After the lost World War I, Germany tried to restore its economy on the basis of foreign credit. Only by continuing to borrow could it pay reparations, invest in its own economy and maintain a level of prosperity to cover the worst political and social discontent. But what if foreigners were no longer willing to extend credit? This happened in 1931. This German financial crisis shows some parallels with the current situation in a number of euro countries.
In 1918, the Weimar Republic inherited the war debts of the Empire. While she had to pay large reparations, the lost war and collapsing economy resulted in insoluble social and political problems. Tax increases to pay the debts were hardly an option. The government had to borrow and could only do so from the Reichsbank, which provided the necessary funds by printing banknotes.
From 1923, this inflationary trick took on unprecedented proportions. Then Belgium and France occupied the Ruhr area because Germany would not have paid the reparations correctly. The republic then guaranteed the wages of workers in occupied territory who had gone on strike in protest, exponentially increasing the cost to the treasury. Now banknote production took on grotesque proportions. The Mark fell deeper every hour on the international currency markets, while prices rose inversely.
Wages were therefore paid twice a day and quickly converted into food, because the packs of banknotes were worth nothing after a few hours. Prices initially expressed in Marks were expressed in thousands, later millions and even billions. In 1924, at stabilization, twelve zeros had to be deleted to give the new currency the value of the pre-war mark.
Hyperinflation hit particularly frugal citizens hard. While the state paid off its entire debt for an amount for which hardly a loaf of bread was available, pensions and savings became worthless. There was no longer any question of saving for a nest egg for the time being. The confidence was gone. Throughout the interwar period, Germany had to do without the savings needed to finance the investments to rebuild the economy. This issue came on top of the reparations.
Almost all Germans suffered from the economic malaise caused by the defeat and the peace terms. This compounded the shock of the loss. Until 1918, Germany had seemed to be winning. The Empire had brought Russia to its knees and its armies were still fighting on foreign soil. The defeat came, many believed, through treason, and from that the republic was born.
The political dissatisfaction these ideas expressed was compounded by chaos and impoverishment. It led to extremism and political violence. To dampen that, economic progress was needed. High taxes to cover the costs therefore did not seem to be a solution. Moreover, after inflation, the issue of banknotes was placed under international supervision. Germany could therefore only finance its obligations from international credits. The business community could only go abroad for credit.
American banks in particular proved willing to provide this from 1924. In this year Germany received a new Reichsmark and in order to revive its economy, according to a new scheme, the Dawes Plan, the reparations were divided in installments and received large international credits. As a result, confidence in the German economy recovered somewhat.
The crisis
Many textbooks refer to the Wall Street Crash of 1929 as the beginning of the Great Depression. In fact, the speculation that preceded it, and the response from the Federal Reserve System (fed ), more problematic for Europe. To quell the speculation, the fed a cash policy. However, she did not dare to face a strong decline in the money supply by selling securities and withdrawing banknotes from circulation. It was feared that she would be blamed for the speculation losses. That is why she followed a half-hearted policy.
The money supply declined insufficiently to cut off speculation, but US banks lost scope to extend international credit. As a result, in the summer of 1929, Germany had to shell out its own beans. Since the Dawes Plan stipulated that Germany would have to pay more every year for four years, the reparations tranche reached that peak.
Until 1929, Germany had borrowed to pay reparations and to make investments. This was no longer possible. Budget cuts and tax increases were the alternative. Just as in a backlash a Keynesian policy can stimulate the economy through extra spending and lower taxation, increased taxes and austerity dragged the weak German economy into a depression. Bankruptcies and rapidly rising unemployment were the result. The Wall Street crash and the loose money policy that followed, sparked some lending again, but it was now clear how weak Germany was.
However, the country did receive a substantial credit in the context of a new agreement on reparations
In 1929 a powerful agricultural depression arose in America. Since the legislator, in order to combat monopoly capital, had forbidden banks to operate across state borders, the banks in agricultural states also ran into problems. They withdrew their funds where they had been due, which increased the withdrawals from Germany. Here the short-term foreign debts were now larger than the gold and foreign exchange reserves.
A monetary collapse seemed imminent. Unemployment, bankruptcies and impoverishment among the peasants meant that in every election (and there were many in these years) Nazis and Communists won more votes. Both sides promised to break interest bondage. It instilled little confidence in foreign lenders.
Disaster year
Financially, 1931 was a disaster year. Not only did the British pound have to leave the gold standard in September, the Reichsmark and several German banks had already run into trouble before that. Now that Germany could no longer borrow, austerity seemed to be the only alternative. However, this led to further economic malaise, greater unemployment and deeper misery, with all the associated political consequences. In early June 1931, Hungerkanzler Heinrich Brüning therefore to suspend the reparations. It reinforced the impression that Germany was unable to pay, causing gold and foreign exchange outflows to swell. Foreign investors tried to save what could be saved.
To prevent a total financial collapse, US President Herbert Hoover announced a payment moratorium on all war debts. It should have produced a shock effect, but the French reluctance to agree negates this. The cash outflow from Germany continued. The spreading US banking crisis reinforced this trend. The German banks now also came under fire.
Many requested their money to be converted into foreign currency and Germans were now fully involved. There was still talk of support from foreign central banks, but they were unwilling or unable to do so, or made impossible political demands. Berlin therefore decided to make the Reichsmark irreplaceable and to freeze the foreign debts.
Contrary to what one might expect, Berlin did not devalue its currency. After all, with such a depreciation of the Reichsmark, the foreign debts, denominated in foreign currency, would only have increased. In addition, during the inflation period, the public had learned to measure the true value of money by the dollar exchange rate. Unions therefore warned that they would come with wage demands in the event of a devaluation. That is why the foreign debts were frozen and the Reichsmark became inconvertible and worthless in international payments.
Any German who owned or received hard currency had to put it at the disposal of the Reichsbank, which paid a fixed, low price for it. The bank also decided whether there was room to use this currency for necessary imports. Germany thus ended up in economic isolation.
In 1931, the balance of the financial markets did not immediately recover. Speculation now turned against Britain. Although it had been considerably weakened economically in World War I, Britain had continued to fund investment in its empire. The foreign money that was outstanding in the short term with British banks in the City had been invested in the long term for this purpose. It would lead to this country also having to leave the gold standard in September. The shaky monetary system collapsed.
Euro
Like Germany in 1931, some southern European countries now have huge international debts, while they have adopted a monetary system that makes smooth adjustment of the currency's exchange rate impossible. Substantial austerity measures to adjust costs lead to political and social unrest in these countries, while without austerity the foreign lending – which now, as in Germany in 1931, is now dependent on political decision-making – will come to a standstill.
As with the gold standard, international monetary policy with the euro has opted for a rigid monetary system that makes it impossible to adjust the exchange rate to the circumstances of the individual country. This has created a bending or cracking situation. Since the political decision-makers still seem unwilling to admit that they have made a mistake in introducing this system and must retrace their steps as soon as possible, it will be cracks.