Wednesday, July 3, 2013

Germany's Hyperinflation in 1923, the Great Depression, and Austerity Led to an "Ugly Deleveraging" and Hitler's Rise to Power (Chart, Ray Dalio Video)

According to Wikipedia ("Hyperinflation in the Weimar Republic" - the last paragraph), here's how Germany's hyperinflation went down in 1922-1923 courtesy of the Reichsbank's printing press:

The cause of the immense acceleration of prices that occurred during the German hyperinflation of 1922–23 seemed unclear and unpredictable to those who lived through it, but in retrospect was relatively simple. The Treaty of Versailles imposed a huge debt on Germany that could be paid only in gold or foreign currency. With its gold depleted, the German government attempted to buy foreign currency with German currency, but this caused the German Mark to fall rapidly in value, which greatly increased the number of Marks needed to buy more foreign currency. This caused German prices of goods to rise rapidly which increased the cost of operating the German government which could not be financed by raising taxes. The resulting budget deficit increased rapidly and was financed by the central bank creating more money. When the German people realized that their money was rapidly losing value, they tried to spend it quickly. This increase in monetary velocity caused still more rapid increase in prices which created a vicious cycle. This placed the government and banks between two unacceptable alternatives: if they stopped the inflation this would cause immediate bankruptcies, unemployment, strikes, hunger, violence, collapse of civil order, insurrection, and revolution. If they continued the inflation they would default on their foreign debt. The attempts to avoid both unemployment and insolvency ultimately failed when Germany had both."

Source: Wikipedia

It's interesting because today the world is trying to balance out the deflationary effects of deleveraging and austerity with the inflationary (or reflationary) effects of monetary stimulus via the central banks (money printing and a zero-percent interest rates). Countries in the Eurozone are currently dealing with a solvency crisis, austerity and deleveragings at the same time, but can't utilize the ECB's printing press to balance out the equation. So EU/ECB/IMF bailout funds and loans have been used as an alternative source of liquidity to prevent a sovereign debt and banking collapse in the Eurozone. Ever since ECB President Mario Draghi announced in July 2012 that the ECB would "do whatever it takes to preserve the euro," and in September 2012 when the ECB announced its sterilized bond buying program (Outright Monetary Transactions or OMTs), government bond yields in the Eurozone have fallen over the past year.

Via Bloomberg at the Irish Times on 10/9/2012:

Mr Draghi told the parliamentary committee the ECB stood ready to act.

"The ECB will conduct OMTs (bond buying) if and as long as countries comply with strict and effective conditions attached to an appropriate programme," he said.

Ray Dalio, founder and co-CIO of the hedge fund Bridgewater Associates (the largest hedge fund in the world), believes we are going through a "beautiful deleveraging" at the moment (read his research report "An In-Depth Look at Deleveragings" at But he warned that an "ugly deleveraging" (imbalanced deleveraging) because of bad policy decisions could lead to social tension and wars like we saw in the 1930s. He discussed this with CNBC's Maria Bartiromo at the Council on Foreign Relations in 2012 (full transcript). The quotation starts at 31:30 in the video below.

MODERATOR: So should we be worried about the $16 trillion debt in this country, knowing who the buyer is and knowing that this country has an ability to print money?

DALIO: I think we have to worry about getting the balances of dealing with these right, right? There's certain -- it's the same thing. There needs to be a certain amount of austerity. There needs to be -- but if that austerity is too much -- we have to worry as much also about the social consequences. We cannot have a downturn -- a bad downturn.

So in worrying about the debt, yes, we have to worry about that and we have to balance that correctly, but we have to balance that in a way that does not produce another 2008 because if you have a downturn, then you're going to have social consequences of the rich and the poor at each other and then also the possibility of doing crazy things, and then the political shifts become meaningful. You know, Hitler came to power in 1933 because it was the bottom of the Great Depression, and democracy -- democracies have a challenge in terms of making effective decision-making. So I think that you have to worry on -- about getting the balance right, right? So the fiscal cliff next year is also something to worry about. So we can't just worry about too much debt; we have to worry about too much austerity; we have to worry about getting that balance right.

And my biggest worry is that people are not -- policymakers and a lot of people are not doing that with a sharp pencil. In other words, they just talk -- they're -- it's just a calculation. You can do the calculations. There's a certain amount of spending. Nominal GDP and real GDP is a certain amount of spending. OK, who are the buyers of goods and services? Where did they get their money from? And then how much do they need? And so it's -- with a sharp pencil, you can deal with that. But it's more with slogans. And so I'm worried about balance.

The Wikipedia page also mentioned that Germany's hyperinflation in 1923 was the initial catalyst that contributed to Hitler's rise to power, but the deflationary effect of the the Great Depression (U.S. banks called in their German loans after the 1929 stock market crash) and government austerity measures in the early 1930s caused an "ugly deleveraging" in the Weimar Republic (and was the end game). So you can see how important the balance is.

Although the inflation ended with the introduction of the Rentenmark and the Weimar Republic continued for a decade afterwards, hyperinflation is widely believed to have contributed to the Nazi takeover of Germany and Adolf Hitler's rise to power. Adolf Hitler himself in his book, Mein Kampf, makes many references to the German debt and the negative consequences that brought about the inevitability of "national socialism". Some economists, however, point out that Hitler's rise was immediately preceded by the 1931 economic crisis, which, while also being partially triggered by Germany's debt, was, unlike the hyperinflation crisis of 1923, characterized by massive deflation created by a government austerity program.[31] Paul Krugman concurred that the "1923 hyperinflation didn’t bring Hitler to power; it was the Brüning deflation and depression."[32]

Read about "Brüning's policy of deflation (1930–1932)" on Wikipedia here. Here's a chart of Weimar Republic's unemployment rate between 1928-1935 from that page. Hitler's Third Reich took power in 1933.

Source: Wikimedia Commons "data from Willi Albers, 'Handwörterbuch der Wirtschaftswissenschaft, Band 9, 1982, ISBN 3-525-10260-7, p. 85"

By the way, the Eurozone's unemployment rate hit a record high of 12.2% in May. Here's the chart via Eurostat.

Source: Eurostat

Now the question is whether today's deleveragings, with total government debt to GDP in advanced economies approaching the highest level since World War II and central bank balance sheets going vertical since the crisis began in 2008, will be balanced. And with China's overextended economy and banking system now rebalancing (1, 2), will banks on Mars have to pick up the tab?

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