As a country, we are desperate to prop up the American suburban experiment, to "get America working again". The non-negotiable American way of life, the standard of living most of us have and even feel entitled to, has been revealed to be more fragile than we would ever have imagined. How far will we go to sustain the unsustainable?
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I spent last week on vacation and, as with any good vacation, got a chance to catch up on some reading. Amongst some lighter reading, I finished off Adam Fergusson's When Money Dies: The nightmare of deficit spending, devaluation, and hyperinflation in Weimar Germany. Now before I get anywhere near apocalyptic-sounding, I want to make clear that I do not consider USA circa 2011 to be equivalent to Germany circa 1923. While the threat of hyperinflation is here, it remains but a remote possibility. I do not predict the chaos and calamity of post-WW I Germany for us. That being the case, the book was chilling and gave me a lot to think about.
Coming off of World War I, Germany was forced to sign a treaty that, amongst other things, forced it to make large reparation payments to the Allied forces. It is a misconception that it was these payments that caused the inflation -- that Germany simply printed money to pay their debt. The payments to the Allies were to be made in gold. Despite the remarks of our Federal Reserve chairman last week that holding gold is simply "tradition" and that gold is not currency, the metal has value across societies and, as we will see in a minute, is what ultimately provided Germany with a backstop for a stable currency.
While the reparations were a tremendous burden, the inducement for inflation was domestic. Having spent and borrowed heavily to finance the war, Germany, as the loser, had no spoils (neither did France or England, in this case, since victory was an armistice and not a plunder). The German government owed their own population tremendous amount of money since it was their own citizens buying government bonds that was largely used to finance the war. To pay this back, they literally just printed money. They started up the printing press and they printed, and printed, and printed money until everyone was paid back.
Of course, this is not a far cry from where we are today. We've financed multiple wars (engagements, presidential actions, etc....) while bailing out banks and insurance companies, doing record stimulus spending, creating a new trillion dollar entitlement, paying out record unemployment and other household assistance and preparing for the pending retirement of America's largest generation. Since 2008, the Federal Reserve has created and injected $5.3 trillion into the economy, much of this given to the U.S. Treasury to finance the national debt. The exact mechanism is that the Fed buys treasury bonds so, in theory, they will get that money back in the future.
Of course, getting that money back will happen when the time is right, when the economy is back booming again. We all remember (not) how, during the dot.com boom or the housing boom, our treasury was so flush and our population so fat and happy that we were willing to tax ourselves more and cut back on our spending to pay off our debt. This is the situation Germany found itself in as well, only they were actually not fat and happy. They were desperate. And so they printed more money. Lots more.
I don't remember the entire Weimar Republic hyperinflation episode as more than one or two lines in my history book, crammed in between the two great wars, but the fascinating thing about this book was how long it took to happen and what the transition was like. At first, the inflation solved a lot of problems. Yes, prices went up, but relatively speaking debt -- the bigger burden at the time -- went down. To quote the book:
With inflation alone....can a government extinguish debt without repayment, or wage war and engage in other non-productive activities on a large scale: it is still not recognized as a tax by the tax-payer.
The reason for this is that the majority of people did not feel poorer. Rising prices were a burden, but wages were rising too. Imagine you make $50,000 this year but next year you get a raise and make $75,000. Even if gas and food prices double, you're going to feel a little better off.
As things went on, the dog kept chasing its tail, and the Reichsbank kept printing money. The government, unable to balance its budget, and unable/unwilling to really tax its people, simply printed its way to solvency. They paid wages and benefits to people largely with printed money. They spent money on programs and infrastructure via the printing press. The objective of the government at the time was full employment, and stimulating the economy through government spending of printed marks was how they accomplished it. Of course, if it were only that easy. From the book:
In the inflationary period new factories were built, old establishments reorganized and extended, new plant laid down, participations in all fields of industrial activity bought up, and the great amorphous concerns founded. Too late, it was found that this process had undermined the capital structure of the country: capital was frozen in factories for which, because of the extermination of the rentier and the reduction of the real wages of so many of the great consumer classes, there was no economic demand. Once the demand for goods was shut off and the flow of cash dammed, the fate of productive apparatus was sealed.
This eerily sounds like America today where, instead of industry, our inflated capital was pumped into the suburban experiment. There it sits frozen, that is, only where it has yet to vanish altogether, for there are few buyers and many sellers now. We're trying to prop it all up -- we've yet to hit the bottom -- but it is getting harder and harder to do.
This is because, as with Weimar Germany, more and more people are being caught on the wrong side of the inflation game. You've had your wages increase from $50,000 to $75,000 (a 50% increase), but your cost of essential items like energy and food doubled (a 100% increase). That may work for a year if you make $50,000 to start, but not if you make $20,000. That lower wage earner soon finds their wages not keeping up with just the essentials of life. As time goes on and inflation continues, progressively higher and higher wage earners are put in the same situation.
In the U.S., wages have been stagnant for a decade. The stagnation was offset by rising housing prices and the get-rich-quick action in the suburbs. And, of course, the most leveraged and least resilient amongst us are the first to feel the effects.
Over time, as prices kept rising faster than wages, some crazy things happened. Workers started to demand to be paid at the end of each day. There were stories of people ordering dinner at one price and then, because of the rapid inflation, having to pay a different price when dinner was over. Large purchases like new cars became impossible as a 20% down payment would be near worthless two months later when the purchaser was to take possession.
People were desperate to tread water, to simply hold onto what they had. They would leave work after getting their wages and go out and buy anything they could find, knowing that whatever tangible they could purchase could later be sold or traded for a higher value. "Growth" was created because people invested it wherever they could, lest they hold onto their money and watch its value disappear. From the book:
As the old virtues of thrift, honesty and hard work lost their appeal, everybody was out to get rich quickly, especially as speculation in currency or shares could palpably yield far greater rewards than labour. While the anonymous, mindless Republic in the shape of the Reichsbank was prepared to be the dupe of borrowers, no industrialist, businessman or merchant would have wished to let the opportunities for enrichment slip by while others were making hay. For the less astute, it was incentive enough, and arguably morally defensible, to play the markets and take every advantage of the unworkable fiscal system merely to maintain one's financial and social position.
As that position slid away, patriotism, social obligations and morals slid away with it. The ethic cracked. Willingness to break the rules reflected the common attitude. Not to be able to hold on to what one had, or what one had saved, little as it worried those who had nothing, was a very real basis of the human despair from which jealousy, fear and outrage were not far removed.
While early on the dollar would trade for 5 marks, by the end it fell to one dollar for 4,200,000,000,000 marks, the entire economy reduced to barter and foreign currency. Unemployment spiked as the inflation-driven investments were revealed for what they were: worthless.
As I said earlier, while the pace picked up at the end, this decline all happened over many years. There were a number of opportunities that politicians and others had to put the brakes to this disaster. Nobody could. This also eerily has a tinge of our current political situation. From the book:
Much as it may have been recognized that stability would have to be arranged some day, and that the greater the delay the harder it would be, there never seemed to be a good time to invite trouble of that order. Day by day....the reckoning was postponed, the more (not the less) readily as the prospective consequences of inflation became more frightening. The conflicting objectives of avoiding unemployment and avoiding insolvency ceased at last to conflict when Germany had both.
We can see ourselves in many ways in that fear of the tough reckoning. While many politicians talk tough, they reflect our unease. Are we really prepared to deal with the suburban malinvestment of the past two generations? Are we prepared to undergo the difficult transformation in our living arrangement and the massive decline in our standard of living required to face up to our core insolvency and lack of productivity? Knowing that we aren't helps us see that the German policy of inflation -- kicking the can down the road -- was not so crazy at the time.
Even so, the result is no less predictable. From the book:
What really broke Germany was the constant taking of the soft political option in respect of money. The take-off point therefore was not a financial but a moral one; and the political excuse was despicable, for no imaginable political circumstances could have been more unsuited to the imposition of a new financial order than those pertaining in November 1923, when inflation was no longer an option....Stability only came when the abyss had been plumbed, when the credible mark could fall no more, when everything that four years of financial cowardice, wrong-headedness and mismanagement had been fashioned to avoid had in fact taken place, when the inconceivable had ineluctably arrived.
As a final thought here, it was also important to note in this book that, as the tough decisions got put off further and further, the solutions obviously became more difficult. As the needed medicine became more distasteful, the politics of the day became more extreme. In Germany of 1923, you had the communists on one side and the national socialists on the other. Their numbers grew as the situation became more desperate, as the pragmatic kick-the-can strategies simply put off and compounded the inevitable reckoning. The communists were for the worker, the Nazis for the industrialists. In the end, the workers lost their jobs and the industries all went bankrupt.
Inflation is the ally of political extremism, the antithesis of order. At other times - in post-revolutionary Russia, in Kadar's Hungary - it may have been deliberately engendered in order to destroy the social order, for chaos is the stuff of revolution. In Germany at this time, however, the inflationary policy was the consequence of financial ignorance, of industrial greed and, to some extent, of political cowardice. It therefore produced hothouse conditions for the greater and faster growth of reactionary or revolutionary crusades.
Of course, we know how that all tragically ended in Germany.
We have a lot to ponder in this country. A lot to discuss. And we have a lot of really difficult decisions to make. It will be politically easier in the near-term to continue to debase the currency, to pretend that we are making good on all of our obligations while continuing to expand our empire, with inflation providing the illusion of prosperity. It will be very tempting to restart the suburban experiment by resetting our private debt levels through inflation. Is this just postponing the inevitable?
Incidentally, after Germany had "plumbed the abyss" they restored their currency by a) stopping the printing press, and b) issuing new currency that was fully backed by and exchangeable for gold. For the United States, the fragility of our suburban experiment is compounded by our experiment with fiat currency (we went off the gold standard in 1971). Never has the world held one reserve currency that was not backed by anything but "good faith and credit."
We may need more of both soon enough.
- When Money Dies: The nightmare of defitic spending, devaluation, and hyperinflation in Weimar Germany by Adam Fergusson
- This time if different; Eight centuries of financial folly by Carmen Reinhart and Kenneth Rogoff
- The Black Swan by Nicholas Nassim Taleb
- Our unfaithful partner (April 11, 2011)
- Lessons from a PIG (March 23, 2011)
- Think Happy Thoughts (January 5, 2011)
- Waiting for SuperFed (October 11, 2010)
- Podcast: Is growth the solution or the problem? (March 10, 2011)
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