German Hyperinflation

One of the most interesting and devastating phenomena to take place in a country was during the post World War I German Hyperinflation from 1918 – 1923. Germany had lost the war and the Allies were forcing them to make reparations. “The central government in Germany, which did not impose income taxes, financed the war almost completely by issuing debt” (Hetzel, 2). Since Germany refused to impose high taxes on their people, they had to pay for the war and the cost of losing the war by printing money.

This resulted in an extreme deficit for Germany since the Allies could collect interest on the German debt. Germany was stuck in a vicious cycle of increasing the money supply, which then led to an inflation of prices, depreciation of the mark, reduction of purchasing price parity of its citizen’s income and revenues, which results in increasing the money supply more. “By the end of 1918 the mark had fallen more than 50% against the dollar” (Economist Millennium issue: German hyperinflation, Dec 23rd 1999).

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The depreciation in currency made German exports cheap to foreigners and prices would keep rising for the Germans. The people in Germany wanted to get rid of their marks because of the opportunity cost of holding them. “By November 5th 1923, a loaf of bread cost 140 billion marks. Workers were paid twice a day, and given half hour breaks to rush to the shops with their satchels, suitcases or wheelbarrow, to buy something, anything, before their paper money halved in value yet again”(Economist, Millennium issue).

The present value of their money was depreciating so rapidly that they had to buy whatever they could as soon as they could because it was more useful to have real tangible items instead of the currency. Since the price level rose so quickly, confidence was lost in their currency. They preferred to buy gold, silver or even barter as a medium of exchange. “The resulting fall in the purchasing power of the mark created a liquidity crisis”(Hetzel, 6). People were getting paid twice a day to keep up and inflation was the only way to keep people working.

This shows what effect confidence has on a country’s currency. Since there was so little confidence in the mark, It was inevitable that printing all of these bills would effectively demolish the German economy. “As early as 1919, when the peace treaty was signed, Keynes had warned that the settlement imposed on Germany would ruin it” (Economist, Millennium issue). The huge compiling deficit and reparations due, crippled Germany and they began to have worker strikes. In early 1923, France took control of the Ruhr when Germany was failing on its promises to deliver coal. With government support, workers in the Ruhr went on strike to prevent France from obtaining the region’s coal and steel” (Hetzel, 7). This was Germany’s way of resisting France in a passive manner. However without the production of coal, Germany’s economy collapsed because Germany was printing bills to pay the striking workers and still the reparations it owed. This economic collapse led to social and political unrest and revolts ensued. In order for the government to survive, they had to reestablish order and credibility to their currency regime.

In November of 1923, the central government developed a temporary solution called the Rentenmark. The Rentenmark was worth 1,000 billion marks and it was backed by pensions. This reform of the currency had to work because of political pressures. “In this changed environment, the Reichsbank ceased monetizing government debt” (Hetzel, 9). Germany started negotiating with the Allies and ultimately came up with the Dawes Plan. In 1924, this settlement rescheduled the reparations that Germany had to make. When the new mark was pegged to the dollar, people regained confidence in their currency and the economy was stabilized.

This economic struggle of the German people that was caused by a huge bout of inflation was devastating and led to the rise of one of the most powerful leaders in history. Keynes describes how disastrous inflation can be, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some…Those to whom the system brings windfalls…become profiteers” (Hetzel, 11).

A wage push model can also describe the false sense of acquiring more money because of the printing of paper bills. The wage push model is essentially paying the workers more but borrowing more credit to do so. “The wage push approach posits that as money wage growth accelerated, the output supply functions of more and more firms become temporarily credit-constrained, in the sense they had to “pay their factors of production before they received revenues from sales, and had to borrow to do so” (Blinder, 1987,329).

This suggests that they were trying to pay their workers to avoid strikes but they didn’t have the money to do it. The government had to keep paying the workers more and more as inflation skyrocketed. This is detrimental to an economy and devalues the currency to the point where they need to fix their currency to the United States. This can be showcased in the Exchange rate model. Germany kept increasing the money supply so the German mark was depreciating severely. This makes German investments less attractive to foreigners.

Foreign investors can get more goods for their money than Germany can in foreign markets. Expectations can effect the exchange rate because outsiders see Germany as an unstable economy to put their money in. When $1 was equal to 4,200,000,000,000 marks, the dollar was incredibly strong versus the mark. This currency debauch leads to an ultimate collapse of the economy. Therefore the Money supply curve would shift to the right because Germany was increasing the money supply. The Exchange rate of return for Germany would shift in because of how much the mark depreciated.