In today’s Exponential Investor…
- Lessons from the great German inflation
- The great parallels with today
- The key question facing investors today
Rarely has my jaw dropped so often during the introduction of a book.
With inflation on the horizon, I’ve picked up a few books all at once actually – and am working through them simultaneously.
Hence why there’s been a bit of a gap since the last review.
But today, I’d like to take a look at one of them – Dying of Money: Lessons of the Great German and American Inflations, by Jens O. Parsson
I mean, we can be clear about this, it’s a history of inflation – something many people might think would be extraordinarily boring.
But it’s quite the opposite.
Its relevance to today helped – I think it’s crucial we all learn as much as possible about how the early onset of inflation has come about in the past.
But also, simply, the magnitude of it all – especially after WW1 the reality and rate of prices going up at speed is truly terrifying to behold.
Investors today must take note of what can happen, and how inflation can develop in a modern economy.
My first encounter with historical inflation was during my history A-levels, learning about the Tudor currency debasements. Back then, wars were the highest and most common major expense for an English king.
Like the Germans in WW1, it was invariably supposed that the war, once victory had been gloriously achieved, would pay for itself with the bounty of the broken opposition.
This rarely worked out, and the English currency would be de-based – that is to say the gold or silver content of each coin would be diluted via a melting process.
I also learned about how the Spanish kickstarted a European depression after importing boatloads of South American gold and silver, flooding the European economy with more capital than it could take.
And yes, I learned about the Weimar hyperinflation too.
Reading Dying of Money though, it was the periods and conditions which led to inflation which most interested me.
I discovered that government attempts to control the mayhem they created (by debasing the currency) goes all the way back to the Roman Emperor Diocletian, and his AD 301 Edict which attempted (unsuccessfully) to put maximum prices on various goods and services.
One quote which really struck me, looking now at the German and American inflations, was this: “Every volcanic inflation in history started as a mildly annoying inflation.”
Right now, inflation in things like lumber, copper or corn could be described as “annoying” – see below.
If you’re trying to build a home, a solar panel or bread factory, your costs are far higher than even before the Covid crisis. This is beyond a “rebound”.
In Germany, in the 1920s, another thing which got me thinking was that the hyperinflation was really just the last straw. For years leading up to that point, inflation had been rising, and spiking and causing problems.
I hadn’t realised, for example, that Germany abandoned its gold standard in 1914, two days before the war began.
If ever you needed proof that governments don’t intend to pay off debt through economic growth and taxation, that was it. The war would be financed by the printer.
In the end, taxation only covered one fifth of the total cost.
Nine years later though, the printers were quite literally shut down, and what happened after the war was a truly tragic tale for any country.
By 1918, prices had doubled over the course of the war. But by the spring of 1920, prices in Germany had risen another 17-fold.
Imagine paying £108 for a pint next Christmas, and you’ve roughly made the same trip as the Germans between the end of a crushing war which they lost, and the start of the 1920s.
There was some inflation elsewhere in the world too – Britain, France, the US.
But in 1920-21, they suffered a deep economic recession. Markets suffered a crash in 1921, before their amazing run all the way to the 1929 crash and the Great Depression.
What’s really interesting though, is that Germany did not.
This is the most interesting passage of the German section, for me:
From this point, however, the paths of Germany and the other nations diverged. The others, including the United States, stopped their deficit financing and began to take their accumulated economic medicine by way of an acute recession in 1920 and 1921.
Their prices fell steeply from the 1920 level. Germany alone continued to inflate and to store up not only the price of the war but also the price of a new boom which it then commenced enjoying. Germany’s remarkable prosperity was the envy of the other leading countries, including the victors, who were in serious economic difficulties at the time.
Prices in Germany temporarily stabilized and remained rock-steady during fifteen months in 1920 and 1921, and there was therefore no surface inflation at all, but at the same time the government began again to pump out deficit expenditure, business credit, and money at a renewed rate. Germany’s money supply doubled again during this period of stable prices.
It was this time, when Germany was sublimely unconscious of the fiscal monsters in its closet, which was undoubtedly the turning of the tide toward the inflationary smash. The catastrophe of 1923 was begotten not in 1923 or at any time after the inflation began to mount, but in the relatively good times of 1920 and 1921.
It’s fascinating to me because I believe we stand in a potentially similar place today.
As investors, we face one great question going forwards – higher inflation, or a deflationary crash?
These could be called “tail risks” – at either end of a bull curve of normal occurrences.
One threatens prices themselves, with stocks falling by half or more in price.
The other threatens valuations. Prices may flutter about here and there, but the value of those prices is dwindling in real terms.
Stock markets, especially in the US, are sitting at very high valuations. The US stock market is now twice the size of the US economy – a height never seen before.
Meanwhile, monetary policy has recently got married to fiscal policy. That is to say, central banks have been fighting alone since 2008, but are now joined by governments who are very keen to spend the money that the central banks are printing.
Amongst other things, this risks a shift to rising inflation, after 50 years where it has steadily fallen.
A crash will hurt investors’ portfolios all at once. Inflation will do so slowly.
In 1921, only Germany kept up the pace of printing, doubling its money supply.
So, prices were stable, and Germany enjoyed a boom. Industry boomed, exports surged, tourists came flooding in. But inflation has become the lifeblood of the boom, and it became dependent on printing more and more. As such, the boom actually nailed Germany to its post, it couldn’t stop for fear of ending the prosperity, and so drove headfirst into calamity.
What I found fascinating about that section above all is that short-term pain in the victor nations saved them immense amounts of pain further on.
Germany deferred its punishment, but it was paid in even larger quantities later.
A recession and market crash could in fact be what saves us from the terror of German-style hyperinflation.
One country exemplifies this dual risk better than any right now. American markets are uncoincidentally the most extremely valued, and have the most extraordinary monetary policy, growing the money supply at the fastest rate, to the highest levels ever.
Scary to think about…
But I’ll leave it there today, and we shall pick up the story on Friday. It only gets wilder from here…
As a history student from university, I can think of few better places to start than the great inflations of the last century, and the book really is fascinating. I urge you to go out and find a copy, or there are PDFs online too.
All the best,
Editor, Southbank Investment Research