Niall Ferguson

The Ascent of Money

Germany's position in the summer of 1921 could have felt optimistic, and such foreign capital as did flow into the country after the war was speculative or 'hot' money, which soon departed when the going got tough.

Yet it would be wrong to see the hyperinflation of 1923 as a simple consequence of the Versailles Treaty. That was how the Germans liked to see it, of course. Their claim throughout the post-war period was that the reparations burden created an unsustainable current account deficit; that there was no alternative but to print yet more paper marks in order to finance it; that the inflation was a direct consequence of the resulting depreciation of the mark. All of this was to overlook the domestic political roots of the monetary crisis. The Weimar tax system was feeble, not least because the new regime lacked legitimacy among higher income groups who declined to pay the taxes imposed on them. At the same time, public money was spent recklessly, particularly on generous wage settlements for public sector unions. The combination of insufficient taxation and excessive spending created enormous deficits in 1919 and 1920 (in excess of 10 per cent of net national product), before the victors had even presented their reparations bill. The deficit in 1923, when Germany had suspended reparations payments, was even larger. Moreover, those in charge of Weimar economic policy in the early 1920s felt they had little incentive to stabilize German fiscal and monetary policy, even when an opportunity presented itself in the middle of 1920. A common calculation among Germany's financial elites was that runaway currency depreciation would force the Allied powers into revising the reparations settlement, since the effect would be to cheapen German exports relative to American, British and French manufactures. It was true, as far as it went, that the downward slide of the mark boosted German exports. What the Germans overlooked was that the inflation-induced boom of 1920-22, at a time when the US and UK economies were in the depths of a post-war recession, caused an even bigger surge in imports, thus negating the economic pressure they had hoped to exert. At the heart of the German hyperinflation was a miscalculation. When the French cottoned on to the insincerity of official German pledges to fulfil their reparations commitments, they drew the conclusion that reparations would have to be collected by force and invaded the industrial Ruhr region. The Germans reacted by proclaiming a general strike ('passive resistance'), which they financed with yet more paper money. The hyperinflationary endgame had now arrived.

Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country's political economy. There surely were less catastrophic ways to settle the conflicting claims of domestic and foreign creditors on the diminished national income of postwar Germany. But a combination of internal gridlock and external defiance—rooted in the refusal of many Germans to accept that their empire had been fairly beaten—led to the worst of all possible outcomes: a complete collapse of the currency and of the economy itself.