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Is it 1932 – or 1923?

By Martin Hutchinson
Contributing Editor
Money Morning

Endless reports in the media have pointed out that this global recession is "worse than anything since the Great Depression."

To be fair, it's not even certain yet that this nasty downturn has beaten the mid-1970s downturn, though it probably will. But even if that does happen, by focusing exclusively on the 25% unemployment of the 1930s and the "Grapes of Wrath" Joad family as our inevitable future, we're ignoring another equally unpleasant potential scenario: The Weimar German hyperinflation of 1923.

The U.S. authorities and those of the G-20 are currently avoiding most of the mistakes that during the period from 1930 to 1932 turned an ordinary recession into the Great Depression. In those years, the U.S. Federal Reserve deflated the money supply by about 30% in real terms. Central bank officials didn't realize they were doing this; banks kept failing, thus reducing the country's bank deposits, while the Fed did nothing to offset the money supply shrinkage the bank failures produced.

U.S. President Herbert Hoover raised tariffs via the Smoot-Hawley Tariff Act of 1930, causing world trade to fall by 65%; his huge income tax increase (with the top rate going from 25% to 63%) in 1932 also contributed greatly to the global economic meltdown. All three mistakes have been avoided this time:

  • The money supply has expanded rapidly, bringing negative real interest rates almost everywhere except Brazil.
  • And fiscal policies have been expansionary and protectionism limited.

The history of the Weimar German inflation was quite different. During World War I, Germany ran moderate inflation, which accelerated in the last year of war and the first years of peace. By 1921, prices in Germany were already 15 times those of 1914.

But it was over the next two years – 1921 to 1923 – that true "Weimar inflation" occurred. By the time it ended in November 1923, the German mark was worth only one-trillionth of what it had been worth back in 1914. The middle classes lost all their savings, but one rich industrialist, Hugo Stinnes, was able though repeated borrowing in rapidly depleting marks to amass an industrial empire that controlled 20% of Germany's industry.

The German hyperinflation was finally quelled by Chancellor Gustav Stresemann and Reichsbank director Hjalmar Schacht, who in October 1923 announced the replacement of the paper mark by a "Rentenmark" (security mark) worth 1 trillion paper marks and backed by a nominal mortgage over German land assets worth 3.2 billion Rentenmarks.

The mortgage was fictitious, but it created confidence in the Rentenmark and prevented the creation of extra Rentenmarks, so inflation rapidly ceased, while the budget was balanced through so-called "windfall-gains taxes" on debtors whose debts had been extinguished by the previous hyperinflation. Normal business was resumed by Germany, which was able to return to a new gold Reichsmark in July 1924.

You can debate which was worse, the U.S. Great Depression or the Weimar hyperinflation; there are arguments for both sides. The Great Depression lasted much longer, from 1929 until the United States entered World War II in 1941. On the other hand, the Weimar hyperinflation wiped out the entire savings of the German middle class.

The lack of confidence in the economy, and the overall misery that this produced, meant that the German reaction to the Great Depression that arrived six years later was much more extreme than in the United States – leading to the election in 1933 of Adolf Hitler.

The current policy mix reflects those of Germany during the period between 1919 and 1923.  The Weimar government was unwilling to raise taxes to fund post-war reconstruction and war-reparations payments, and so it ran large budget deficits. It kept interest rates far below inflation, expanding money supply rapidly and raising 50% of government spending through seigniorage (printing money and living off the profits from issuing it).

Even John Maynard Keynes, no monetarist, recognized the problems with this, stating in his 1920 treatise the "Economic Consequences of the Peace" that "the inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance."

The really chilling parallel is that the United States, Britain and Japan have now taken to funding their budget deficits through seigniorage. In the United States, the Fed is buying $300 billion worth of U.S. Treasury bonds (T-bonds) over a six-month period, a rate of $600 billion per annum, 15% of federal spending of $4 trillion. In Britain, the Bank of England (BOE) is buying 75 billion pounds of gilts over three months. That's 300 billion pounds per annum, 65% of British government spending of 454 billion pounds. Thus, while the United States is approaching Weimar German policy (50% of spending) quite rapidly, Britain has already overtaken it!

U.S. authorities probably won't pursue expansionary monetary policies with quite the dogged Germanic persistence that caused the mark to fall to one trillionth of its former value. However, the turnaround needed to stop a Weimar repetition will be very unpleasant, so there will undoubtedly be considerable denial and fudging of the figures as inflation begins to take off (especially if Ben S. "Drop Money From Helicopters" Bernanke is still serving as the head of the U.S. central bank).

As investors, we need to ensure that our money is safe from the inflationist onslaught. Our portfolio should thus currently contain no bonds – even Treasury Inflation Protected Securities (TIPS) are linked to the U.S. consumer price index (CPI), which has been fiddled before and will be again, so will not provide true inflation protection.

Only gold will play its traditional role as a protector of savings against inflationary onslaught. Once policymakers get serious, gold prices will drop, as inflation risks recede. But before that gold prices are likely to shoot much higher, perhaps beyond their 1980 peak of $2,300 in today's dollars. You have to remember that gold is a thin market, with only $100 billion mined annually, so a surge of hedge funds into the gold market could move the price very quickly indeed.

Two avenues into gold should be attractive, the SPDR Gold Shares ETF (GLD) which invests in gold directly and the more financially solid gold mining companies, such as Barrick Gold Corp. (ABX) and Yamana Gold Inc. (AUY). Since gold has fallen back recently to below $900 an ounce, it may be a good time to buy.

[Editor's Note: When it comes to banking or global economics, there's literally no one better than Money Morning Contributing Editor Martin Hutchinson, who brings to the table the kind of high-level expertise that our readers have come to expect. Fans and followers of Hutchinson's work will soon be able to subscribe to a new product – The Permanent Wealth Investor – that will feature more of his expertise. Watch for The Permanent Wealth Investor to debut in the next week.]

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  1. Simon Peter | April 9, 2009

    Thank you for your articles, which I read with interest.

    Why, O Why, however, do you not mention GoldMoney or BullionVault for the purchase of gold and silver?

    The ETFs are not the real metal and are, therefore, open to counterparty risk. When I buy from the edealer GoldMoney, I own the gold and the silver outright. I have no risk!

    Why buy from the gold and silver mines when you can buy large ingots, and parts of, through a internet dealer?

    There is a blind spot in the eyes of financial commentators regarding the purchase by the ordinary person of real gold and silver via the edealers. They NEVER mention them!

  2. Michael Paulsen | April 9, 2009

    Excellent article!!! Since I have a large chunk of my savings already in physical gold, I am not as concerned about the financial effects of this situation. What is more alarming to me is the political and social ramifications when the Fed attempts to put the brakes on the stimulus and tries to raise rates. The reference to the election of Adolf Hitler is really the scary part of this. The potential for significant social & political unrest should not be underestimated.

  3. Phil Steinschneider | April 9, 2009

    Hitler was never elected to office. He was actually named to the position by the German president of the time, Paul von Hindenburg. Both von Hindenburg and von Papen (the Chancellor) tried to contain Hitler by offering him the position of Vice Chancellor, which Hitler declined. Eventually, von Papen was able to convince von Hindenburg that if Hitler was given the Chancellery, Hitler could be controlled. He was given the position.

    After the Reichstag was set ablaze by a supposed communist, Hitler used the event to suspend all constitutional liberties and moved towards eventually becoming the authoritarian leader of Germany.

    Arguably, a series of foolish political blunders allowed Hitler’s rise to power; not only the economic situation in Germany at the time. He was simply the "right" person at the "right" time who managed to slide into a dictatorial role by using the political miscalculations of rival politicians.

    In fact, right before being named Chancellor, the Nazi’s lost seats in parliamentary elections. The Nazi Party remained a minority party—albeit the largest one—up until Hitler began exercising authoritarian rule by severely hobbling (or banning outright) competing parties.

    Regardless, as Mr. Hutchinson correctly explains, the current monetary policy of the United States reflects the behavior of Weimar Germany in many ways. Just as Germany tried to inflate itself out of burdensome war reparations imposed on it by the Treaty of Versailles, the US is trying to inflate itself out of debt brought about by profligate and unproductive spending by government, corporations, and the consumer.

  4. gordy three horses | April 9, 2009

    buy silver& palladium, take delivery and you have ZERO default risk, not so with paper. OWN THE METALS OUTRIGHT!

  5. K. Klein | April 9, 2009

    I believe the answer to the story tag line is: both. I think we will see another 1-2 years of rapidly accelerating downhill slide, completely wiping out the middle class in our country, and then, at the bottom of the depression, once the fallout settles, the government will have to reckon with their reckless spending and massive overprinting of worthless fiat currency. Hyperinflation will then take off like a rocket, and the American way of life as we have known it, will be gone for good. I do agree that precious metals (with physical possesion of said metals) is the best course of action at this time, but I do not know where the "values" will go. People keep touting gold at $2300-$2700/oz, but with the dollar devaluation freefall that will occur during hyperinflation, what meaning will $2700/oz have?

  6. Paul, WA | April 10, 2009

    But not zero risk. Physical bullion can walk right out your door in a raid. As more citizens invest in assets they personally hold… and this becomes common knowledge, the risk (including injury and death) becomes higher.

  7. Simon Peter | April 10, 2009

    gordy three horses, surely it's the "taking delivery" of your metals which puts most punters off buying the precious stuff.

    There must be very few people, like you, who actually want to have the worry and the cost of the delivery of the gold and silver to their house or their bank.

    Then, you've got the problem of sending it back into the market with associated costs when you want to sell the stuff.

    I am into gold and silver purchases, but if I had to have the stuff delivered to me on every occasion, I'd give the whole idea up.

    I cannot understand why people don't see this as a problem for the ordinary person in the street. Why does no one appear to consider, in public, the use of dealers who will store the gold and silver for you in safe and audited vaults?

    Why all this shyness about eDealers?

    The bullion market would, surely, shoot upwards if John Doe and his wife bought real gold and silver in great abundance, because there are millions of John Does around, and the price for investors like you and me would rocket up. After all, there is only a limited amount of gold for sale, so the price goes up.

    Anyone out there used an eDealer? Anyone used GoldMoney as I have? GoldMoney has linked up with Apple iPhone so you can buy and sell your precious stuff when you're away from the office or from home.

    That's the best way TO OWN THE METALS OUTRIGHT, gordy three horses!

  8. ROY KENDALL | April 10, 2009

    Everyone must read "Ommius Parallels" by Leonard Piekoff. Paralells between pre-Nazi German and the USA today.

  9. Simon Peter | April 10, 2009

    If you own the metals outright, you have to take delivery of them and store them at home or at your bank. This puts the ordinary John Doe off buying the real metals, and makes paper for gold attractive.

    I am an ordinary John Doe and I purchase my gold and silver from GoldMoney. They store it for me in a vault in London or in Zurich so that I don't have to take delivery of it. It's easy to sell as well since they, presumably, shift what was mine from one side of the vault to the other, so to speak.

    GoldMoney is an eDealer and I have just purchased an Apple iPhone because I can buy and sell gold and silver over the internet using my iPhone. Great if I'm on holidays or away from a computer!

  10. erich kellner | April 10, 2009

    gold is a fear gauge, not an inflation hedge. Was there no inflation in the 22 years between 1980 and 2002? The last time we had excessive fear was in the 70's, causing gold to spike to $850, the same level it is today.
    I shorted gold at $1000 and made out great.
    The best way to hedge against fear is to buy a gun, with it you can get all you need and protect it, while the one with a gun will take your physical gold and then shoot you. Also, the grocer won't make change for gold and the edealer will long be over the hill if for no other reason than that the government will have confiscated all. Good luck, suckers!

  11. David | April 12, 2009

    Gold has for thousands of years been associated with the idea of a store of value and a medium of exchange. One must ask, will this continue? It will, so long as there is a popular consensus that it will, and as long as governments allow it to be. However, in the US, since 1933, gold has been government property, supposedly to back the value of the currency. In the '70's, the government went off the gold standard altogether, which has led to the gradual eroding of our currency through inflation, to the point that the current dollar buys what 2 cents bought in 1933. There are reasons for this involving the highest levels of economic and political world powers, and can be researched on the internet.

    At this juncture, if one wishes to protect the value of one's life savings, one must be clever and nimble, because investments have become a mine field. It is an open question whether gold will preserve the value of one's savings or not. The influences of new technology and those that control it stand as possible opposition to such ownership. It has been proposed that an ideal future would consist of each world citizen being perforce implanted with a tiny chip at birth, and this chip would contain all pertinent information regarding this individual, which can be read by scanning. One's earnings would be credited to the chip, and debited as they are spent. What place will gold hold in this scenario? What will be its value, other than as an industrial metal? There may still be coin collectors that enjoy a market exchanging these relics among themselves. But gold sitting in a vault somewhere, maintaining the value of paper receipts, may no longer exist.

    As to holding physical gold, it is a dangerous proposition. If times become desperate enough, there will be those who will injure and kill to get hold of something of value. Thus you have suggestions cropping up, such as 'buy an gun and learn how to use it.' I suspect that most people would find the idea of shooting someone or being shot to be unpleasantly intimidating, and decide on some other option.

    If one puts one's gold in a bank vault, then it is subject to government confiscation, as in the thirties, and if the account holder should die, then a government rep must be present when the heirs open the box, to take an inventory and assign taxes. It is also not insured if thieves should break in and steal it. If one uses a service like goldmoney, one is betting on there continuing to be a level of technology and civilization to enable them to cash in their holdings at some point in the future, and that a government or a gang of sophisticated thieves (what's the difference) doesn't manage to make off with it to parts unknown.

    In conclusion, the world is not so much different than it was in ancient times so far as the attitude toward money/treasure is concerned. What is different now is the new layer of technology overshadowing the actions of individuals, and its potential for turning one into a de facto slave of the state or world government. Insofar as how one can actually own precious metals while avoiding the associated dangers and problems, I have to assume that either there are none, or those who have solved the problem aren't talking.

  12. Mike | April 12, 2009

    >gold is a fear gauge, not an inflation hedge

    So true!

    What's the stock return during that hyperinflation period ?
    Why the auther did not point that out ?

  13. Simon Peter | April 13, 2009

    OK but the suckers can watch the spot prices of gold and silver, buy on the upswing and sell somewhere higher than they bought the metal for.

    Even a 3% profit is good enough if it occurred over, say, two weeks. One can then repeat the exercise and maybe obtain a higher percentage rise on one occasion at least in the year.

    A buy and sell event can be repeated many times per annum because the spot prices of gold and silver are constantly bouncing up and down.

    This is short term buying and selling. Over a two week period in Feb-March, I gained 19% profit. I sold too late for something higher, but I am gaining experience.

    I don't mind a twice daily note of the spot prices and usually more frequently through the day. Doesn't take a moment using GoldMoney to monitor price changes.

    Once I've sold, the money goes into a deposit account of a bank but which is linked to my GoldMoney account for my next quick purchase as I interpret an ongoing price rise. All done on the internet!

  14. Simon Peter | April 13, 2009

    Come on, David, I've been writing my head off about how to store the gold and silver safely!

  15. Doug | April 15, 2009

    It's because these guys know nothing other than pushing paper debt liabilities. I heard one commentator remark that
    to buy physical gold one would then have to go to the expense of hiring an armored truck company to transport it
    and then pay exorbitant vault storage fees. Give me a break,
    you could certainly find a safe place to hide something so small on your own property, a million dollars of gold can all fit
    into a 5 1/2" cube.

  16. Simon Peter | April 19, 2009

    Gold and silver prices are nicely falling at the moment. Watching this price fall daily +, ought to help sense when to buy once more to ride the rise upwards.

    Since mines sell their gold into the market at no lower than $700-800 because production costs prohibit a lower price, I figure that the market won't fall lower than this.

    At that price, gold mines stop selling into the market whilst gold users, such as jewellers and electronics, continue buying, however, little. A rise is seen and then, hopefully, hedge funds and others start to buy again.

    You just need internet access to gold and silver spot prices. If you use GoldMoney, I find that if you click on GoldMoney, the spot price is refreshed.

    Is it really as easy as this? What am I missing?

  17. Simon Peter | April 24, 2009

    Thank you for referring to Martin Hutchinson's article. I am encouraged about your statement that dividends, especially high-yielding, and gold should be THE portfolio.

    I have invested twice over the past two years in a new PLC which I consider is going to be a high-yielding earner in dividends. It is called Primary Water PLC and possesses specialised knowledge of where to drill boreholes at any place on the surface of the earth, including the USA, for non-saline water.

    Since there is such a lack of fresh water, and since human beings will pay for it for drinking, sanitation and, of course, food production, it seems to me that shares in Primary Water PLC are going to be very productive.

    Oil companies have got big from drilling boreholes for what has been trapped below ground since time immemorial and which has never seen the light of day.

    So, also, is this company doing the same for water which has never, ever been part of the hydrological cycle, never seen a cloud in its life.

    They have a website which is http://www.primarywater.com.au/

    I wonder what Money Morning would make of this company?

  18. Busy Man Fitness | April 27, 2009

    This single sentence hit me hard:

    "On the other hand, the Weimar hyperinflation wiped out the entire savings of the German middle class."

    Reminds me of the current times.

Trackbacks

  1. […] Comparing today's US, Swiss, Japanese and UK 'money printing' with the hyper-inflation of 1920s Germany, the Bank of England was already set to buy "£300 billion per annum, 65% of British government spending," as Martin Hutchinson has noted at Money Morning. […]

  2. […] Economists will tell you that governments can't default on bonds in their own currency, because they can always print more money. In extreme cases, printing more money will lead to high inflation or even hyperinflation, leading to an effective repudiation like that perpetrated on my great aunt, or even like that carried out by the German Weimar Republic in 1923, when German prices were measured in the trillions of marks. […]

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