Inflation is the lesser evil

I normally try to be optimistic but we are living in difficult times. The risk of a calamity in the European economy is alarmingly high. While catastrophes such as the pan-European slump we are now threatened with have multiple causes, the most important is the seeming inability of European politicians to understand the scale of the problem and act accordingly. And above all it is the attitude of German politicians which is most worrying.

What puzzles me about the German opposition to any solution beyond relentless “austerity” on the part of indebted nations is their selective memory. It is often and correctly said that German memories of hyperinflation lie behind their great respect for sound finance and opposition to anything that risks inflation, including the “printing money” that the British and US central banks are willing to do under the name of quantitative easing. Both the Bank of England and Federal Reserve Board are dedicated to fighting inflation but they also see an obligation to try to fight the evil of unemployment. Surely German history argues for at least the same commitment from Germans influencing the ECB?

For some reason, the great hyperinflation of 1922-23, at the peak of which German prices rose at a rate of three million percent a month. The Reichsmark currency became worthless before being replaced by the Rentenmark in 1923, when 12 zeros were shaved off prices overnight. The episode was rooted in the highly controversial war damages that German was required to pay for its role in the First World War at the Treaty of Versailles. At the peak of the crisis, France occupied part of Germany’s Ruhr industrial region, adding to the general sense of chaos and humiliation felt by German people. Many lost their savings in the hyperinflation, which characteristically produced rapid and arbitrary shifts in wealth distribution leading to a great and lasting sense of injustice.

It is often said (and Wikipedia repeats it) that the hyperinflation helped to bring Adolf Hitler to power. But there is a glaring gap in that story. The Nazis got only 2.6% of the vote in the 1928 general election and were widely ridiculed because of the so-called “beer cellar Putsch” in Munich in November 1923, when Hitler tried to copy Mussolini’s March on Rome but failed ignominiously.

Yet in 1930 the Nazis got 18.3% of the vote and became the second largest party in the Reichstag. In 1932 they got 37.3%, when Hitler came a respectable second against Hindenberg for the German Presidency. What had changed was mass unemployment. Germany had nearly 25% unemployment in 1930. Germany was in the early stages of a brutal deflation, caused by high interest rates and a government deficit that was being shrunk, even as unemployment rose. The very response to the hyperinflation limited the possibility of using central bank finance (printing money again) to mitigate the crisis, and the burden of foreign debt associated with war reparations crippled Germany’s economy.  The collapse of the Austrian bank Creditanstalt in 1931 led to global banking collapses and tightened the noose around the German economy. (See “Lords of Finance” by Liaquat Ahamed for a very readable account of the whole inter-war financial collapse). Unemployment reached one third of the working population in 1932. With conventional deflationary policies discredited, Hitler offered an alternative and was made Chancellor in January 1933.

So why don’t German politicians remember the disastrous consequences of high unemployment, as well as the damage of hyperinflation? As I mentioned in a previous post, German inflation seems to be heading close to zero so inflation hardly seems like a problem. But the combined pressure of cuts in public spending in most other Eurozone economies, plus the UK, is putting European employment at risk. If Italy defaults and we have widespread bank collapses, we face a real risk of depression and mass unemployment – again.

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