The risks of sticking to über harte währung strategy | FT Alphaville

The risks of sticking to über harte währung strategy

Germany’s ‘hard money’ principles and opposition to Quantitative Easing by the ECB are, more often than not, framed with reference to the hyperinflation in the Weimar Republic.

Indeed, it’s a widely accepted truth that the horrors of the Third Reich were caused by the three year period of hyperinflation between June 1921 and July 1924.

But not in the way many people think, reckons Dylan Grice. The SocGen strategist believes the reaction to the policies of Reichsbank president Rudolf E. A. Havenstein played a more important part in Hitler’s rise to power. And this has implications for those attempting to understand the Eurozone crisis and Germany’s response.

But while Hitler’’s first attempted power grab occurred in Bavaria at the peak of the hyperinflation,– the November 1923 “Beerhall Putsch” – by the late 1920s the Nazis were little more than one of the larger fringe groups whose best days were judged to be behind it.

But as the world economy collapsed in the early 1930s the gold standard broke up. Successive countries chose to devalue their currencies and inflate their way out of painful deleveraging (chart below). Germany was the exception. Haunted by von Havenstein’s ghost, it fatefully chose to bear instead the brunt of gold standard deflation, experiencing a depression arguably greater even than America’’s. It was then that something broke in Germany’’s collective psyche. With resurgent Nazi support, Hitler won power in 1933, his rise facilitated not only by the 1923 inflation, but by the subsequent fear of inflation.

And in pictorial form.

Now, Germany did actually leave the gold standard in 1931 (via the imposition of capital controls) but it kept the value of the Mark pegged against gold. And more importantly, says Grice, Germany kept a gold standard mentality – the dictates of high interest rates and economic deflation were strenuously adhered to. Indeed, by 1932/3, unemployment had risen above 30 per cent.

The depression broke something in the German people. Even after the horrors of hyperinflation, which peaked in 1923, and the subsequent currency stabilisation of 1924, which caused a deep depression in 1925, the Nazis were barely on the electoral radar (see chart below). But, by the time Germany’’s late 1920s depression was in full swing, the situation had changed. (As the chart shows, the depression began sooner in Germany than in America. This was because the US, as Germany’s main creditor and most important financier of its reconstruction, began to repatriate funds back to the US in the late 1920s, first to earn better returns in the then booming US economy, then to cover the losses caused when the boom turned to bust).

Now, this raises an interesting ‘What If’ question. If Germany had chosen to respond to the Great Depression by inflating their economy, what would have happened?

After leaving the gold standard, the UK saw its unemployment rate decline by about a third from 1931 to 1933, while Germany’’s rose significantly over the same period. If Germany had been willing to follow the UK in inflating, and its unemployment rate had followed a similar trajectory, it would have stood at 17% rather than 33%. Would this have averted what followed? Would Hitler have won that March 1933 election with 45% of the vote? Would the world have experienced the evils of the Nazis in power? World history might have been verydifferent. There might not even be a euro today, let alone a euro crisis.

What Grice, a hard money libertarian, takes from this is that there are times when creating inflation might the right thing to do. And for Germany that time might be now.

The risk of sticking to the über harte währung strategy is that ever-more austerity creates ever-more deflation which creates ever-more misery in ever-more troubled countries (Greece, Spain and Italy today, France tomorrow?). We can argue about how big that risk is and over what time horizon, but that it is real and non-zero is undeniable. A second risk is that such misery will act as oxygen for opportunistic politicians who will blame the euro in general and Germany in particular for their misery. Again, we can’t quantify that risk but we know that it’s real and nonzero (we also know that it is already happening across Europe today). Therefore, the logical implication of a refusal to sanction ECB money printing is that the euro breaks up and Europe splinters apart, in keeping with the various cycles of European history over the millennia. And the logic of Germany’’s uncompromising stance against the ECB money-printing is that it is happy to run that risk.

For that reason, it’s Grice’s guess that Merkel will eventually back ECB money printing.

Related links:
Five steps to financial crisis – FT Alphaville
The ECB must step in to save the eurozone – FT