Last Friday, while many were off for Veteran’s Day, we put in a day at the office, belaboring things portentous to our clients…and by extension ourselves. Nonetheless, we paused a moment to consider the ‘all quiet on the western front’ Armistice and today’s world we live in.
From what we gather ‘the war to end all wars’ brought a new disorder to Europe. By the time it was over, economies were ruined, governments were defeated, and national confidences were crushed. On top of that, the Treaty of Versailles, and its repercussions, prompted Germany to blow up its currency. It was the rational thing to do.
One of the provisions of the treaty required Germany to make reparation payments that were impossible for their economy to cover. To lighten the burden the German government, the Weimar Republic, began printing paper banknotes. The results were disastrous.
Between January 1922 and November 1923 the wholesale price index rocketed from 36.7 percent to 726,000,000,000.0 percent. By late 1923 it took 200 billion marks to buy a loaf of bread. In effect, Germany’s money died…along with its middleclass.
Interestingly, the lesson Germany learned from the hyperinflation in the 1920s was the opposite of the lesson the United States learned from the depression of the 1930s…
Lessons of the Great Depression
Throughout the roaring twenties businesses in the United States doubled down on their growth and overbuilt their operations. Following the stock market panic in late 1929, the U.S. economy’s capacity overhang was exposed to be grossly out of balance with its real demand. That’s when the banking system’s fractional reserve debt pyramid that supported the build-out imploded.
“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate,” were the advice of then Treasury Secretary, Andrew Mellon, at the onset of the Great Depression. If President Hoover, and later Roosevelt, had followed Mellon’s advice it’s possible that the economic downturn and recovery would have been more abrupt, yet shorter in duration. Instead, the government larded up the economy with loads of debt based stimulus spending and directed it into unproductive make work programs, which extended the downturn into a 10-year depression.
On the monetary side, the Federal Reserve, created in 1913, was still finding its way at the time and was hesitant to inflate. Additionally, the pesky gold standard, which required a 40 percent gold backing of Federal Reserve Notes, also limited their ability to expand the money supply. Between 1929 and 1933 the Federal Reserve stood by while the quantity of money declined by a third and the banking system collapsed.
In “A Monetary History of the United States,” Nobel Prize winning economist Milton Friedman assigned blame for the Great Depression to the Federal Reserve. According to Friedman, if the Federal Reserve had inflated the money supply the banking system wouldn’t have collapsed and millions of people wouldn’t have lost their life savings.
These days, where U.S. monetary policy is concerned, Friedman’s assertions are the gospel. Just ask current Federal Reserve Chairman Ben Bernanke. In his November 21, 2002 speech, Deflation: Making Sure “It” Doesn’t Happen Here, Bernanke explained, “The U.S. Government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
Since the financial crisis of 2008, Ben Bernanke has added $2 trillion dollars to the Federal Reserve’s balance sheet – tripling its size. Based on the lesson of the Great Depression, as laid down by Friedman, this is what he’s supposed to do. He must inflate…for it’s the solution to deflation.
European Money Printing: What Could Possibly Go Wrong?
In Germany, to the contrary, the lesson of hyperinflation is what’s seared into their psyche. Their grandparents told stories of burning money to heat the home because it was cheaper than fire wood. They learned of Reichsbank President Rudolf Havenstein’s epic misunderstanding of what was happening, and how he perpetuated the inflation by printing up more and more money to meet an increased demand caused by the mark’s devaluation.
In today’s world, from what we’ve read, the European Commission’s looking to come up with €1 trillion euros to bail out southern Europe and Ireland. So far their efforts have been unsuccessful. What’s more, they may ultimately need close to €3 trillion euros.
In short, the bail out money needed does not exist and the banking system’s insolvent. Moreover, credit markets are imposing limits via rising interest rates restricting the ability of these countries to finance their massive debts. This leaves few options, except, to use the European Central Bank’s printing press.
Given Europe’s predicament, the allure of printing money is gaining support across the continent. So far ECB purchases of sovereign debt have been offset with sales of euro paper. But that could soon change. The goal of monetary inflation would be to print up euros in sufficient quantities to reduce its value and lighten the burden of over indebted European nations. Like Bernanke’s efforts in the U.S., and against Germany’s demands, we expect that money printing will be the expedient path the ECB takes.
What could possibly go wrong?
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