Wretched Excess.
There were multiple reasons for this hyperinflation: The Weimar economy was still suffering from the effects of World War 1, when the German government had printed more and more money to pay for the ever-escalating costs of the war, thus significantly devaluing the mark. The economy was put under further strain by the reparations demanded of the young Weimar republic in the Peace Treaty of Versailles. I know all of this sounds jargonish so let me simplify all of this.
A gradual rise in the cost of goods and services followed by a decrease in purchasing power is called inflation. Inflation is like alcohol: good when in limit, or the consequences will make you wonder, "How did it all start"? A decent amount of inflation is required for the prosperity of a nation. Bearable inflation leads to an increase in income, which leads to a rise in spending, which keeps the economy rotating. Now we're talking about hyperinflation. As the name suggests, it is a rapid, excessive, and out-of-control general price increase in an economy. While inflation measures the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50%.
Although hyperinflation is a rare event for developed economies, Germany has faced its fair share of it. One of the most prominent causes of hyperinflation is excessive printing. Again, as quoted earlier, everything within limits is good, especially when it's about an economy. Governments often turn to printing money in order to increase the amount of cash and liquidity in the economy.
Usually, the currency in circulation is backed by some form of hard asset. For example, in the 1990s, the Indian central bank used to print with respect to the gold reserves held by the RBI. It's not the case today, but at least it saved India from creating such a nuisance. Now, let's talk about Germany.
To pay the large costs of the ongoing First World War, Germany suspended the gold standard (the convertibility of its currency to gold) when the war broke out. While France was funding the war using taxpayers money, Germany decided to fund the war entirely on the basis of borrowings. The government believed that it would be able to pay off the debt by winning the war and imposing war reparations on the defeated allies. A wise old man once said that overconfidence will drown you in the sea of reality. As a consequence of excessive borrowing, the exchange rate of the German mark against the US dollar devalued from 4.2 to 7.9 marks per dollar between 1914 and 1918.
As luck was busy pampering someone else, Germany lost the war, which left the new Weimar Republic saddled with massive war debts that it could not afford, totaling 132 billion marks ($33 billion, 1914 exchange rate). Having no economic resources to back it up, the debt problem was solved by printing money. The demand in the Treaty of Versailles for reparations further accelerated the decline in the value of the mark, with 48 paper marks required to buy a US dollar by late 1919.
Because the western front of the war had been mostly fought in France and Belgium, Germany came out of the war with most of its industrial infrastructure intact, leaving it in a better position. Germany was imposed with economic sanctions and hence, as a reparation, had to meet the payments. The first payment came in June 1921, which marked the beginning of an increasingly rapid devaluation of the mark, which fell approximately to 330 marks per dollar. Reparations totaled 132 billion gold marks, but Germany had to pay only 50 billion marks at the time, as the reparations were required to be paid in hard currency and not paper money that was devaluing on a daily basis.
By the end of August 1921, the president of the Reichsbank, Rudolf Havenstein, started buying foreign currency using the printed mark at any price, ignoring inflation, which fueled the collapse in the value of the mark. In the first half of 1922, the mark stabilised at 320 marks per dollar. The second half of 1922 was when the inflation turned into hyperinflation. The German mark devalued to the extent that 7400 marks were required to buy 1 dollar. (For those who are not able to understand the importance of the situation, it's like paying Rs 7400 for getting $1.) That was a 17-fold increase.
The strategy of printing currency to pay reparations and to buy foreign currency had failed miserably, which exacerbated the inflation of paper money. The image below shows what happens when a home currency devalues at that rate. Below is a man with millions of marks standing in a bakery to buy a loaf of bread. That's how deadly hyperinflation and currency devaluation are. Germany literally started printing currency notes in the billions.
As a stabilisation policy, economist Karl Helfferich proposed a plan to issue new currency that would be backed by mortgage bonds indexed to the market prices of rye grain. The plan was rejected because of the greatly fluctuating price of rye paper. Finally, gold bonds were indexed at a rate of 2790 gold marks per kg of gold, the same as pre-war gold marks. Rentenmarks were not redeemable but were only indexable to gold bonds. The plan was adopted as part of the monetary policy reform.
On November 16, 1923, the new Rentenmark was introduced to replace the worthless paper marks issued by the Reichsbank. Eventually, some debts were reinstated to partially compensate creditors for the catastrophic reduction in the value of debts that had been quoted on paper before the hyperinflation. Revaluation means raising the exchange rate of one national currency against other currencies. So, by stopping monetizing government debt, issuing new currencies, and playing with the currency rates, the German hyperinflation finally came under control by the end of 1923. The concluding lines look a bit easy to comprehend, but to stabilise the kind of hyperinflation Germany was facing, a lot more effort was put in. These were just some of the conclusions. So, next time a friend or a relative of yours says, Why doesn't the government just print some rupees and eradicate poverty in India? just ask them to read this blog. They'll get some perspective, and I'll get some views. If this wasn't a good sales pitch, then what is?
HAPPY INVESTING.
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