Dr. Haversteins Fiducial Folly
At times of catastrophe it is incumbent on those in a position of authority to act in a calm, responsible manner. Being human, this does not always happen. Errors of judgement on the part of an inflexible established authority can, as we have seen, lead to disaster, but the following story is that of a sincere administrator whose obstinate persistence in a supposedly remedial course of action led to staggering, incalculable harm. The setting is in Germany, after their defeat in the First World War.
For Germany the years 1920-23 are remembered as the nightmare period of Weimar hyperinflation. This was the time of the 'wheelbarrow' economy, when prices increased daily, even hourly; when 100 Mark notes, then 1000, then 1,000,000, became successively worthless; when nobody, least of all those running the economy, seemed to comprehend what was going wrong. It was a period when the entire economic life of an advanced industrialised nation simply fell apart at the seams. The underlying cause of the fragile state of the German economy in this post-war period was, of course, the War itself, and in particular the abuses that it had suffered under the military government during the conflict. These difficulties were further aggravated by the punitive reparations demanded by the victorious Allies (who pursued the vengeful, but contradictory, policy of wanting to punish Germany by making huge capital demands). At this critical moment in its history Germany desperately needed a skillful economic administrator - instead they got a man of almost legendary incompetence. Dr. Rudolph Havenstein had been President of the Reichsbank since before the war, a man of rigid views and narrow outlook, he was singularly unsuited for the task of reviving a national economy.
It was later said of Havenstein that no situation was so bad that he could not make it worse - and he was to encounter very bad situations. During his term in office the German economy was subjected to monetary chaos of a kind that had never before been experienced by an advanced country. Nobody who lived through the period ever forgot it, and because of its role in the rise of Nazism, nobody in Europe escaped its longer-term consequences. The Weimar catastrophe will always stand as a reminder of the truly appalling social costs that may ensue when a currency is allowed to spin out of control.
The problem of inflation was not, of course, a new one. Ever since money was devised as a means of exchange there has been a tendency for it to devalue, and as a result, for prices to rise - it seems as immutable a law as that of gravity. Prices go up (gradually, or less so) just as things in general tend to fall down. There have always been problems with the mechanics of money. Inflation tended to occur even in those traditional economies that were based on Gold or Silver, but the invention of paper money brought with it the potential for far greater economic mayhem.
Paper currency was first used in China. By the time Marco Polo encountered it, in the reign of Kubilai Khan, it had already been around for some 300 years. For the roving Venetian it was one of the most impressive aspects of the Chinese mercantile system. As a merchant himself he well appreciated the efficacy of printed money, and extolled its virtues at length in his Travels. He described the system as a 'perfect alchemy', 'the production of Gold from mulberry leaves' (which were used to make the paper on which banknotes were printed). The invention of printed money had in fact followed fairly closely on the invention of printing itself (which by the 10th century was common throughout China). Paper money was first developed by merchants for their own benefit, in the form of banker’s drafts, which were used as a means of exchange between cities. The effectiveness of the system was soon recognised by the central government that commandeered and monopolised it. In this way the Chinese economy was monetised; a central, controlling bank was established (the first of its kind), but from the beginning there were problems.
The introduction of paper currency saw the appearance of the two spectres that would haunt it forever after, namely, forgery and inflation. As early as the 12th century Chinese banknotes were being printed on special papers using a complex system of six colours, with each note bearing individual sequential
serial numbers. These precautions were necessary, of course, to deter counterfeiters. Despite the horrifying punishments that were prescribed for the crime of forgery there was ever a temptation to create wealth by this most direct of methods. It was, however, always the second of these two monetary evils that posed the more serious threat to the repute and value of a paper currency.
Inflation manifests itself as price escalation. Historically this was always most likely to occur when an issue of paper money was unsupported by more tangible assets such as cash deposits, gold or silver. When a currency begins to slip the ensuing loss of confidence can set off a feedback reaction and may easily trigger a process of accelerating inflation. If they are not checked these developments invariably led to a currency being thoroughly distrusted, so that in a chronic situation it becomes increasingly worthless. This train of events occurred several times in the early history of paper money in China (despite the currency being backed by bales of silk in the Mongol period).
The price of a stable paper currency, it seems, is eternal vigilance. But just as there was always a temptation to counterfeit money so there was for hard-pressed administrations to print it. Whenever there was a desperate need to raise funds (usually for warfare), it was always the easiest option. But it was never a safe one. Time and again the reckless issuing of money led to depreciation, with inevitable price escalation. In this way inflation was repeatedly both the symptom and cause of social breakdown. A disintegrating currency always seems to offer a ghastly mirror to a decaying body politic.
Despite its many failures the institution itself survived in China. It was just too useful an idea ever to be entirely abandoned. It was a mainstay of currency in China and many hundreds of years later the system, with all its faults, was followed by the Western barbarians. The first European banking systems using a centralised issue of banknotes were set up in Germany and Sweden in the mid 17th century, along Chinese lines. Other nations soon followed their example, the Bank of England issuing notes in 1694. As with the Chinese experience the European economies had to come to terms with the inexorable tendency for their respective currencies to gradually lose purchasing power.
Or not so gradually. Paper currencies have always proved to be highly sensitive to a prevailing social mood. Whenever there was social stability there was ready money; whenever there were the major disturbances of wars or revolutions currency depreciated, often dramatically. Inflation, it would appear, is always waiting in the wings, and always ready, given the smallest opportunity, to take over the stage. Attempts, on the part of ill-informed administrators, to print their way out of their nation’s financial problems have a very poor record, frequently producing widespread social misery. Hyper-inflation, on the scale that Germany experienced in the early 1920ies, is however a mercifully rare event. The devastation of the Wiemar Reichsmark can only properly be compared with such other monetary disasters as the collapse of the Continental notes of the American War of Independence, the Assignats of the French Revolution, or that of the Soviet Rouble during the Civil War period - but it was to be more destructive in its effects than any of these.
The conditions that produced the Weimar inflation were complex, so there are difficulties in determining the precise extent to which economic mismanagement contributed to the debacle, but they were considerable. In the years after the 1914-18 war the German economy was a shambles. The militarist wartime government had financed the war by reckless borrowing and by printing money. The new civilian government had the thankless task of dealing with this financial mess, and the severe reparations imposed by the victorious Allies compounded their problems. They were also compounded by the attitudes of the President of the Reichsbank.
The aforementioned Dr. Rudolph Havenstein was a man of set ideas and firm principles: unhappily for Germany his ideas and principles were hopelessly mistaken. In defiance of the most elementary rules of economics he consistently refused to accept any connection between the over-issue of paper money and its constant fall in value. Never, to the end of this extraordinary period of was he deflected from his views. As far as they can be understood he seems to have felt that it was his duty to maintain the means of exchange (ie. the money supply) at all costs. Even when his money had gone completely off the scale, his primary concern seems to have been the logistics of making vaste amounts of his, by now worthless, notes available to a public that no longer wanted them.
The fall of the German Mark was, at first, gradual. During the War years it had halved its value relative to other currencies, and by 1919 it had halved again. By the early months of 1920 it held only one fortieth of its pre-war purchasing power. Bad though it was this degree of devaluation was understandable against the background of a national mood that was far from calm. To the shock of defeat there was added a widespread resentment of the punishing reparations imposed by the Allies. The terms of the Treaty of Versailles were felt, as they were intended, as pure retribution. Many, especially those on the Right, were unable to accept the defeat and sought scapegoats. The political situation was very unstable; there were literally hundreds of assassinations of prominent left-wingers.
By late August 1921 the Mark, which had been depreciating steadily since the Armistice, was drawn into an inflationary runaway reaction. Havenstein printed money in order that the government could 'fulfil its obligations’; this rapidly led to a reduction of the purchasing power of the Mark, which was experienced by the German public as price increases. At this stage it was clear that no one appreciated, least of all the Bankers, just how far this process of depreciation could go. Most believed that the Mark would eventually settle down. Everyone hoped for better things, but in fact confidence had already been fatally undermined. Anyone who was in a position to, including the country's principle industrialists, were exchanging their Marks for foreign currency of almost any kind.
These individual measures of financial self-protection simply fuelled the inflationary situation, so that they had a self-fulfilling effect. In June 1921 a Pound Sterling was worth 261 Reichsmarks, by August this was 310; but by November a Pound was only fetching 1040 Marks. Prices began to soar, and these increases, in turn, caused industrial unrest and a clamour for higher wages. It also meant that the savings of the middle-classes were being eaten away. With money devaluing so rapidly it became foolish to hold onto it, and a desperate consumerism took hold. People became frantic to exchange their wages for almost any item that would hold its value, which the mark clearly was not. This gave some sections of manufacturing an artificial stimulus, and many were kept in work as a result. The working class began to make demands for wages that kept pace with inflation, although the increases that they received continued to fall behind the ever-rising costs of essentials. The middle classes (who did not have trade union support), civil servants and those on fixed incomes, suffered badly. The prices of basic items of food began to increase by the day, creating a sense of confusion and near panic.
By the end of November 1921 the Mark had dropped to 1300 to £1 sterling, and there were food riots in Berlin and other cities. A culture of blame took hold. From a German perspective it appeared that prices of food, clothing and other essentials were being forced up. The fault was laid on other classes and other nations; those of other political allegiances were held responsible, as were racketeers and, ominously, the Jews. By May 1922 the frenetic round of price increases, industrial unrest and wage demands were having a terribly destabilising effect on society. At this critical point the Reichsbank was declared autonomous, giving Dr. Havenstein even greater powers. In a public statement he once again affirmed that there was no connection between the Bank's issues of paper money and the fall in value of the mark. He acknowledged that price escalation had created a demand for currency, and there was not enough cash available for ordinary transactions. His solution was to print more money, much more.
By August 1922 the German economy was like a mad dog chasing it own tail, £1 sterling was now worth 9000 Marks. The situation became increasingly bewildering. The only rational thing to do with cash was to unload it as fast as one could. People tried to spend their wages within an hour or so of receiving them. It was pointless holding on to money, since it would be worth far less the following day, but these panic actions further stoked inflation. During the second week of October 1922 the Mark entered free fall, going from 9000 to the £1, to 13000 in just six weeks. Prices of ordinary foods (milk, bread, eggs) were now doubling every month, and wage increases, where they were given, were simply not keeping pace. There was also a general shortage of liquid cash, forcing people to resort to barter, or to use foreign currencies when they had them. Dr. Havenstein responded by doubling the rate of note issue to 4 milliards of Marks (4,000,000,000) per day.
The industrial situation was deteriorating. Workers, angry at their failure to get wage increases proportionate to the spiralling cost of living, were demonstrating and striking all over Germany. Political extremists of the Left and Right flourished in these conditions. A mood of self-preservation and disregard for others emerged. Profiteering was rife, food riots and looting broke out in various regions, and there was great distress among those, like elderly pensioners, who were unable to fend for themselves. In the course of November 1922 the Mark steadily fell away from 30,000 to the £1, to 34,000. To cope with the situation Haverstein launched into a programme of the unlimited printing of notes. Henceforth the only restraints on banknote production were the capacity of the presses and the physical endurance of the printers. Many more printing presses were commandeered for the purpose. Very soon half the presses in Germany would be printing money around the clock.
The crisis lead Germany to apply for a moratorium on its Reparation payments: they also offered the Allies a 30-year Peace Pact. Both proposals were brusquely rejected. In early January 1923 the French invaded and occupied the Ruhr, in order, as they stated 'to bring Germany to her senses and compel payment'. Precisely how the annexation of Germany's industrial heartland was supposed to forward this process was unexplained. The effect on the Mark, however, was disastrous. Immediately after the invasion it plummeted to 48,000 to £1, and by the end of January it had sunk to 127,500. In response to this devaluation the Reichsbank brought their first million Mark note, by the time it appeared in February, however, it was worth less than £5 sterling. The continuing devaluation of the Mark led to a complete confusion at every level of commerce. It became impossible to set prices for manufactured goods; farmers were less and less willing to exchange their produce for the ever diminishing currency; and the taxation system was thrown into complete chaos, since the taxes that were paid could barely cover administration costs. There was a general mood of desperation for price stability, and the middle-classes in particular were becoming increasingly attracted to a new, extreme, organisation promising economic salvation, the NSDAP. Despair was the feeding ground for this group, who were already known as the Nazi party.
The Reichsbank was now contributing, at the rate of 450,000,000,000 per week, to the notes already in circulation. By May 1st the Mark had fallen to 200,000 to the £1 sterling. Also on this day Hitler’s storm troopers attacked the annual demonstrations by the Trade Unions. By the end of May the Mark reached 320,00 against sterling, and the exchange rate was being adjusted several times a day. During this month the price of an egg rose from 800 Marks to 2,000, a litre of milk from 1,000 Marks to 3,800. For wage earners the situation was grim, for those without it was frequently desperate. Many pensioners and impoverished bourgeoisie survived by exchanging the contents of their houses for food, often for pitiable amounts. Typically a grand piano might be exchanged for a weeks supply of potatoes. Petty crime, burglary and mugging increased dramatically. All normal moral and social obligations were being eroded. But the printing of banknotes went relentlessly on.
Havensteins stepped up production to dizzyfying new limits. Notes to the value of 500,000,000,000 Marks per day were issued to keep up with demand. In July a new range of banknotes was introduced with the values of 10, 20 and 50 million Marks. But the political and economic situation continued to deteriorate, and there was a truly terrible disorganisation of economic life. Industrial workers demanded pay rises (and daily payment) and pressed their claims with further strikes and demonstrations in every part of the country. Clashes between Left and Right factions became increasingly bitter, often resulting in street battles. Against this background Dr. Havensteins policy of the unlimited production of notes was beginning to be questioned, but he retained the confidence and support of his immediate colleagues. And the depreciation of the Mark raged on, lurching from 800,000 Marks to the £1 in early July to 5,000,000 Marks by the end of that month. The countryside was now withholding food from German towns, and there was a serious food crisis throughout the nation, increasing the general sense of desperation.
By the end of July 1932 the tax system had virtually broken down. The Mark was thoroughly distrusted by everyone, but since there was little alternative most people tried to persevere with it. The difficulties that this imposed were almost surreal. The most ordinary transactions could involve several minutes, first of calculation, then of counting out the endless piles of notes. Queues formed everywhere. The most trivial purchases could take ages, fraying everyone’s nerves. A new medical condition arose, 'cipher-stroke', in which people were dazed and confused by constantly having to deal with strings of zeros.
The general frustration with the absurd situation to which the country's finances had been reduced was now being voiced at the highest level. Dr. Havenstein's policy was being seriously questioned from all sides, but the President of the Reichsbank was oblivious to criticism. He pointed to the efficiency of his system (by this time 30 paper mills and 2,000 printing presses were working day and night to meet the demand) and he remained convinced that the money supply was unconnected either to exchange rates or price levels. To steady nerves he delivered a speech to a Council of State proudly stating that the Reichsbank was now in a position to issue 20,000,000,000,000 newly printed Marks on a daily basis. The effect of his speech was immediate and dramatic; the Mark plunged to 22 million to the £1. There were now many calls for the Presidents dismissal, but he refused to resign. In September the Reichsbank produced a new note with a face value of 500 million Marks. But by the time it was issued this astronomical denomination was worth less than £10.
The sight of workers queuing with prams to collect their wages, and of shoppers laden down with baskets of newly minted banknotes, was now common throughout Germany. There was a growing feeling of the need for strong measures to rectify the situation. Hitler cynically exploited this mood. After a successful rally at Nuremburg on September 2nd he openly called for the establishment of a dictatorship. The national circumstances were by now horribly receptive to his extremist solutions. By November 1923 domestic prices were running at 1,422,900,000,000 times the pre-war level! No one was bothering with notes of less than 1 million Marks, and in many places the lack of confidence in the currency hindered the distribution of food. Starvation began affect many German cities. Behind the mind-numbing statistics of inflation there lay countless scenes of individual frustration and distress.
The end, when it came, was sudden. In November 1923 a new cabinet, with self-appointed, and almost dictatorial powers, completely repudiated the Reichsmark and at a stroke introduced a new currency, the Rentenmark, which was valued at no less than a thousand billion old Marks. The Rentenmark was declared to be fully backed by the lands and assets of the Reich. This device was, in the most literal sense, a confidence trick, but it worked - confidence was restored. The scourge of inflation, like some virulent disease, had apparently run its course. The Rentenmark was gratefully accepted and financial normalcy began to be restored. The country began to lick its wounds; but the wounds were deep and not easily healed. The events of the past four years had made an indelible impression on the German psyche. The most serious casualty was the principle of democracy itself, which had unfortunately become thoroughly identified with the financial and social chaos of the inflation years. Dr. Havenstein himself, in one of those coincidences so favoured by history, died on November 20th, the very day his Reichmark was discarded. He remained President of the Reichsbank to the very end.