CHAPTER VII
THE GERMAN MONETARY COLLAPSE
Additions to Gold Supply Impossible
Whatever may be the ultimate outcome of the monetary and banking situation in western Europe, there is little doubt of the future in Germany and in the other nations of central and eastern Europe. It is impossible to conceive how these countries can ever reach a position where they can redeem the present outstanding currencies.
Progressive deterioration of the reserve and progressive depreciation of the currency appear inevitable. Of such tremendous importance is a clear understanding of what lies in store for central and eastern Europe to an appreciation of the whole problem of European rehabilitation, that a careful analysis of Germany's inevitable financial future is required.
In the first place, it is impossible for the Reichsbank to increase its gold holdings. Practically all of the gold supply of Germany is now in the Reichsbank; there is no more that can be withdrawn from the channels of circulation. And since Germany is not a gold-producing country, she can add to her total stock of gold only by importing it. Let us see what this involves.
In the previous discussion of the foreign exchange mechanism,1 1See Chapter II. it was shown that gold will flow to a nation only when the volume of exports exceeds the volume of imports—allowance, of course, being made for the other items entering into the international scale-pans. But in the case of Germany, under present conditions, no gold can be received until the exports exceed the imports by more than the amount of the annual reparations payments, which, as will be seen in later discussion, can in the main be made only by the shipment of goods abroad. The subsequent discussions of the terms of the reparation settlement will indicate that for something like a half century Germany cannot expect to receive any appreciable inflow of gold.
Deflation of Currency
Could Germany, by reducing her outstanding circulation sufficiently, resume specie payments? Suppose we consider first the possibility of resumption upon the basis of Germany's existing gold supply—assuming, for the time being, that none of it is exported in reparations payments. To what extent would the German currency have to be deflated in order to make possible a return to the pre-war gold standard? In the United States a minimum of 40 per cent reserve in the federal reserve banks is considered essential to the maintenance of specie payments. Before the war the German banking law required a reserve of at least 33 per cent against outstanding notes. Much more than this was, in fact, ordinarily maintained. While other leading countries required no definite reserve, practical experience had in all cases led to the maintenance of large specie holdings. 2 2 See table on page 68 for the reserve in 1914. But it is doubtless possible to effect a restoration of gold redemption on a much narrower gold basis than was formerly the case. Assume, therefore, that the accumulation of a reserve of 20 per cent would be sufficient. What amount of deflation would this require, and what would be involved in the process?
The amount of outstanding Reichsbank notes now stands at about 80 billion marks, and the reserve at slightly more than 1 billion marks. (The outstanding deposit claims amounting to more than 15 billion marks are here omitted from consideration.) To make the reserve of 1 billion marks equal to 20 per cent of the note issues would require a reduction of the notes to 5 billion marks. Sixty-five billion marks, over 80 per cent of the entire momentary supply, would have to be eliminated from circulation.
To understand the full significance of so drastic a contraction of the currency, it must be recognized that it would involve a reduction of bank loans to roughly one- fourteenth of the present total. Such a drastic reduction of loans would produce complete business prostration and result in almost universal unemployment. It would also involve the cessation of unemployment insurance and pensions, and a failure to cover by new loans the huge governmental and railway operating deficits. 3 3 The railway operating deficit in 1921 was over 9 billion marks. Incidentally, these deficits would also make the payment of reparations impossible. No government could last which resolutely undertook any such contraction of bank loans; the certain results of attempting it would be political revolution.
If the contraction were sought to be effected only very gradually—say in fifty years—there would merely be a prolongation of the agony of deflation, and an apparently perennial era of desperately hard times. Prosperity never accompanies contraction of currency and falling prices. Neither the Germans nor any other people will submit to a prolonged period of hard times and unemployment, when the power of restoring business activity through a renewal of inflation is ready at hand.
Argument Against Deflation
There is another reason why a return to gold redemption of the existing currency will not—many students say, should not—be undertaken. The existing government debts have largely been contracted on the basis of highly inflated values. And to reduce prices, and hence money wages and profits, to a pre-war basis, or to anything approximating a pre-war basis, would enormously increase the difficulty of raising the necessary taxes. The point is that the interest on the public debt would not be reduced as the result of deflation, while the wages and profits out of which tax revenues must come would be reduced.
The following statement substantially as made by the Right Hon. R. McKenna, Chairman of the London Joint City and Midland Bank, will indicate what would be involved in deflation, even in England, where the price level now stands at only twice the pre-war figures: The two items of interest on the public debt, £350,000,000, and war pensions, £120,000,000, would, if prices and profits were reduced to a pre-war level, call for a tax of over 13 shillings in the pound, "a rate absolutely impossible for any country to bear." Thirteen shillings in the pound, it may be explained, means roughly 60 per cent of the national income. The other governmental revenue required would be additional to this. In Germany and France the difficulty would, of course, be intensified many fold.
If a deflation of prices and values back to pre-war levels should occur, it would be necessary to scale down in some way the public debts. This might be done either by repudiating them wholly or in part, or by reducing the rate of interest, paying in Germany, for example, perhaps the equivalent of one cent on the dollar. Such a proceeding is, however, beset with great political danger. It would arouse bitter opposition among certain groups. Human beings like to have taxes reduced; but they regard a scaling down of interest payments as a species of governmental robbery.
Even if the government debts could be scaled down, this would not end the difficulties. Private obligations of stupendous amounts have been incurred since the currency became inflated. Corporations could not possibly pay interest and dividends on capitalizations contracted on the basis of values that obtained in Germany in 1920, if profits in terms of money were to be reduced, for example, tenfold. All private corporations would in consequence have either to scale down their interest charges by some device, or else reduce their outstanding bonds and shares. The attempt to undertake this would, of course, only serve to intensify business and financial uncertainty.
Stabilization of Present Prices
Considerations such as the foregoing have led many students of the situation to suggest that we should let bygones be bygones, and accept the present price and exchange level as a permanent fact. That is to say, they would stabilize the value of the mark, franc, etc., at approximately their present values and not attempt to go back to the pre-war gold parities. 4 4 It is often argued, however, that some countries should first affect a substantial deflation. The paper mark is now worth about one-twentieth of the gold mark—equivalent in American terminology to about 5 cents on the dollar; the franc is now worth about two-fifths of its normal value. Now to stabilize the currency at present values would require a rigid limitation of its quantity—a prevention of any further inflation.
Right here lies a practical impossibility—in most countries—of accomplishing the end in view. It is idle to talk of restricting further issues of paper currency so long as government budgets remain unbalanced. When taxes suffice only to meet a small percentage of government expenditures, the floating of government bonds soon becomes impossible and the issue of more paper money becomes the only means of acquiring government funds. We do not need to go back to early European experiences, or even to American colonial history, to find striking illustrations of the difficulties in controlling the supply of paper money when once a nation is well advanced on the highroad of inflation. They may be drawn from the recent history of eastern Europe. 5 5 See further discussion of this problem in Chapter VIII.
The nations of central and eastern Europe are thus faced with a three-horned financial dilemma. To attempt a return to pre-war values and standards is fraught with the gravest industrial and social consequences, not to mention political results. Stabilization at existing levels is a practical impossibility, unless government budgets are first balanced, and government budgets cannot be balanced. Further inflation, the third horn of the dilemma, only leads to ultimate monetary collapse.
Continued Inflation Likely**
What, then, is the probable outcome for Germany? Which of these equally disastrous roads will she seek to travel? All the evidence points towards the third—the pathway of continuous inflation. Business men are inclined to accept this course as the lesser of many evils. For, until the end comes—and most of them do not see the end—it means rising prices and good profits. It is, moreover, a stimulant to export trade; and Germany must increase her exports if she is to pay reparations. Some of the industrialists of France are also reconciled to this view of inflation.
That there is no present thought in German governmental circles of arresting further inflation is evident from a recent legislative enactment. In April, 1921, it was provided that the 33 per cent reserve requirement against bank notes should no longer be required.6 6 The reserve during the war was composed of gold and darlehnkassenscheine. The darlehnkassenscheine are the irredeemable promises to pay of certain German loan companies. Before the war the law required the Reichsbank to hold a gold reserve of outstanding notes of at least 33 per cent, but it was found expedient early in the war to modify this position and to permit the darlehnkassenscheine to constitute lawful reserve money. It is accordingly now legal to expand the note issues indefinitely—to the point of worthlessness. 7 7 A bill was also recently introduced in France providing that the present limitation of 43 billions of note issues by the Bank of France be raised to 150 billions. We are informed that the measure has considerable backing.
The altogether probable drift in Germany will therefore be toward further inflation, rather than toward either deflation or stabilization. As has been the case in Austria and Russia, we may expect German currency to expand from 80 8 8 Within two months after writing the above the total note issues had increased to over 80 billions. to 90 to 100 to 200 billions, and the value of the mark to decline from one cent, to a half cent—and ultimately to zero. No nation—it should be repeated—has ever been able to retrace its steps after its monetary system has once approached a condition comparable to that of Germany today. Repeatedly in history depreciation has continued gradually to utter worthlessness. The end usually comes when those having food or other necessities refuse longer to part with them for paper currency at any price.
Incidentally, paper currency in Austria is still not quite worthless. For example, a beer manufacturer uses paper crowns (kronen) as labels, existing kronen being cheaper than paper for the purpose; he thus advertises "kronen" beer. This will prove a short-lived opportunity, however, since it now costs about five crowns to manufacture a one-crown piece.
We have been saying "depreciation to zero" and "utter worthlessness." Perhaps it will not go quite to zero. Before the point of utter worthlessness is reached the government may undertake some redemption scheme, whereby perhaps 100 marks in paper would be redeemed for one mark in gold. The effect would nevertheless be substantially the same.
Effects of Repudiation
There is little likelihood of outright repudiation of the mass of either German paper money or government bonds. Repudiation requires political courage; and courage is seldom an attribute of governments in financial distress. It is less difficult, and less painful, no doubt, to allow economic laws to accomplish in due season the same end that would be produced by political edicts.
What will happen to modern German industrial life if German currency goes the way of that of Austria and Russia? If the currency becomes worthless the government bonds issued in exchange for paper money must share a similar fate. What would be the economic result if a hundred billions of bonds and a hundred billions, or so, of currency should become utterly worthless? Would this mean starvation for millions of Germans, and political disintegration and bolshevism for the rest? No categorical answer can in the nature of things be given to such questions. That the industrial consequences of such an economic shock would be of unparalleled severity is not, however, to be questioned.
In one way this virtual repudiation of government bond and bank note obligation may be said to amount to little. For while the people would no longer receive interest, it would also be unnecessary for them to pay taxes. What they would lose—in interest—with their right hand, they would save—in taxes—with their left. But unfortunately, the matter is not so simple as that. As individuals we seldom pay taxes in precise proportion to the interest received on government obligations; some pay more, some less, and some neither pay taxes nor receive interest. Accordingly, repudiation involves wholesale injustice to citizens and would result in a thorough-going redistribution of wealth, with accompanying widespread social disaffection. It is, therefore, the part of wiser statecraft to allow ultimate repudiation to come through the indirect process of inflation to the point of worthlessness.
Some idea of the economic consequences of this ultimate debacle may be gained if one considers that practically all of the collateral that is back of bank loans would be worthless; that the assets of savings banks and insurance companies—representing the savings of German citizens—would be wiped out; that the investments of the reserve and other funds of corporations would be destroyed; and that all private financial obligations of whatever sort would be automatically obsolete. The entire financial structure would collapse.
Development of New Credit Structure
Land, factories, equipment, railways, etc., would, however, remain. And since these constitute the primary foundations of wealth production, it is not to be supposed that a financial cataclysm would result in a complete cessation of economic activity. Nevertheless, all of modern economic life is organized and controlled through the financial machinery. Business is conducted in the midst of a complex system of established prices and values. A collapse of the entire financial mechanism would, therefore, result for a time at least, in nothing less than economic chaos.
Whether such an interregnum could be compassed without political and social revolution of the extreme variety is very doubtful. Mention has already been made of the redistribution of wealth, and of the social disaffection that would result from government repudiation of bonds and paper currency. Indirect repudiation through the inflationary process might permit a particular government for the moment to escape responsibility, but in the end some government would be held accountable.
However disastrous to large masses of the population the first shock of the financial cataclysm would be, the nation would undoubtedly survive; and in spite of political upheavals, some day, no doubt, a new credit system based on the existing gold stock of the Reichsbank would be reared. Germany might eventually get started again on a sound money basis, that is to say, with new issues of paper money, redeemable in, and therefore as good as, gold. 9 On the basis of this new monetary system would gradually be developed a new credit structure, a new series of financial relationships, a new economic system. It should be understood, however, that, as in the case of ordinary bankruptcy, the past would remain the past—old values and claims would not be resurrected, not even the claims of foreigners to German paper marks, purchased in simple faith that Germany must and will come back. After bankruptcy present German obligations would be dead.
Thus stands the European monetary and banking situation at the present time. There is little hope that any of the nations east of the Rhine can return to sound money, save by the disastrous route of financial bankruptcy. West of the Rhine, the continental situation, if less desperate, is still admittedly extremely difficult. The best that may reasonably be expected there is some effort toward stabilization at existing levels of monetary depreciation; but in view of the popular unwillingness to be taxed sufficiently to balance budgets and in view of the control that the masses possess over the fiscal policies of governments, there is little hope in this direction. In England, on the other hand, there is little cause for anxiety—provided only some measure of industrial peace and economic stability can shortly be attained.