Inflation and Hyperinflation: Weimar Germany 1923

What you will learn

• The causes and timeline of the German hyperinflation from 1914 to the currency reform of November 1923.
• How to convert monthly inflation into yearly and daily rates, and what the 50%-per-month definition means.
• Why holders of money and nominal claims lost, while debtors and owners of real or foreign assets often did better.
• What the episode does and does not teach about inflation risk today.

Explanation

Inflation measurement and real returns are covered in the Macro course, and gold's record against inflation in the Gold course. This lesson studies the extreme case: a currency that stops working.

Definition

Hyperinflation is usually defined, following the economist Phillip Cagan (1956), as inflation above 50% per month. That sounds moderate per month but compounds to about 12,875% per year (1.5^12 − 1).

Timeline

• 1914–1918: Germany financed the First World War mainly with loans and by printing money, not with taxes. In July 1914 one US dollar cost 4.2 marks. By November 1918 wholesale prices had more than doubled.
• May 1921: reparations were set at 132 billion gold marks, payable in foreign currency and goods. Budget deficits continued and the central bank, the Reichsbank, kept buying government debt with newly created money.
• From August 1922: monthly inflation passed 50%, the start of hyperinflation according to the Hanke–Krus table of hyperinflations.
• January 1923: French and Belgian troops occupied the Ruhr, Germany's industrial centre, after missed deliveries. The government called for passive resistance and paid striking workers with printed money, while output fell.
• October 1923: the peak month, with inflation of about 29,500% per month, equal to about 20.9% per day; prices doubled roughly every 3.7 days.
• 15 November 1923: the Reichsbank stopped financing the state, and the new Rentenmark was introduced at 1 Rentenmark = 1 trillion (10^12) paper marks. From 20 November the dollar was held at 4.2 trillion paper marks, exactly a trillion times the 1914 rate. The Reichsmark followed in 1924.

Why it ended

Stabilisation worked because the money printing for the state stopped, the new currency's supply was limited, and in 1924 the Dawes Plan restructured reparations with foreign loans.

Winners and losers

A nominal claim is a promise to pay a fixed amount of money: cash, bank deposits, government bonds, life insurance, pensions fixed in marks. All of these lost practically their entire value, which impoverished much of the middle class. A debtor with a fixed-mark loan could repay it with almost worthless money; the largest debtor of all was the state. Owners of real assets (buildings, land, factories, goods) and of foreign currency kept more of their value, although they also suffered from the collapse in output and later taxes.

Worked example

Hypothetical example: in July 1914 three households each hold wealth of 10,000 marks, worth 10,000 ÷ 4.2 ≈ $2,381. Household A holds a 10,000-mark government bond. Household B owns a house worth 10,000 marks, financed with a 10,000-mark mortgage. Household C converted 10,000 marks into $2,381. We value everything at 4.2 trillion marks per dollar (November 1923). Interest, taxes, rents and real-estate price changes are excluded; we assume the house keeps its real value.

The bond saver lost everything. The indebted homeowner ended with a debt-free house. In reality rents were controlled, and from 1924 the state partly revalued some old claims and taxed property owners. But the direction is clear: in hyperinflation, fixed money claims are destroyed and fixed money debts disappear.

A second calculation shows why saving in money was hopeless. Suppose a bank pays 20% interest per month while prices rise 100% per month. The real monthly return is 1.20 ÷ 2.00 − 1 = −40%. A high nominal interest rate does not protect you when inflation is higher.

Common mistake

Practice activity

On paper: (a) Monthly inflation is 30%. What is the yearly rate? Is it hyperinflation by Cagan's definition? (b) A savings account pays 10% per month during that inflation. What is the real monthly return? (c) A household has €0 savings, a house and a fixed-rate mortgage. Another household has €50,000 in a bank account. Which is more exposed to very high unexpected inflation, and why?

Key takeaways

• Hyperinflation is commonly defined as inflation above 50% per month; Germany peaked at about 29,500% in October 1923.
• The cause was state spending financed by the central bank, under war debts, reparations and the Ruhr occupation.
• It ended only when money printing for the state stopped and a credibly limited new currency was introduced.
• Nominal claims were wiped out; debtors and holders of real or foreign assets were relatively protected.

Next step

The next lesson jumps to 1987, when a strategy designed to protect portfolios helped produce the largest one-day fall in the Dow's history.