The Magic of Money – Hjalmar Schacht and how to defeat hyperinflation.

Hjalmar Schacht will be judged kindly by history. One of the few people to be acquitted at Nuremberg. Perhaps unsurprisingly as he was never a Nazi party member, had no role in world war II, plotted against Hitler, saved the Wiemar republic from the crisis of hyperinflation, and was in good part responsible for policies which lead to germanies miraculous recovery from the great depression, fixing the deficit and building the autobahns. When tested as an american prisoner at Nuerberg he had the highest IQ there of 143.

Ironically if these policies had not been persued then Germany would never have been strong enough to persue agression. In 1935-36 he urged Hitler to reduce military spending, turn away from autarkic and protectionist policies, and reduce state control in the economy. He didnt succeed.

In the Wiemar period he was a hyper conservative banker appointed monetary commissioner for his typical old style banker stoicism. At that time the central bank was nominally independent, operating a ‘real bills’policy and he was a civil servant.

In his 1967 text ‘The Magic of Money’ he blamed the hyperinflation on the central bank monetarising the allied reparations induced debt, causing easy credit, used by speculators to naked short sell against the mark. The allied powers had insisted on a loosening of control of the Central Bank by the german government – which only made things worse as the bank thought that the state balance sheet with reparations was ruinous.

Following the allied occupation of the Ruhr following a debt default, the programme of ‘passive resistance’ saw the workers on strike, but still being paid by the government money printing. Think about this. T=o, so prices must rise and real wages fall, even without the presses running, profits are eliminated, as are government revenues, so debts rise and the currency falls, a self reinforcing cycle develops. As soon as such a cycle unfolds the future becomes predictable and expectations come into play.

As his Secretay said of his work at the highlight of the crisis in 1923

‘What did he do? He sat on his chair…No, he read no letters. Did he write letters? No, he wrote no letters. He telephoned a great deal …Apart from that he did nothing.’

As Bortkiewicz (1925) wrote at the time

‘One need not turn the quantity theory of money on its head in order to explain the disproportional growth of money supply and inflation at a certain stage of the inflation process. Instead, the theory needs to be re-interpreted in a way that allows for the fact that the price level is not exclusively determined by the money supply but also by the expectation of the level of further emissions.’

Schacht scuppered the naked short sellers by announcing in advance a new currency at a predictable value.

In Joan Robinson’s view

‘lack of confidence in the domestic currency, the expectation of further emissions and devaluation, has direct bearing on the level of prices and therefore magnifies the effect of an increase in the money supply. As a corollary, the proportionally higher rise in the price level compared to the supply of money creates a monetary scarcity, which actors are trying to overcome by accelerating expenditure thereby raising the velocity. This adaptation process might eventually lead to a substantial acceleration of the circulation of money.’

The phenomenon of hyperinflation is much more than just printing presses, it is as much about expectations, exchange rates and cost factors bidding up money wages and reducing real wages and profits. Given fears today about QE we need to understand its subtleties much more.