Inflation kills your money- a cautionary tale from a European fiscal giant

Money can die, it’s happened before and it’ll happen again. My great-grandmother saw it happen to her.

I was lucky enough to have met my great grandmother, who had lived in Germany through the 1920s. She didn’t trust paper money, she didn’t trust banks, her economic belief was in holding hard goods and land.

Bear in mind that though this was in the 1960s, the German Deutschemark already had a legendary reputation as a result of Konrad Adenauer’s Wirtschaftswunder. As a very small child, I visited her in a nursing home which seemed a model of clean and attentive services (she was physically though not mentally frail that I could see) and the Germany I travelled through by train was clean and modern. This struck me when compared with the shabbiness of early 1960s Britain and the bomb-sites that still littered London which would provide me and my schoolmates a playground in the years to come.

As another example of why this looked odd to even an unsophisticated pre-schooler like me, my grandmother wondered why there were so many bangers on the roads of Britain, compared to at home where the VWs, Audis, BMWs and Mercedes Benzes that were the output of the Wirtschaftswunder were humming up and down the federal highways of West Germany.

So against this backdrop, what on earth was this good lady on – after all, her son-in-law worked for a bank. My mother explained that she had seen some bad stuff happen in the past and had lost her life savings, twice.

Inflation in 1920s Germany

This kind lady’s eyes sparkled as she passed over a piece of knowledge across four generations in the peculiar way that only personal knowedge can, and my grandfather from the bank filled in the backstory over te years to come, I think he even showed me one of these, which I recently saw again in a free exhibition entitled Inflation, War and Global Financial Crisis at the Fitzwilliam Museum in Cambridge.

a 100,000 Mark note

a 100,000 Mark note

Here it is, a big, strapping 100,000 Mark note. It’s difficult to say how much this would have been worth, but the number on the front wasn’t so outrageous. For instance if it were Italian Lire before 2000 this would be about equivalent to a fifty pound note.

However, soon it wasn’t enough. It was causing the sort of problems the chap in the photo on this post was having. With the aim of easing the workload of the Weimar Republic’s chiropractors, and returning the country’s sack-barrows to the urgent task of moving barrels of Pilsner about, there was clearly a need for a bigger denomination.

Milliard Mark note

Milliard Mark note. I believe a Milliard is a US billion, a thousand million or 10E9. It's a lot, anyway

Now let’s think about this for a moment. We’ve shifted scale from 100,000 to 1,000,000,000, four orders of magnitude. Consider the UK currency, which manages with a smallest note of £5 and a largest denomination of £50, just one order of magnitude. The Euro manages with two orders of magnitude, €5 to €500. Something very dramatic must have happened in Weimar Germany to need such a range.

Germany inflation (from wikipedia)

You can see in the five years from 1918 to 1922 the German population ate a hit of 100 times inflation. That’s pretty bad – though I’ve spent enough time berating UK inflation as rotting savings, these poor Germans experienced the same amount of inflation in five years as you would if you took 20 five pound notes from Queen Victoria’s reign and presented them to the Bank of England in return for two shiny £50 notes. That’s tough, but nowhere near as tough as the ten thousand million to one inflation they experienced in 1923. This ended when the Reichsmark took over and twelve zeros were struck off the paper marks.

10 Reichsmark note

This story impressed me as a pre-schooler. Imagine what it did to the German nation.

The ghosts of those who lost everything the Weimar Republic still whisper across the generations in modern Germany

I noticed it as a young adult when I took my first road trip to Germany and Switzerland in the 1980s. I was able to use my credit card in France, but as soon as I crossed the border at Aachen I had to use Eurocheques and a Eurocheque card. The Germans just didn’t do credit, they had seen where that had gone and even three generations down the line they would have none of it.

Even nowadays though credit cards find wider acceptance you would be ill advised to rely on it in Germany for everyday purchases, and cash is used more than I am used to in the UK. Other apsects of life are touched by the background radiation of the 1920s still decaying in the German collective conciousness, for instance a German would look at the British twenty-something’s eagerness to buy a house with a mixture of pity and wonder. Germans tend to save money and buy a house in middle age; and as a result they have a rental market that is far more lifestyle-friendly than in the UK.

This attitude to credit is part of why Germany now looks around it and the wreckage of European Monetary Union and asks itself  “how did things get this way?” It is part of why Germans save more than Greeks, why they run a tighter fiscal ship.

Deep within the family traditions, the ghosts of the 1920s Weimar Republic are preserved and whisper to Germans why you don’t live life on the never-never, burning through tomorrow’s money today as we have been doing in the UK and in America. It wouldn’t be so bad if we spent it all on wine, women and song, but what we did with it is inflate the price of property, making ourselves feel richer by taking money from our future selves, and in a casual drive-by shooting of our younger folk inflating the price of an essential asset, accommodation.

History doesn’t repeat itself, but it can rhyme

There’s a clear takeaway from the German experience. It is harsh, and few people will have the balls to use it, but it is written in the graph above. As a German with financial wealth, you had one chance to do something about this, and it was in 1918 to 1919 (I’m aware that they may have been dealing with other problems as a result of action prior to 1918….) The message is this

When you have lost half your financial wealth to inflation within the space of a couple of years, convert your paper wealth into hard assets, or prepare to kiss it goodbye.

Now I’m not saying that it will happen here. Though our situation is dire, I’m not making the case that it is as desparate as that of the Weimar Republic. But I am saying that it could happen here.

It is hard to take that action under fire. It takes great intestinal fortitude to surrender the norms of one’s life to a new reality and then take action on that new reality. This sort of crisis is not within living memory in the West. It may take a different form, for instance peak oil and resource shortages might change the value of non-financial assets too. However, in general, the people that survive a black swan event are usually the people that do something different in response to their new reality.

Disclaimer

The response to inflation and the threshold is my opinion, and should be read as such. Look at the data and form your own opinion, and act accordingly. None of this should be construed as investment advice.

Super post ermine, and it comes at an interesting interlude for me as I’m reading “The Art of Deleveraging” by Gary Shilling and wondering whether I should start to buy a handful of gilts again, even at today’s tiny yields – just in case.

There’s a lot to be said for 5% in gold/hard assets and 5% in fixed income, just to give you some protection from the long tails of inflation/deflation.

That said, I don’t think we need to worry about hyper-inflation yet. Monetary easing has bounced us as planned out of deflation, it seems (though I’ve still to get to the meat of Schilling’s deleveraging argument) but there’s still an awful lot of spare capacity about in countries like the US, UK and Spain.

We live in interesting times, I’m playing with the concept of REITs and you’re toying with the yellow metal. Perhaps 2011 will be the time of extreme diversification ;)

The trouble with hyperinflation is you don’t get long to worry about it. The Germans, in a time of much slower communications, had about six months at the end of 1918. By the end of 1919 it was all over bar the shouting – if like them I lost 90% of my net worth I’d be done for… There are some things in life that reach a cross-point rapidly, where you have to commit force or surrender. I’d like to think I’d respond, but I fear not, because of the power of the normalcy bias.

The Fitzwilliam museum exhibition is small, a single cabinet worth. It also had some more modern examples from South America, including the Argentinian debacle and something from Brazil, as well as the obligatory Zimbabwean object lesson :)

[…] as a proportion of your wages. That’s what they did in Weimar Germany, and it all took about a year to go totally pear-shaped. For those whose history is kind of hazy, it didn’t end well at […]

Nice post with the personal touch. I think most episodes of hyperinflation occur in the aftermath of war or severe social dislocation. The chief accompanying indicator is large numbers of people buying non-monetary assets or foreign exchange. The suddenness of the the take off is indeed frightening and in a true hyperinflation I don’t think a 5% holding in gold will be that much help.

However, in an era of stable or declining property prices, I don’t think hyperinflation can be a real threat, since bricks and mortar must be one of the best defences. Maybe I’m wrong here, but I’d like to see some contrary evidence on that one.

A more likely threat to my mind is normal inflation. 10 years @ 10% or more, such as we had in the 1970s, would make me cry.

@SG I know I’m of a more nervous disposition than many, but I hadn’t realised how much –

> most episodes of hyperinflation occur in the aftermath of war or severe social dislocation

thinks P.O, social dislocation, check

> people buying non-monetary assets

check. And I’ve considered the Swissie…

It was you who convinced me to take the value of my house out of my net worth, when I was net worth focused :) To my present thinking the house purchase is an income bearing investment whose interest happens to be in the form of (almost) free rent.

I’m not sure how much housing bears on monetary price inflation. If prices decrease modestly people won’t be remortgaging to splurge on holidays, new motors and Louis Vuitton handbags. If they decrease precipitously then a lot of people will be out of a home, but inflation could still be high if the money supply is inflated to pay benefits for the newly homeless and jobless.

As for gold, well, if 5% of assets are in gold and the other 95% fall by two orders of magnitude then that gold is looking good. However, it has to be real gold in your hand rather than my ETF style holdings which will be wrecked by counterparty risk in such troubled times.

> if the money supply is inflated to pay benefits for the newly homeless and jobless

Yes, foolish behaviour by governments is always part of the mix, I think. If QE is permanently off the agends now, so much the better, IMHO.

> that gold is looking good

Indeed, but the house would be a greater comfort to my way of thinking. Imagine what would happen to rents!

If you’re interested in big picture monetary policy, you should read, The Fall and Rise of Global Capitalism. You might also find it interesting to note that Mr. Zelloeg ( not sure of the spelling ) IMF, is talking about re-introducing the Gold Standard. Remember the Gold Standard ? I always wondered what happened that caused runaway inflation in the 70’s. It turns out it all happened because America ( USA ) went off the Gold Standard ! I was a kid then, but I remember what happened as a result ( not a pretty picture ) and for years I was trying to figure it out. Are we in trouble ? If an American economist at IMF says maybe we should return to the Gold Standard, I think the answer is Yes ! I’m not British ( thank God, no offense ), but from what you describe you are right to be worried. With this much US currency floating about, it being a reserve currency, inflation should be ( Economics 101 ) a foregone conclusion. How do we correct this ? Go back to gold which is fine but then a lot of folks are going to find themselves in deep… I’m not rich. I consider myself poor, even though I’m not as poor as the other 95% of the planet but, be that as it may, it’s my number one goal to pay off my shack even if it eats my meager savings. Why? Because inflation is inevitable. There ain’t no way around it ! Hence, Mr Zelloeg’s wanting to fix value in national currencies by making those currencies backed by gold. Just like the good old days… By the way, what is the price of gold ? It’s higher than it was in the seventies and early eighties ! Who’s buying all that gold ? Anyway, I think your great-granny was right buy land real-estate, agricultural or rental property ( mortgage free ) and and wait for the inflation monster to take us back to the gold standard.

Robert Zoellick, President of the World Bank, has made that suggestion, but he’s not alone –it’s a favourite of Austrian School economists. I’m sure it’s on the agenda, but not in the form of Bretton Woods which failed for many reasons, including lack of gold. I tend to agree with the analysis here, though.

http://www.telegraph.co.uk/finance/comment/rogerbootle/8132581/At-least-we-seem-no-nearer-to-falling-for-the-gold-delusion.html

The US can’t expect the dollar to be the reserve currency forever, but equally why should we accept that of any other regional power? My own suggestion would be for an international pseudo-reserve currency, created out of a weighted mean of all major world currencies, whose weights would be periodically reviewed by
some kind of international panel. Complex geopolitical games, I know, but that’s life.

@g I’ve always felt that the issue with the gold standard is that the amount of gold in the world is reasonably static, whereas in an ideal world the amount of money in circulation would match the value of goods and services. Otherwise if we produce more stuff but need to spread it over a fixed amount of money then prices would have to fall over time. This means there would be an incentive to sti on money, which reduces the velocity of money and impairs its value as a means of interchange.

What we need is an impartial arbiter that executes the head of any government that creates more money that is justfied by the amount of goods and services in the economy ;) Anything else and the temptation to steal money from savers to give out to voters by inflation will always be too much. There are always fewer savers than voters.

@SG Didn’t Keynes propose a pseudo-reserve currency called the bancor but the US overrode this with Bretton Woods? It looks like Keynes idea is finding new friends. This paper from the Bank of International Settlements looks to me like the serious parking of Chinese tanks on the US Federal Reserve’s lawn.

[…] went to Cambridge on the 27th December for some Weimar Germany inflation porn at the Fitzwilliam Museum. Obviously I wouldn’t dream of using the train, although the actual […]

@MP Just reserved When Money Dies from the library, I am 4th in the queue so there’s a fair amount of interest :)

[…] was given to me many years ago by someone in my family, not as long ago as when I heard the story of inflation, but a good few years ago – I don’t think the issuing bank is still in […]

Zoellick : President of the World Bank. Sorry. I have problems sorting out World Bank vs IMF. Mea culpa !

@solisgrano : Yes, you’re right. I think this concept is what Brazil and China are asking for. They want to revalue their currencies but not against the dollar. I have long believed that the Americans realized some time ago that they were “the only game in town” so their debt was not a problem. The dollar being the reserve currency of the world, and the American market being the only market worth exporting to, they figured they could just keep going this way, but suddenly they are beginning to realize their debt is out of control. The President’s task force on debt is sending out the alarm bells and Defense Secretary Gates has just said that the debt ( deficit ) is a threat to national security. The American elite is obviously concerned that the debt is unsustainable as it is and it appears everything is up for cutting, including the military. How this will pan out, I have no idea, but I suspect the Republicans will fight like hell to stop cuts to the military. Anyway, I’m just hoping the American recovery will continue past the second quarter and that they’ll start to deal with their debt. I agree with you that a gold standard will not solve the problem and you’re probably right that we’ll end up with some sort of pseudo-currency ( ducats ?)

@sls You’re probably right, but at the same time there’s already a glut of stuff in the world and prices are cheaper probably than they have ever been ( thanks to Chinese prison labor and third world sweat shops ). Saving and being frugal is also a way of sitting on money, but as long as you’re investing money it is still moving through the system. I just want to pay off my house and save more money to buy other real assets ( solar panels and batteries ) and investments so that I won’t find myself completely impecunious in my declining years ! Inflation is definitely coming so we’ve got to “batten up the hatches” before the storm.

[…] hold some of their value, unlike paper assets which can get rendered down to toilet paper by inflation or monetary disasters. But because of its illiquidity, if you can buy cash using an investment […]

[…] be enormous changes to the economy if indeed it survives intact. My financial investments may be rendered down to toilet paper so relying on those may be unwise until the smoke clears a […]

[…] German experience was far worse that anything we have experienced in recent times, and has had a deep effect on the German psyche, with a low tolerance of debt and a low tolerance of Club Med profligacy at the moment. This book […]

[…] interesting reading Reply With Quote   + Reply to Thread […]

[…] when the government borrows on the never never and prints money to make up the difference. I heard my great-grandmother describe what life was like then, and this scar runs deep within the German psyche, that you just […]

[…] if the endgame is nigh for industrial economies, then even cash will lose its value. Germans know this already, which is why they aren’t rushing for a second bite of the […]

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