Life was madness, nightmare, desperation, chaos.1 Extreme inflation or hyperinflation2 is in the news as price rises in Venezuela hit the stratosphere. The cataclysm of hyperinflation is both a symptom and cause of deep-rooted economic and political malaise. The example of Germany in 1923 may be an instructive historical example for investors today.
Gold no more
Before the First World War, the global monetary system was based on the gold standard with most currencies fixed to gold. Germany came off the gold standard at the outbreak of war in 1914 to provide financial flexibility at a time of crisis. Before 1914, under central bank policy, a third of bank note issuance had to be backed by gold, constraining the money supply.3 When this constraint was removed, the amount of paper money rose substantially, from 2 billion marks in 1913 to 45 billion in 1919, unleashing inflation.4 During the war years the cost of living trebled.5
Treaty of Versailles
A spirit of revenge characterised the post-war settlement. The Treaty of Versailles reduced Germany’s population and territory, while lumbering it with substantial reparations – large sums to punish it for the conflict, calculated to be £6.6bn in 1921, which had to be paid in yearly instalments of £100m.6 Raising this money was a continuous struggle for the German government and undermined the currency from the beginning of the Weimar Republic.
The period after the war was one of intensifying political instability in Germany. The failed Kapp Putsch attempted to overthrow the Weimar Republic and establish a military dictatorship in 1920, while 400 political murders between 1919 and 1922, including Finance Minister Mathias Erzberger and Foreign Minister Walther Rathenau, intensified political risk and contributed to surging inflation as the currency weakened.7
Inflation to hyperinflation
The journey from inflation to hyperinflation gathered pace in 1921. In the second half of that year there was a 50% increase in official food prices. The price of an egg rose 180-fold between 1914 and July 1922, while a litre of milk climbed from 7 marks in April 1922 to 16 in August and 26 by mid-September.8
In July 1922 prices rose by 50% month on month for the first time, a level now generally accepted as hyperinflation.9 During the following year inflationary pressures escalated. Ultimately prices were rising every few hours. Barter became a common form of exchange based on commodities like brass and fuel. A cinema ticket could be paid for with a lump of coal. There were stories of people ordering meals in restaurants and being charged more when the bill came.10
During these years the currency collapsed as the mark’s supply rose exponentially. It fell from 7.4 per US dollar in November 1918 to approximately 2.5 trillion per US dollar on 15 November 1923 on the eve of currency reform.11
Year of the Wheelbarrow (1923)
The French occupation of the Ruhr in January 1923 in response to non-payment of reparations resulted in further weakness of the mark. The decline in government revenue caused by the occupation put further strain on government finances and encouraged more money printing.
The hyperinflation can be followed in bank note denominations. The first 100,000 and 1-million mark notes were printed soon after the occupation of the Ruhr.12 By July 1923, a 50-million mark note was being printed and by September a 500-million mark note.
In October it was noted that the number of marks to the pound equalled the number of yards to the sun. 13
By the end of October, banknote circulation amounted to 2,496,822,909,038,000,000 marks. On 2 November 1923, close to the peak of hyperinflation, the Reichsbank issued a 100-trillion mark note.14 During the hyperinflationary period 2,000 presses printed banknotes day and night.15
Descriptions of the worthless German bank notes of these years are well known: baskets full for shopping trips, wheelbarrows full to pay workers’ wages. They were used as wallpaper or, in bundles, as children’s toy building bricks. The currency was destroyed as a means of exchange.
The madness persisted because the political will to stop it did not exist. Fear of extreme austerity causing even higher unemployment and further instability paralysed politicians.
Share prices reached a bottom in October 1922, well before the end of the hyperinflation. By then the stock market was down 97% from its 1913 level.16 Prices continued to rise in real terms during the first half of 1923, even as the hyperinflation entered its climatic phase.17
Germany was starting to fall apart. Riots and plundering erupted across the country with unemployment among the unionised workforce spiking to over 23% in October 1923.18 Rebellions against central authority broke out in Bavaria and Saxony, and separate currencies were launched by cities, threatening the long-term survival of the German state. The existential threat to Germany finally encouraged politicians to act.
An enabling law of 13 October 1923 allowed the government to legislate without Reichstag approval; Germany in effect becoming a temporary dictatorship. A new central bank, the Rentenbank, was established on 17 October and a new currency on 15 November, at an exchange rate of 1-trillion old paper marks to one new Rentenmark. The printing of old marks stopped on this day. The supply of new Rentenmarks and government expenditure were both kept in check thereafter. By the end of August 1924 Germany had a stable currency. The madness was over.
Hyperinflation inflicted severe damage on the German people, causing food shortages, rioting, looting, poverty and political instability. It intensified corruption, tax-evasion, food-hoarding, currency speculation and anti-foreign feeling.
It brought about a fundamental redistribution of wealth in the country. Those relying on fixed salaries or pensions experienced a collapse in income in real terms and those with domestic savings or war loans lost everything. Rents fell close to zero as they were usually fixed, destroying the income of landlords.
Anyone with debt benefitted as debts were inflated away to nothing under hyperinflation. For example a Pomeranian landowner took out a loan to purchase a property in February 1922 and repaid it in the autumn from the sale of less than half the crop of a potato field.19 The government also benefitted as its debts were inflated away.20
Towns starved as farmers refused to take paper currency in payment and delayed selling their produce, anticipating better prices, causing conflict between cities and the country, and encouraging the emigration of 2 million people from urban areas to the countryside during the inflationary period.21
Hyperinflation caused a huge trade in physical assets, initially foreigners taking advantage of the collapse of the mark to buy German goods in foreign currency. The middle class was forced to sell their possessions, from paintings to pianos, when incomes collapsed. Germany’s capital was no longer spread among millions but was focused on a new hated plutocracy.22
Descent into Hell
Despite the end of the hyperinflation, Germany’s nightmare had only just begun. Hyperinflation did not bring Hitler to power but provided fertile ground for extremism. The SA, the paramilitary wing of the Nazi Party, founded in November 1921, numbered 6,000 within a year. On 2 September 1923, during the peak of the hyperinflation, a hundred thousand attended a Nazi rally in Nuremburg.
It would be a decade before Hitler came to power during the global depression of the 1930s. As one historian has put it: ‘hyperinflation… nurtured the seed of Nazism. A decade later, depression… brought the toxic plant into fruit.’23
Lessons for investors
At Stewart Investors we are bottom-up investors, focusing on companies. However, this does not stop us considering important macro developments.
Hyperinflation involves the risk of complete capital wipe-out for bond and equity investors. Capital preservation is fundamental to our investment philosophy and is often forgotten by investors focused primarily on returns relative to a benchmark index.
It is always necessary to remember the risks of investing in emerging or frontier markets, where the rule of law and institutions are often fragile. The recent examples of Venezuela and Zimbabwe are a stark reminder of the dangers of hyperinflation.
At Stewart Investors, our investment philosophy remains the same whatever the economic conditions. We invest in quality companies in terms of management, franchise and financial structure which are trading at reasonable valuations. We believe this will provide positive returns for investors over the long-term.
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