The Economics of Inflation

A Study of Currency Depreciation in Post-War Germany, 1914-1923

Constantino Bresciani-Turroni, Millicent E. Sayers

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781135033217
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The Economics of Inflation provides a comprehensive analysis of economic conditions in Germany under the Great Inflation and discusses inflationary conditions in general. The analysis is supported by extensive statistical material.
* For this translation the author thoroughly revised the original work
* Includes an appendix on German economic conditions in the years following the monetary reform, 1923-24

Chapter II
The National Finances, the Inflation and the Depreciation of the Mark*

Part I

I. The Helfferich Explanation of the Depreciation of the Mark

1. The discussions provoked by the depreciation of the mark in Germany during the decade 1914-1923, present an interesting resemblance to the controversies in England in the years which preceded the publication of the Bullion Report. Throughout the period of the inflation the theory held by the Reichsbank, by successive German Governments, by the great bankers, by great industrialists, by German officials, and by a great part of the Press, was that the depreciation of the mark was caused by the state of the balance of payments. During the war Germany had a "passive" balance because of excess imports over exports; later it was accentuated by the effects of the payment of reparations and of the other burdens imposed by the Treaty of Versailles.

It would be exaggerating to affirm that this was also the point of view of all the German economists. Some of them, as Liefmann, Schlesinger, Pohle, Beckerath, Terhalle, and Lansburgh, clearly recognized the influence of the paper inflation on internal prices and on the exchange rate. But others refused to admit a relation of cause and effect between the increase of the quantity of paper money and the depreciation of the exchange, and they adhered to the "theory of the balance of payments."† This mental attitude, contrary to quantitative monetary conceptions, was the effect of the line of thought which was prevalent before the war, and which preferred that type of monetary approach which Altmann called "Qualitative" as opposed to the quantitative.‡ Writers were attempting to construct a "sociological" conception of money. Under the influence of these views, as opposed to the quantitative theory, such economists stressed the movement of the value of money as an "historical process," which is not simply a matter of comparing flows of money and of goods, but which demands the comprehension of the entire complicated economic structure. To this was added the influence of the work of Knapp, who diverted German studies from the analysis of the quantitative relations between money, prices, and exchange rates.

Dalberg* claims to have been the first to introduce into the post-1914 literature about monetary problems the theory that the diminution of value suffered by a currency in the internal market is the determining factor of the movement of the exchanges, i.e. of the "external value" of that money. In making this claim Dalberg disputes that of Liefmann, who had claimed that he himself first introduced this theory into Germany, though he did not claim to be the originator of the theory—the relation existing between "internal value" and "external value" being well known outside Germany. "The recognition of this relation," continues the same author, "has a decisive importance. The scientific value of all the publications of the first three years of the war is doubtful, for those works take no account of this relation; ignorance of it explains, moreover, many errors or omissions in German monetary policy."

2. To a great number of writers and German politicians the deficits in the budgets of the Reich and of the States, and the paper inflation, were not the cause, but the consequence of the external depreciation of the mark.†

The most authoritative representative of this theory is Helfferich, who expounded it in the sixth edition of his work Das Geld (Leipzig, 1923)·

The increase of the circulation [affirms Helfferich] has not preceded the rise of prices and the depreciation of the exchange, but it followed slowly and at great distance. The circulation increased from May 1921 to the end of January 1923 by 23 times; it is not possible that this increase had caused the rise in the prices of imported goods and of the dollar, which in that period increased by 344 times.

That the collapse of the exchange rate was entirely disproportionate to the increase of the circulation also appears from the following argument: The circulation of the Reichsbank of January 24th, 1923, represented a value in paper marks of 1,654 milliards, but in gold only 330 millions; that is, no more than a twentieth of the value of the circulation in the period preceding the war .... It is not to be doubted ... that the increase of the circulation did not even distantly keep pace with the depreciation of the mark abroad. The theory, according to which the inflation is the cause of the depreciation of the German mark, is based on the petitio principi that the external value of money (expressed by the foreign exchange rate) can only be determined by the quantity of paper money.

Now in the present case the causes of the collapse of the money are inde pendent of the conditions of the paper circulation. These causes are obvious; on a country whose balance of payments was passive by about three milliards of gold marks, there was imposed the burden of the reparations bill, amounting annually to about 3·3 milliards of gold marks; to that was added the payments for the redemption of short-term debts; for the costs of occupation, etc., etc.

According to Helfferich, the concatenation of the facts is as follows:

The depreciation of the German mark in terms of foreign currencies was caused by the excessive burdens thrust on to Germany and by the policy of violence adopted by France; the increase of the prices of all imported goods was caused by the depreciation of the exchanges; then followed the general increase of internal prices and of wages, the increased need for means of circulation on the part of the public and of the State, greater demands on the Reichsbank by private business and the State and the increase of the paper mark issues. Contrary to the widely held conception, not inflation but the depreciation of the mark was the beginning of this chain of cause and effect; inflation is not the cause of the increase of prices and of the depreciation of the mark; but the depreciation of the mark is the cause of the increase of prices and of the paper mark issues. The decomposition of the German monetary system has been the primary and decisive cause of the financial collapse.*

3. The ideas expressed by Helfferich were also common in the German Press.† The following opinions which were expressed by an authoritative periodical towards the end of 1922 are characteristic:

Since the summer of 1921 the foreign exchange rate has lost all connection with the internal inflation. The increase of the floating debt, which represents the creation by the State of new purchasing-power, follows at some distance the depreciation of the mark .... Furthermore, the level of internal prices is not determined by the paper inflation or credit inflation, but exclusively by the depreciation of the mark in terms of foreign currencies .... To tell the truth, the astonishing thing is not the great quantity but the small quantity of money which circulates in Germany, a quantity extraordinarily small from a relative point of view; even more surprising is it that the floating debt has not increased much more rapidly.

The theory formulated in German official circles, to explain the causes of the depreciation of the mark, is expounded with clarity also in the following passage from a memorandum of the Central Statistical Office.‡ "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."

The conviction, so widely held, that the depreciation of the mark was only the expression of the disequilibrium of the balance of payments for a long time prevented any serious consideration of monetary reform.

In the congress of German bankers which took place in September 1920, Warburg maintained that the exchange was the expression of the depressed economic, financial, and social conditions of Germany, and that an improvement (or a stabilization) of the exchange could not be achieved until the general situation had been improved from this threefold point of view. Until then every measure of monetary policy would be ineffectual.

In July 1922 the Minister of National Economy elaborated a project for monetary reform which, it was hoped, would have resulted in the stabilization of the exchange. But the project was not carried through, because of the opposition of the Reichsbank. During 1922 the management of the Reichsbank tenaciously refused to allow the gold reserve to be used for monetary reform. At the meeting on August 28th, 1922, of the Central Committee of the Reichsbank, Havenstein, the president, categorically stated that it was not possible to make even an attempt at the stabilization of the exchange while the principal cause of the German crisis remained, that is until Germany succeeded in obtaining a moratorium and a tolerable solution of the reparations question. Havenstein alluded to the failure of the recent intervention of the Reichsbank in the exchange market; 230 millions of foreign exchange had been uselessly sacrificed without the Reichsbank having succeeded in preventing the continued depreciation of the exchange. But Havenstein did not add that the action of the Reichsbank must necessarily be fruitless if at the same time it continued to issue new paper money.

Also in November 1922, after a committee of foreign experts called in by the German Government had declared the stabilization of the German exchange to be possible under certain conditions, the Reichsbank stuck firmly to its theory, according to which it was useless to attempt monetary reform. Fatalistic ideas dominated the governing circles. Once more I quote the opinion of 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."*

Opposed to the German theories were those which can be called the "English" (because vigorously upheld by the representatives of Great Britain in the Reparations Commission and in the Guarantees Committee) according to which the fundamental cause of the depreciation of the mark was the Budget deficit, which provoked continued issues of paper money. I hold this second theory to be essentially correct, although it is necessary to recognize that in the last stages of the depreciation of the mark the relations between the Budget deficit, the quantity of paper money, prices, and the exchange became more complicated, as we shall see in the course of the present enquiry.

In certain writings of American economists one encounters the influence of the argument advanced by the Germans. For example, according to Professor Williams the causal order of events was the following: "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."* Commenting on the work of Professor Williams, Professor Angell observed 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."†

II. The Conditions of the National Finances During the War

4. Let us examine, in the light of the facts, the theory according to which the budget deficit was not the fundamental cause but the effect of the depreciation of the mark.

In the following table, in millions of marks, the total income and expenditure of the German Reich during the years 1914-1918 are indicated.‡

The income figures shown in the preceding table include the proceeds from the war loans, subscriptions to which amounted to about 98 milliards of marks. The result was, therefore, that scarcely one-eighth of the expenditure of the years 1914-18 was covered by ordinary income. The difference between the total expenditure and the total income was covered by means of the issue of Treasury bills. The discounting of the Treasury bills at the Reichsbank provided the channel for an inflation which in part is shown directly in the increase of notes in circulation, and in part remained latent for a certain time.

The method adopted by the German Government for financing the war* consisted in funding the floating debt by means of periodical issues of loans. But already by the autumn of 1916 the failure of the method was becoming patent. From then onwards the sums yielded by the loans were always less than the amount of the floating debt. At the end of September 1918, after the issue of the ninth war loan, the floating debt amounted to 48 milliards of marks.

The circulation was not increased in the same proportion, because about half of the Treasury bills had been taken up by the principal banks, public institutions, or some great private firms. From July 23rd, 1914, to October 31st, 1918, the paper circulation (notes of the Reichsbank and those issued by the Loan Office) was increased by 24·2 millions of paper marks.

5. The German Governme...