How Germany Recovered Its Economy After WW I

Year 2020 will be known in the history as a period of insurmountable struggle, which has made the whole world to join together and fight. The entire humanity is fighting a war with an invisible enemy. Just about everything around us has undergone a sea change. The end of the battle is not in sight as yet. In fact, we have not even reached the proverbial ‘beginning of the end’. The corona pandemic can attack us through a second wave at the fall of the year, even if we can flatten the exponential curves. The global lock down has already had a profound effect on the economy of nations. In India, millions of workers have been thrown out of jobs, and many businesses like the malls and multiplex complexes have shut shop indefinitely. The tourism and hospitality industries have bleak prospects and thousands of sports personalities, who have spent the last four years dreaming of medals in the Tokyo Olympics, will have to wait for at least one more year to show their prowess and skills.

“What next” and “what after the Corona crisis” are questions that beg for an answer. We have to look into the pages of history to see how economies were successfully ‘turned around’ in the past. The period between the two World Wars (1919 to 1939) is an interesting era. Germany was ravaged by WW1. The defeat left them shattered. But what they achieved by the year 1939, was nothing short of a miracle.i have been researching the life and times of Hjalmar Schacht, and produced a piece for the benefit of those who like a bit of serious economics.

For a long time it had been a mystery to me as to how Germany recovered from the devastation of World War I, the stiff and unfair terms of the Versailles Treaty, the hyperinflation, the reparations and the Great Depression of 1939. I had read a little bit about Hitler’s dictum of using deficit financing for a fair day’s work. But I did not know any details.

The provocation for this article was a paper titled “Fiscal Options & Response to Covid-19 Epidemic (FORCE)”, which the IRS Association presented to the Prime Minister’s Office (PMO) and the Union Finance Ministry. The paper recommended raising income tax rate to 40 per cent for those who earn over Rs 1 crore a year, re-introduction of wealth tax, effecting a one-time Covid-19 cess of 4 per cent on taxable income of over Rs 10 lakh, direct cash transfer of up to Rs 5,000 a month for the poor, and a three-year tax holiday for all corporates and businesses in the healthcare sector.

The Ministry of Finance quickly distanced itself from the paper, making it clear that the paper did not represent government thinking.

Further, the Central Board of Direct Taxes issued chargesheets against three principal commissioner-rank IRS officers for “misguiding” young taxmen and “unauthorisedly” releasing the report to the media.

The bureaucracy in India is very powerful. Many of them would love to go back to the days of Morarji Desai, his 11 tax slabs and his 97.75 % rate at the highest slab of income tax. So, it is very necessary to learn from history and for the public to be aware of different ideas.

Now the internet has opened up huge vistas. What would have required months of study and visits to many libraries is now available if only we take the trouble to search.  I stumbled on Dr Hjalmar Schacht and how he was instrumental in German recovery from hyper inflation, from the deflation of the Great Depression and how he co-founded the Bank for International Settlements.

Germany was in dire economic straits on account of losing World War I. The Treaty of Versailles imposed severe conditions on Germany and they had to pay reparations. On top of that, the Allied blockade continued for a year after the war ended. The result was hyperinflation. In 1914, the exchange rate of the German mark to the American dollar was about 4.2 to one. Nine years later, it was 4.2 trillion to one.

 

 The central cause of the hyper inflation was the Reichsbank itself. The term of its president, Rudolf E. A. Havenstein, was for life. He kept issuing ever greater amounts of Papermark for keeping the Reich financially afloat. Finally, on 15 November 1923, the Reichsbank was made to stop monetizing government debt and issuing new money. At the same time, it was decided to make one trillion Papermark equal to one Rentenmark. On 20 November 1923, Havenstein died suddenly of a heart attack. That same day, Hjalmar Schacht, the Currency Commissioner, took action and stabilized the Papermark against the US dollar: the Reichsbank made 4.2 trillion Papermark equal to one US Dollar. And as one trillion Papermark was equal to one Rentenmark, the exchange rate was 4.2 Rentenmark for one US dollar. This was exactly the exchange rate that had prevailed between the Reichsmark and the US dollar before World War I. The “miracle of the Rentenmark” marked the end of hyperinflation.

Hjalmar Schact

In college, Schacht studied medicine, philology, political science and finance at the Universities of Munich, Leipzig, Berlin, Paris and Kiel before earning a doctorate at Kiel in 1899 – his thesis was on mercantilism.

Schacht joined the Dresdner Bank in 1903, becoming a deputy director in 1908. From 1915 till 1922 he was a board member of the German National Bank.

Schacht was a freemason, having joined the lodge Urania zur Unsterblichkeit in 1908.

During the First World War, Schacht was assigned to the staff of General Karl von Lumm the Banking Commissioner for Occupied Belgium, to organize the financing of Germany’s purchases in Belgium. He was summarily dismissed by General von Lumm when it was discovered that he had used his previous employer, the Dresdner Bank, to channel the note remittances for nearly 500 million francs of Belgian national bonds destined to pay for the requisitions.

In 1918 Schacht co-founded the German Democratic Party. He became a fierce critic of the post-World War I reparation obligations imposed by the Treaty of Versailles.

In 1923, Schacht applied for and was rejected for the position of head of the Reichsbank, largely as a result of his dismissal from Lumm’s service. But, later that year, in response to the devastating inflation in the country the German government appointed him the Currency Commissioner and gave him near dictatorial powers over the German economy.

“He brilliantly understood the key point of psychology of money, which is as valid today as it was in the hyper-inflation of the 1920s: the appearance of financial stability creates monetary value. If people believed that someone was in charge, that the chaos would end, and that the Rentenmark had value, then it would be valued.”

The aim, Schacht said, was to “make German money scarce and valuable.” In this he succeeded mightily; so well in fact that a month later, on December 22nd, 1923, Schacht was promoted and became, in addition to Currency Commissioner, the President of the national central bank of Germany—the Reichsbank. Schacht went on to play a vast role in both the formation of the Bank for International Settlements (BIS) and the rise of Hitler and Nazi Germany

With the Rentenmark functioning as a currency, Schacht had brought German inflation under control. His next step was to begin the process of building a gold reserve to give the currency a more sound backing. To this end, on December 31st 1923 he travelled to London and was met at the Liverpool Street train station by none other than the legendary governor of the Bank of England himself—Montagu Norman.   Norman had been governor for over 3 years and was widely considered one of the most powerful and influential men in the world.

Schacht’s purpose in visiting Norman was to obtain a loan for $25 million from the Bank of England to a new Reichsbank subsidiary, the Gold Discount Bank. The two bankers instantly took to each other and Schacht got his loan. With the loan and the implied approval of the Bank of England and Norman, world perception of Germany’s financial prospects immediately improved. This further opened financial doors in both Wall Street and London. Their meeting in London started a friendship that lasted until Norman’s death in 1950 and would have consequences that reverberate to this day.

With the assistance of these loans Germany resumed reparations payments. However, the German government, people, and particularly Hjalmer Schacht, still hated them and wanted them gone. The fact was that Germany was only able to make its payments because it was borrowing from other nations.

By 1928 Schacht felt that it was no longer feasible to keep borrowing from Peter to pay Paul. Meanwhile France, Belgium and other Allies were adamant that the reparations continue. The upshot was that a new conference to resolve the reparations issue was convened in Paris in February of 1929, this time chaired by Owen Young.

The conference got under way cordially but quickly became contentious. Schacht and the Germans proposed a complete re-structuring of the reparations schedule requiring relatively small payments of $250 million per year for the next 37 years. The French, headed by Bank of France governor Emil Moreau, demanded $600 million a year for the next 62 years. Neither man would yield from their position and the resultant impasse persisted. Despite the discord, one idea put forth by Schacht and Montagu Norman was getting some traction: the creation of a new bank for the prime purpose of managing Germany’s reparations payments. The two bankers held that the new bank would keep the issue free of politics and would manage the payments on a purely financial basis—something that was actually very unlikely, considering how politically charged the reparations issue was. In actual fact Norman had been considering similar ideas for years.

Writing later about the bank’s creation, Schacht stated: “…my idea of a Bank for International Settlements had met with such enthusiastic response from all those taking part in the Young Conference that soon there was not one among them who would not have claimed the suggestion as his own.”

Nevertheless, despite the role he played with Montagu Norman in getting the BIS established, Hjalmar Schacht declined a directorship in the BIS that would be his by virtue of his post as president of the German Reichsbank. Upset that the Young Plan did not dramatically reduce the German reparations, or eliminate them altogether, he resigned from the Reichsbank in March of 1930, turning his post as president over to former German minister of finance and Chancellor, Hans Luther.

In February of 1930 the dream of Montagu Norman and Hjalmar Schacht of a “Central Bankers Club” was ushered into reality when the foundation documents of the Bank for International Settlements were signed. As Adam Lebor reports in “Tower of Basel”:   “Under the cover of the Young Plan, as well as the need for an impartial financial institution to administer German reparations payments, Norman, Schacht, and the central bankers had by brilliant sleight of hand created a bank with unprecedented powers and privileges.”

For Further Reading:

1.  Guillebaud, C W (1939), The Economic Recovery of Germany from 1933 to the Incorporation of Austria in March 1938, Macmillan and Co.

2.  Mahe, E (2012), “Macro-economic policy and votes in the thirties: Germany (and The Netherlands) during the Great Depression”, Real-World Economics Review Blog, 12 June

3. Paying the piper, reaping the returns

Hans-Joachim Voth 18 September 2008

4. Ahamed, Liaquat. Lords of Finance: The Bankers Who Broke the World, Penguin Books, 2009 ISBN 978-1-59420-182-0

5. Weitz, John. Hitler’s Banker: Hjalmar Horace Greeley Schacht. Boston: Little, Brown and Co. 1997. ISBN 0-316-92916-6.

6. Braun, Hans-Joachim (1990). The German Economy in the Twentieth Century. Routledge.

7.  The Bank for International Settlements

https://www.bis.org/

8. The Weimar Republic 1918-1929

https://www.bbc.co.uk/bitesize/guides/z9y64j6/revision/5

9.   90 Years Ago: The End of German Hyperinflation

https://mises.org/library/90-years-ago-end-german-hyperinflation