The 1920s in the Weimar Republic, Germany, constitute a unique chapter in the global economic narrative, a chaotic symphony of financial forces that culminated in one of the most prominent hyperinflations ever witnessed. In this ephemeral period, the upward curve of price indices tested the limits of economic understanding and monetary stability.
Between 1921 and 1923, the reichsmark—the German currency of the time—plunged into an inflationary spiral, where annual inflation rates exceeded hundreds of percent. In 1923, these rates catapulted into the spectacular realm of millions of percent in months. The fundamentals of this phenomenon, although multifaceted, are rooted in the unstable political and economic exacerbations in the face of the French occupation of the Ruhr. Like an economic nightmare that transcended conventional calculations, German hyperinflation from the 1920s reflects the latent dangers of monetary and fiscal policies in the postwar scenario even today.
Many prominent people—such as Karl Helfferich, the former Reich vice-chancellor—argued that the hyperinflation of the German mark was due to a structural imbalance in the balance of payments, mainly due to the war debt that Germany held after the First World War, signed under the Treaty of Versailles. This attempt to blame all the structural problems, both of the framework and of the conduct of fiscal and monetary policies, solely on the deficit in the balance of trade was a major impediment to a reform of the Reichsbank’s institutions and rules.
If we follow the roots and chronology of events, we come across an amalgam of events caused by carelessness in the conduct of economic policy and complete disregard for the basic predicates of economics.
The uncoupling of the German mark from the gold standard in 1914—a decision driven by the exigencies of World War I—marked a departure from the principles of sound money, particularly from the perspective of the Austrian School of Economics. This move, replicated by several nations embroiled in the war, reflected a significant monetary policy shift characterized by a departure from the discipline imposed by the gold standard. According to the Austrian School, a currency tethered to a tangible asset, such as gold, serves as a crucial check on the arbitrary expansion of the money supply by governments and central banks.
The abandonment of the gold standard during times of conflict, as observed in Germany, exposes the currency to the whims of government financing needs. This shift not only undermines the stability of the currency but also places it squarely at the mercy of discretionary policies, potentially leading to inflationary pressures and eroding the value of money over time. From an Austrian perspective, the relinquishing of the gold standard can be seen as a precarious step toward making the currency a mere instrument in the hands of government authorities and central banks, vulnerable to manipulation for short-term economic and wartime exigencies.
The new era of fiat currency has distorted the real meaning of money, which emerged from voluntary exchanges to meet the needs of market agents. Instead of serving as a medium of exchange and a store of value based on individuals’ preferences and interactions in the market, fiat currencies can now be manipulated at will. Governments—not constrained by the discipline of commodity support—can print money at their discretion, leading to issues such as inflation, currency devaluation, and the erosion of purchasing power.
Additionally, depending on the circumstances in which the underlying increase in the monetary base is distributed to specific groups favored by the government, these groups gain a competitive advantage over other market participants that do not benefit from the expansion of the monetary base. These privileged groups can leverage their increased purchasing power within an economic landscape that mirrors the pricing conditions before the expansion of the monetary base. This phenomenon is commonly referred to as the “Cantillon Effect.”
The result of this incursion into the praxeological foundations of the economy is that fiat currency is under the heavy burden of serving the populist interests of governments. There is an erroneous conception that money, to have value in the real economy, needs the approval of the state or some monocratic institution, as in the theory of valor impositus.
Based on its prerogative to increase the monetary base, the Reichsbank completely ignored that exchange rates—even with possible manipulations using the purchase and sale of foreign currencies—are in essence part of a market phenomenon, with economic agents acting through their decentralized and dispersed knowledge. Friedrich von Hayek’s concept of information decentralization emphasizes that individuals, dispersed throughout the economy, possess unique and localized knowledge about their circumstances, preferences, and expectations.
In the context of exchange rates, this means that market participants, driven by their diverse and decentralized information, respond to changes in the monetary base in ways that cannot be fully predicted or controlled by central authorities. With the underlying increase in the monetary base and with market agents no longer considering the currency as a reliable means of exchange or value, the German mark was oversold, causing a rapid depreciation in its value. This loss of confidence in the currency’s purchasing power resulted in hyperinflationary pressures and an erosion of its role as a stable medium of exchange.
With the monetization of debt without the consideration of tax revenue—which would be a source of revenue that would not cause an increase in circulating assets, but its valuation would be highly unpopular—the Reichsbank began to cover the chronic deficits of the German economy by issuing Treasury bills. The discounting of Treasury bills provided a channel for inflation that was reflected directly in the monetary aggregate. Germany spent the entire fiscal year of 1914 and much of 1915 without creating any ordinary sources of revenue.
Amid the growing deficits and the eventual reparation payments, the “perfect storm” for the German mark’s catastrophe was formed: reparation payments, currency devaluations, a rise in domestic import and export prices, a rise in domestic prices, budget deficits and a consequent increase in the demand for bank loans, and an increase in the issuance of currency to crystallize and feed back into this cycle.
In 1923, the December issue of the newspaper Wirtschaft und Statistik published some measurements of the disproportionality of Treasury bill issues and government loans compared to the German government’s sources of revenue raised from taxes. The result revealed that only 15 percent of total expenditure was covered by taxes, indicating a significant gap between government spending and tax revenues. As a result, the financial gap was filled through monetization, with a massive issuance of currency and an expansion of the monetary base. This reliance on the printing press to finance government spending led to a severe devaluation of the German mark and ultimately contributed to the hyperinflation crisis of 1923.
The reichsmark crisis is extremely useful in understanding the dangers associated with irresponsible fiscal and monetary policies, especially when attempts are made to override market phenomena. This historical episode serves as a stark reminder of the dangers that arise when governments ignore the real nature of economic phenomena and, through centralization hubris, intend to usurp the role of market mechanisms themselves.