot” money from flooding back out, interest rates had to be kept higher than other countries for the rest of the decade. Everyone realized in 1927 that the return to Gold was a mistake because British manufactures were losing steam and competence in the international market whose prices were falling every year at 5 per cent. In addition, Britain was now tethered to the health of America which was now in boom and had lower interest rates thus keeping money in Britain, but the day the interest rates had to be increased due to domestic considerations, all this hot money would have to flow back due to Gold Standard adherence.
The American Story:
The country that came out the strongest of the war was also now in command. Its chief banker Benjamin Strong was also a very strong character who ran the whole show on his discretion. He was directly beholden to the other three bankers i.e. Norman (who was his closest friend), Schacht and Moreau. America had plenty of gold, its manufacturing was booming and its economy was going great guns because of new inventions e.g. the Ford Model T, the radio, the washing machine etc. The biggest thing that was booming was of course its stock market. The situation pretty much became like what we saw before the current crash. Stock prices went through the roof since money was cheap and everyone was getting rich. Every person started investing in the market and there were specialist loans offered by banks to stock brokers called broker loans. This was accompanied by land price booms, a strip of land in Miami that cost quarter million dollars before the boom was priced by early 1925 at close to $5 million. Everyone was getting in on the action and magazines were being run for housewives on how to invest in stock etc.
Keeping this boom going was the decision of the Fed to keep lowering interest rates in America so that Britain could keep on the gold standard with higher interest rates. This caused money to become freely available. There was a lot of resistance in Washington on the speculative “orgy” on wall street and in the country but Benjamin Strong felt that as long as prices were falling (there was a worldwide drop of prices of commodities due to more gold being available and good harvests) and the demand was high he could afford some inflation. Till 1928, everyone was expecting a crash and the Fed tried a couple of times to increase rates to dampen the market but could not succeed much. Any negative sentiment against the roaring stock market was seen as a statement against the American economy. Worst, this boom meant capital from all over the world was getting sucked into the stock market vortex in America thus resulting in a recession in Germany due to flight of capital. It is very telling that most of the bigger stock brokers liquidated their portfolios around the end of 1928 since they expected the market to crash. Joe Kennedy (JFK’s father) liquidated his holdings in the market because he heard his shoeshine boy giving tips on stocks which prompted him to say ,”The day I heard my shoeshine boy and my butler know as much as me about the market, I knew something was wrong and I had to get out.”.
The world was coming closer to a precipice, Britain was sustaining higher interest rates despite being in a slump, Germany was tottering on bankruptcy again due to flight of capital and America was living in a dream world from which it was about to wake rudely.
So much for this week, will conclude the story in the next part.
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