German politicians view the monetisation of sovereign debt as the road to Weimar. They expect the ECB to be the heir to the Bundesbank and not the Reichsbank
– Willem Buiter, Citigroup chief economist
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Samizdata quote of the daySamizdata Illuminatus (Arkham, Massachusetts) · Economics, Business & Globalization · Slogans & Quotations December 22nd, 2010 |
 17 comments to Samizdata quote of the day |
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The memories of the hyperinflation of the Weimar government are burned deep into the German economic pshyche.
They know what is down the road that the EU are pushing them towards and at some point the Bundesbank will balk and say thus far and no further.
Then the only option will be for the breakup and probably collapse of the Euro or the Bundestag and Bundersrat will have to amend the charter of the Bundesbank to allow progress towards fiscal union.
This would most certainly be challenged in Karlsruhe as the monetisation of extraterritorial debt instruments violates the Basic Law of the Federal Republic.
For a more detailed social account (rather than an economists view) of the Weimar Hyperinflation, read Adam Fergusson’s excellent book “When Money Dies”.
For an amusing ‘Future History’ of the collapse of the Euro:
http://www.belfasttelegraph.co.uk/business/business-news/the-day-the-euro-died-15016427.html
And yet the same German politicians have agreed first to the bailout of Greece, then to the bailout of Ireland, then (just about a week ago) to the bailout of ANY Euro zone country that gets into trouble.
The Euro Central Bank (like the Bank of England and the Federal Reserve) is committed to creating money (“we do not print money” – no you create it via a computer, sorry but it has the same effect) to prevent any nation going bankrupt and defaulting on its debts (“nations do not go bankrupt” – only if you do not include creating more money as de facto bankruptcy, and nations with debt in other currencies still go bankrupt).
Why?
To protect banks – including German banks.
So the whole “German politicians are committed to sound money” story is a big shining LIE.
“But the German people……”
The German people (like the people have of virtually every other major nation bar Switzerland) have virtually no influence on policy – so the opinions of the German people are not relevant.
“Representative democracy” has proved (in Britain, Germany, indeed everywhere) to be not “democracy” at all.
It is the rule of an “educated” (establishment indoctrinated) political class – with elections just being a game of musical chairs among politicians who will all sign on for the same basic policies (bailouts, monetary and fiscal “stimulus”, crawling to hostile cultures, and so on).
Interestingly enough, Weimar inflation wasn’t so much driven by supply inflation as velocity. Once the inflation had kicked off, the workers demanded daily payments, so the whole economy’s liquidity was changing hands every day and that was when the “hyper” kicked in.
Also interestingly enough, it was solved by Keynesian confidence. The new Rentenmark was inflated after its inauguration too, but the population believed it was a reliable currency, and the panic ceased. In the end, inflation only occurs when sellers in the market think they can or should raise prices, and the greater liquidity supply is found to accomodate that. That’s why it’s so unpredictable. And why in say the UK inflation is strongest in property, a market in which inflation is presumed to be not only the norm, but positively a wonderful thing.
Yes, I just read “When Money Dies”. It’s a good read.
Ian B. – “confidence” can indeed be an important factor, but NOT in the longer term.
A government (or a private businessman) can con the public for a short time – but if the goods are no good (say a government is inflating the currency, or the businessman is selling goods that just do not do the job he says they do) then objective reality will trump confidence.
For example, the fact that workers where demanding payments every day was not the CAUSE of the inflation – it was the RESULT of justified fear of the loose monetary policy (beware of putting the cart before the horse).
Just as if the new currency had been inflated to the same extent the old one was – it also would have failed (regardless of “confidence”, “animal spirits” or any other confidence trick).
The German Basic Law:
Even honest judges (and where are they to be found?) might not be any good – as the German constitutional document itself is trapped in a contradiction.
It says that Germany is independent and that its people are free and are expressing self determination – but it also says (with equal force) that Germany is a part of a “united Europe”…..
This contridiction also goes down to the specific clauses of the Basic Law.
For example, German citizens are not to be handed over to foreign courts – unless they are European courts or (even) “international” courts, A “take back” form of wording that runs through the entire document – for example there is a “right” to set up private schools, but the state may close down such schools if it wishes (some “right”).
The Bavarian Constitution is less wordy than the German Basic Law – but the same contradictions run through it.
Bavarian is to be free, power comes from the people of Bavaria – but it is to be part of a united Europe (what if the people of Bavaria do not want to be part of a United Europe and obey all its edicts? “shut up Mr Marks”).
There is to be the rule of law – but it also to be a social state.
The Rechtsstaat (rule of law State) and the SocialRechsstaat (social rule of law State) are, of course, incompatible (the word “social” acts as what Hayek called a “weasel” word – sucking content out of the concept it is attached to as a weasel sucks out the contents of a egg whilst leaving the shell).
One has to choose (for example) between the rule of law and the social rule of law for (as German legal thought understood as far back as the 1700’s) the powers the state needs for a Welfare State (then, in German thought, considered to be a part of a general “Police State”), by their very nature, run counter to the limited government idea of the rule-of-law state.
But the German Basic Law of 1949 (and so on) does NOT choose between the concepts – it tries to have it both ways.
So (yet again) even if one could find honest judges they might not be any help – as the basic texts themselves are a mess.
The interesting question though is why prices start rising. If I pop into Patel’s for a crate of alcopops and a copy of Razzle, he has no idea how much money I have, so how does he know to raise prices? It’s all very well saying, “inflating the currency causes prices to rise”, but how does anyone know how to raise their prices? Patel doesn’t know M0 or M3, and nobody did before we started measuring those things.
Once the inflation has kicked off and the banknotes are into the quadrillions, people start predicting it. But prior to that, how does it get going? How does anybody know there is too much money? It’s not like shaved coins that have a literally lower, measurably lower commodity value. It’s just bits of paper.
“A mark is a mark!”
How did people figure out that a paper mark was no longer a goldmark?
Ian, inflating a currency does not cause prices to rise. It allows them to rise. They cannot rise without a prior inflation in the monetary base, but just because there is base inflation doesn’t mean that they will. The Weimar case, IIRC, took approximately two years between inflation of the base and increase in prices that it allowed. That is why economists make such a big deal about confidence.
What happens is that at some point holders of the increased base observe the unwarranted expansion of money supply and reduce currency savings and increase currency velocity, and at that point is when the expansion becomes apparent in prices. Think ‘musical chairs’ played not by removing chairs, but by adding people. The expanding supply of people are the currency chasing the same number of chairs.
Since velocity and FRB multipliers tend to run at the maximum most of the time, it is during a slowdown/contraction that central banks usually inflate the base. It is when there appear to be signs of a recovery that the inflation takes off. Another telltale sign to look for is the term of bank lending. The shorter lending is on a market wide basis, the less confidence the banks are showing that there will not be inflation. For purposes of that sentence, floating interest rates are factored not on the term of the contract but on the float lag.
Was that your question?
I can expand on the musical chairs example. A bunch of people are playing musical chairs and 1/3 have to go to the bathroom at the same time. The central bank looks at this, sees the ‘contraction’ in player supply and decides to add more players. Feeling much relieved of their post consumer beer, the 1/3 of the players return. That is when the central banks inflation becomes apparent. We are in the situation now in the US with interest on un-lent reserves being paid to consumer banks (effectively they are being paid to not lend available funds) that it is as though the central bank was paying players to stay in the bathroom.
Once money has been created there are only three options:
– it is invested in producer goods (capital goods), that is to say that more money compete to acquire the same capital goods, and hence it raises their price.
– it is consumed in consumer goods, that is to say that more money compete to acquire the same consumer goods, and hence it raises their price.
– it is hoarded, and hence in the measure that satisfaces the need of hoarding it allows the otherwise hoarded money to be used in the same way than in the two previous cases.
To sum up, both relative prices and absolute prices are ALWAYS affected by an increase in the money supply. All the rest being equal, the time lapse between the increase in the money supply and the price distortion depends only in the institutional efficiency of some society: language, contracts, marketplace, etc.
After all it was money (not “confidence”) that people were carrying in those carts.
If people (or rather banks) have a “crises of confidence” and go to the government saying “supply us with more liquidity” (i.e. print more money) the government can always say NO.
Take an extreme example.
The dying period of the Confederacy.
The Confederates (Ludwig Von Mises Institute people please note – although you never do) followed an even more statist policy than the Union did.
Higher and more “progressive” income taxes, more regualtions (even more trade regulations), and lots of government control (even government ownership) of enterprises.
And (no surprise) the monetary policies of the Confederates were even worse than the Union also.
So vast inflation (i.e. increase in the money supply – the old meaning of the word “inflation”) lots of people turing up with lots of Confderate Dollars – and prices going up (the modern meaning of “inflation”).
Yet in the dying period of the Confederacy when “confidence” was at its WORST (i.e. everyone knew the South was going to lose) inflation actually stopped for a bit.
Why?
The Union army had overrun the southern money printing factory, so the supply of new Confederate Dollars was cut off for awhile.
The pressure of lots of new notes turning up in shops (and so on) was cut off.
inflation wasn’t so much driven by supply inflation as velocity
Ian, with all due respect, that’s nonsense.
The money was increasingly worthless, so people spent it faster to get something of value before the money became even more worthless. It isn’t the velocity that drives inflation, it’s the worthless money.
The very concept of “money velocity” is silly. Money is a commodity owned by its current holder. In a barter society, would we torture ourselves with equations explaining, for example, the velocity of wheat and how it affected wheat’s price?
The idea’s preposterous.
Velocity is how often the same base money (central bank money) changes hands. If people elect to not hold any cash in their accounts and/or banks elect to not lend the allowed maximum against the money that is deposited in their banks, then velocity drops down off of ‘the governor’, that is it drops below the structural maximum imposed by the quantity of central bank money times the money multiplier. This causes a ‘contraction’, a perception of a reduction in the amount of money, when in fact it is only the velocity that is shrinking. In order to make up for the shrinkage in the velocity of money during times of economic stress, politicians and central bankers love to issue new currency to fill the gap left by the shrinkage in velocity. This stabilizes consumer prices right up until the point that velocity picks back up again. At this point the extra base money added by the central bank during the contraction gets fed into the velocity calculation along with the return of the original base to its usual maximum velocity. This is when the inflation in the base money supply generally becomes apparent to consumers and this point, not the point at which that extra currency was added, is the point at which velocity and consumer prices shoot for orbit as everybody tries to not hold the now-recognized-as-inflated currency.
In the case of the Weimar (the case that Ian was referring to) the people did not do as you say. At least not immediately. The currency was inflated but velocity and consequentially consumer prices did not increase until approximately two years later when it did so rather abruptly.
Your statement:
may be intuitive, but it isn’t how it happens. There is typically a large gap between ‘printing’ the excess currency and people doubting its worth.
Mid, I don’t get this part:
This is probably a familiar chart to most people here, as is this one. This is probably a less familiar one.
Did you see that one and only significant downward blip? Consumer prices shrank dramatically during the second half of 2008 doing something they haven’t done even once in the last 60 years. Here is another interesting chart you probably haven’t seen.
Notice that consumer debt peaked and began crashing at the same time the Fed/Treas starts pumping out more funny money. They are doing it to counteract the contraction in the money supply brought about by the major shrinkage in borrowing. Notice that all of those charts are following steady (but not sustainable) trajectories until the wheels fell off. At that point all of them go nuts and only one returns to its previous course, consumer prices. To compare to my previous comment, this is where the central bank decided to add more players to the game so the ratio of players to chairs (dollars to goods) wouldn’t change much. What the central bank didn’t plan for was what to do when those other players come back to rejoin the game.
To recap, those smooth upward lines on the charts indicate the structural maximum imposed by the constraints of the system. The downward trend in consumer debt is velocity ‘dropping off of the governor’, that is dropping below the maximum allowed by the constraints in the system. Those jaggy lines during and after 2008 indicate the removal of those constraints, the biggest one being the limited supply of base money, in an attempt to maintain the smooth consumer price trend.
It is when the economy starts to pick back up again that the inflation of base money supply during the contraction will become apparent. That will be the Weimar moment. But in our modern banking system it will probably have a different failure mode and there won’t be any wheelbarrows of cash.
What will cause it to pick back up again?
In approximately descending order –
Backtracking all new regulations/legislation to even as little as ten years ago would turn things around with such energy that the monitization would probably be adsorbable.
Dissolving several cabinet level departments.
Ending interest payments on excess bank reserves.
Changing the tax structure to make us not the most progressive income tax system of any major economy.
Adamant gridlock combined with the SCOTUS preventing an imperial executive doing by administrative fiat what the legislative branch refuses to pass as law.
Basically anything that is bad for the governing class is good for the governed class.
My fear is of the lingering death of politicians fighting the symptoms, doing just enough to suspend the crisis du jour until we find ourselves living in despotic poverty without enough energy or institutional memory to recover.
Excellent series of posts by Midwesterner (as usual). Frankly, I can’t see any of the items in his list occurring, which strongly suggests that the last paragraph is the most probable outcome. However, I think it is also possible that a “recovery” will begin once the new Congress is sworn in next week and people begin to believe that the worst excesses of the Obama-Reid-Pelosi years will be moderated. (Whether or not Congress actually does so, with two of those three players still in positions of power, remains to be seen, of course.) This is where “confidence” comes into play. However, if the economy does start to recover that’s when we’ll see serious inflation manifest itself (as was Mid’s original point). So we’re screwed either way. Happy New Year, everybody!