It Comes Down to Politics, As Usual

In his latest Popular Delusions research report, "Some Useful Things I've Learned About Germany's Hyperinflation," SG Cross Asset Research strategist Dylan Grice notes some disturbing parallels between the economic and political environment that existed in Weimar Germany and that which we have now:

[Reischsbank president Rudolf] Von Havenstein was faced with horrible fiscal problems; as is the case for today’s central bankers, the distinction between fiscal and monetary policy had blurred; as is the case for today’s central bankers, the political difficulty of deflating was daunting; and as is the case for today’s [Quantitative Easing]-enthralled central bankers, apparently respectable economic theory reassured him that he was doing the right thing. One might think that the big difference is that today we have a greater expertise. Surely we understand what happens when deficits are financed with printed money, and that it is only backward and corrupt states that don’t know any better, like Bolivia and Zimbabwe? But just a few years ago didn’t we think that it was only backward and corrupt states that suffered banking crises too?

And anyway, how could Von Havenstein not have known that the continued and escalating printing of money to fund government deficits would cause inflation? The United States experience of unrestrained money printing during the Civil War had been well documented, as had the hyperinflation of revolutionary France in the late 18th century. Isn’t it possible that, like today, he was overconfident in his ability to control his creation and in the economic theory which told him such control was possible? Certainly, in an article in the New York Times on the eve of the First World War, again from Liaquat Ahamed's book, there seems to have been evidence of the general optimism that there would be no unlimited issue of paper money and its steady depreciation … since monetary science is better understood at the present time than in those days.

The fact is we do understand the economics of inflation. Despite what economists everywhere say about being in uncharted territory with QE, we know that if you keep monetizing deficits eventually you get inflation, and we know that once you’re on that path it can be extremely difficult to get off it. But we knew that then. The real problem is that inflation is an inherently political variable and that concern over debt sustainability and unfunded welfare obligations leaves us more dependent on politicians than we have been in many decades. Frank Graham concluded his 1930 study of the Weimar hyperinflation with the following observation, which I think is as ominous as it is apt today:

The mills of international finance grind slowly but their capacity is great. It is also flexible. The one condition is that the hoppers be not unduly loaded in the effort to get the whole grist from a single grinding. So much for the economics of the question. What politics has in store is, however, an inscrutable mystery. It can only be said that such financial difficulties as may occur will almost certainly arise from political rather than from economic sources.

In other words, it won't really matter whether economists and policymakers know the right course of action (though I'm doubtful about that). The final decisions will be made by politicians who are primarily concerned about getting elected and staying in office.

In fairness, Grice makes it clear that one impetus for the complete abandonment of fiscal discipline is currently lacking:

I don’t want to overplay the parallels. In fact, there is one very clear difference between the hand Von Havenstein had to play then and those today’s central bankers have to play now, namely the stability of today’s political climate. Clearly this can change, but the class warfare, nationalistic xenophobia and revolutionary spirit poisoning the political atmosphere of 1920s Germany is at the very least dormant today, and certainly not meaningfully visible across the political landscape.

But as we have seen over the past three years or so, things seem to move so much faster than they used to. Is it really such a stretch to think that the nascent rumblings of political dissent we're already seeing -- à la the tea party movement -- can suddenly escalate into widespread discord, where the torches and pitchforks are out in force?

One other thing: some people seem to think that buying equities is a great way to hedge against inflation. Is that correct? The answer is that "it depends." Based on what occurred during the Weimar years, inflation isn't the only consideration. Real output, among other things, also matters. Those who bought German equities just as hyperinflation accelerated into its intermediate phase lost around 80 percent of their investment in real -- inflation-adjusted -- terms over the course of 10 months. As with most investment decisions, timing is everything.

Comments

[Steve]

What a wonderfully intelligent read! I'll read that again a few times.
Would be great to get some thoughts on protecting your money and wealth during a hyperinflation. Real estate should keep pace or at least have good relative value after the currency is reformed (provided you can keep your payments up so as to not lose the house). But what about other aspects.

Your note on stocks during Weimar hyperinflation was intriguing. Would be good to get some direction on thoughts on investing to preserve capital. Gold? Silver? Stocks?

[roger]

Drawing parallels with Weimar Germany is risky and misleading.
The Weimar problems where rooted in WW1, a direct result of
borrowing (credit ) and war reparations. it was a question
of National survival,in other words the armed conflict
metaphored in economic war. The 4 principal players being
the UK,France , the USA and Germany.

[Rocky]

William Shirer was a news reporter in Germany in the late 1920's and into the Nazi era. He was not an economist. But he understood how inflation in Wiemar Germany contributed to the rise of the Nazi party. Read pages 59 to 62 in his book "The Rise and Fall of the Third Reich". As to other investment options in an unstable world: Real estate can't be put in your suitcase if you have to flee the country. You wouldn't receive a good bid on your mansion in Wannsee if the only bidder was your local Nazi gauleiter (party boss, or more formally, provincial governor) and he was only offering to give you an exit visa in exchange for the mansion. Robert Rothschild of the Paris Rothschilds refused to turn over his factories to the Nazis in exchange for an exit visa from France, so they sent him to Auschwitz instead, to be gassed. Many years ago, an acquaintance of mine told me that she had survived the war by bribing border guards, police and other assorted corrupt officials in France with pieces of jewelry. When your world is turned upside down, diamonds are a girl's best friend.