The Magic of Money
by Hjalmar Horace Greeley Schacht, 1967
(he served as the Currency Commissioner and President of the Reichsbank under the Weimar Republic)
-- Excerpts --
The first time I was called in to master a difficult monetary problem was when the German Mark had been so devalued by the inflation following the First World War and the French invasion of the Ruhr that an American Dollar was equivalent to 4 trillion German Reichsmarks. Expressed in figures this reads: $1 =DM 4,ooo,ooo,ooo,ooo. The problem was to create a currency with which the small man could once again operate.
The next monetary absurdity confronted me with the problem of how Germany was to pay the reparations with which it had been saddled after the First World War. These payments had to be made in foreign currency. Quite apart from the fact that the German Mark was worthless, the victors had no use for Deutschmarks in their economies. They wanted to be paid in their own currencies. But where was Germany to find these foreign currencies ?
A third problem arose out of the fact that after the First World War Germany had borrowed 20 billion Marks in loans raised abroad, intending to use the loaned money to bring its economy back to a viable condition. The loans and the interest on them had to be repaid. Not only had the necessary funds to be raised in Germany, but once again foreign currency was needed before payment could be made. The outstanding credits and loans were expressed in Dollars, Francs and Pounds Sterling, and had to be repaid with interest in the same currencies.
Another time I was faced with the problem of how to help a German economy which was completely impoverished and left far behind in foreign trade back onto its feet. The world economic crisis at the beginning of the 1930s had reduced world trade to 1/3 of its former level. Markets contracted and deprived many countries, including Germany, of their export opportunities. Industry stagnated leading to massive unemployment. Social misery and communist agitation grew into a real threat. How could this situation be relieved ?
Germany's re-entry into world trade was the next problem in the solution of which my experience in monetary policy had to be brought into play. How could a Germany bereft of capital and cutt off from foreign currencies once again obtain the raw materials required for the resurgence of its industries ? Germany's own mineral resources are inadequate. To meet the needs of its people for agricultural products and of its industry for raw materials, imports are essential. Germany must seek to pay for these imports out of the proceeds from the sale of its industrial products. And where were the means necessary to create these proceeds to come from ?
And finally, there was the need to develop the country's means of production and investment so that the empty workshops, the idle machines and the willing labour could once again be made productive. Stocks of commodities had dwindled, capital savings had been consumed in the crisis years. New capital and new means of production had to be brought into existence.
The problems which were encountered in the period between 1920 and 1940 are not unique phenomena. They recur from time to time in this or similar form. Thus at the end of the Second World War financial problems were once again in the forefront of the world economy. Perhaps it is possible to discern a few things in the history of the war and inter-war years which lead away from theories and into practice.
It always bears repeating that the politics of currency and money is not an exact science, but applied art. Naturally, every art has its own handicraft. So too dealing with money, as in banking, is a handicraft the rules of which must be mastered. But the correct assessment of economic processes, and last but not least, the strength of character to resist tempting pathways and interventions by political force, are also part and parcel of monetary and currency policy.
some history :
The expansion of world trade which took place towards the end of the Middle Ages necessitated a professional organisation which would regulate the transmission of payment from place to place and country to cooutry. The banking system developed in conjunction with the goods trade. The cradle of our modem banking technique is to be foWld in the towns of Northern Italy. It was here that the problem of an inter-local and international payment system, by means of bills of exchange and letters of credit, was first posed and solved.
In the Middle Ages professional money lenders were almost always Jewish. Their concentration into ghettos, and the dictate which forbade Christians to charge interest, more or less compelled Jews to become money dealers and money lenders. Although at the beginning it was tainted with the odium of usury, the credit business proved just as useful and necessary for the development of the economy as the interlocal transmission of payment. Without the transmission of payments by banks to countries everywhere, our modern world economy and our all-embracing world trade would be unthinkable.
The transmission of payment and the granting of credit have an important common pre-condition. They rest on faith in the word of and the ability to pay off the other parties to a transaction. Creditworthiness and integrity occupy a central role in the business of banking. The banker must acquire exact information about the character, financial resources and diligence ofhis clients. He enjoys a relationship to his clients similar to that between doctor and patient. The banking system cannot operate without the legal security of suitable laws resting on the recognition of private ownership. The banking system will always remain one of the mainstays of private ownership and of contractual obligations. It is very much in the interest of the banks that their clients should not suffer as a result of falls in the value of money.
In the course of the historical development of the economy the credit demands by customers reached proportions far in excess of the fmancial resources of individual banking concerns. This was especially the case in all business transactions where credit was sought not by individual concerns, but by larger corporate bodies. In feudal times it was the territorial overlords who needed credit on a large scale. Road building and other provisions for traffic required great capital outlays, even in peacetime. But it was especially preparations for and campaigns of war which required more money than was readily available. Here the solution was to raise loans the repayment of which was spread over a great many years.
As a result of this development the banker ceased to be a money lender with his own capital and became a money dealer, money transmitter and money lender handling the capital of others, who helped his customers to obtain money from third persons. The retinue of nearly all the larger Ducal courts included a so-called Court factor, whose duty it was to raise money for the Court and the State. In time these factors became permanent advisers and managers in matters concerning money. They did much of value, but at times their advice led to taxes which were hard on the underdog. Many amongst them earned the hatred of the populace.
The princes made every endeavour to retain the services of their Court factors, and, in addition to making profits by way of interest and commission, they were protected from persecution, and often also rewarded with external honours, such as elevation to the nobility, permission to own land and similar privileges. The procuration of money by means oflarge loans led to the sub-division of the amount of the loan into smaller segments which were then sold to the general public. This method of raising money involved considerable risks.
In addition to the demand for credit by public bodies, the development of the modern economy led to a massive need for credit in production and trade, a need which could no longer be met by the private banking firms. The formation of consortiums soon proved to be an inadequate answer to the great increase in private industrial credit. This led to the development of other forms of industrial enterprise, such as joint-stock banks, limited companies, and savings banks, which existed side-by-side with the private individual banking concerns. The larger companies become, the more directors and managers are needed, so that a family on its own can no longer provide all the executives. The banking profession has thus become a profession which is open to everyone. With the development of the large banking institutions a certain degree of bureaucratic administration has become unavoidable.
Confidence in one's business partner plays a decisive role both in transmitting payment from place to place, and in the mutual interaction between the parties to a large-scale credit arrangement. In the Middle Ages the transport of effective moneys was extremely difficult, not only for technical reasons, but also on grounds of security. For this reason a system of surety by letter of credit came into being. A banker in one town gave a client who needed money in another town a letter to a banker in that town who, when the letter was presented, gave the client the required money and charged it to the letter-writer's account. The same thing happened in the opposite direction, and the balance was settled on a suitable occasion. From the very beginning of the modem banking system a close network of relationships and friendships between many private firms was essential. The Rothschild family, its five brothers each resident in one of Europe's business centres, provides a good example.
The legal protection afforded by British preponderancy in world trade was, before the two world wars, an important factor contributing to the frictionless functioning of the international payments traffic.
The leaders of large industrial undertakings and the leaders of the big banks also on intimate terms, have full confidence in each other. Their relationships extend over a wide field, and have been developed through constant contact over the years and decades.
* * * * *
In constantly repeated public exhortations I warned both the German borrowers and the foreign lenders against the dangers of this course, always without avail. That did not prevent my being inllildated with reproaches, and being blamed for Germany's inability to pay, when disaster in due course occurred. A just verdict on these foreign loans would show that the responsibility of the lenders was at least as great if not greater than that of the borrowers.
There is even less excuse for a widespread abuse which took place in the spring of 1927. The cautionary example of the consequences of excessive foreign indebtedness did not prevent the German banks from continuing to employ short-term foreign loans in their business. Not only was this bad management on the part of the individual banks, but the overseas indebtedness was also a burden on the Reichsbank' s stock of foreign exchange, because it was payable in foreign currency.
Perhaps the prompt settlement of the Stinnes foreign debt even served to reinforce the banks in their assumption that they could at any time obtain sufficient foreign currency from the Reichsbank. Be that as it may, the banks without the slightest hesitation continued to raise loans abroad and to use the resulting funds for their current transactions.
I had confidential talks with a number of bank directors to ascertain what quantities of short-term moneys they had borrowed from banking associates abroad. My inquiries revealed so considerable a sum that I was impelled to give a most dire warning, particularly since a large portion of these foreign loans was being used to grant credits to customers for the stocks and shares dealt in by the banks, who in their turn used these credits for stock exchange speculation.
Since such individual measures did not have the desired effect, the central bank in May 1927 insisted that the banks instigate a drastic restriction of credit to customers for securities. The Reichsbank had to retain control over its reserves of foreign currency and gold, and could not leave them at the mercy of the lack of comprehension and the egoistic business interests of the banks. This regulative measure led to a major fall in stock exchange prices on 13 May, 1927, a day which was henceforth to be known as 'Black Friday' in the annals of the Berlin stock exchange.
Another factor which contributed to lessening the crisis was that some of the big banks were impelled by the Reichsbank's intervention to reach an agreement with their foreign loan-granting banking friends, whereby a portion of the short-term credits were consolidated for a number of years.
Between the wars Germany had rarely achieved any export surpluses, and then only very small ones. I therefore always fought for the greatest possible reduction in the loans raised abroad, because I placed the responsibilities of Germany as a borrower just as high as the responsibilities of the foreign issuing banks as lenders.
Within two years of the coming into force of the Dawes plan, Germany had already taken up long-term loans from abroad to the value of 3,5 billion Marks. Insofar as these foreign moneys served to further the efficiency of German industry, enabling it to earn foreign exchange through exports, earnings which would then be used to pay interest on and repay the loans, all was well. But these foreign loans became grave in their consequences if their equivalent value was used for local political purposes by the state, provincial, or local government. Such use did not create the means to pay interest on and repay the loan. Here, as so often both before and since, politics made the error of leaving social and economic consequences out of account. The battle for votes impelled all parties without exception, but especially those of the left, to let as much foreign money as possible into the country, in order to create cultural and social comforts for the people. How nonsensical were the conceptions about these things which prevailed in certain provincial governments can be seen from the fact that towards the end of 1924 one German state planned in all seriousness to raise a foreign loan amounting to 100 Reichsmark per head of population. Had the rest of the Reich followed suit, this would have added up to an amount of 6 billion Reichsmark.
While in New York in the autumn of 1925 I had the opportunity of alerting the American authorities to the dangers of granting too much credit to Germany. My efforts came to grief because the American bankers had an insatiable appetite for business, and continued to offer German borrowers new loans.
When at the end of 1929 the New York stock exchange crash put an end to the granting of loans, Germany had, within six years, borrowed some 20 billion Marks from abroad. This was exactly as much as the United States of America had used in its development over the previous forty years. Even if the bankers did not see it, the American public became aware that great danger was inherent in the loans granted to Germany.
It was not long before Germany had to declare itself unable to pay the annual interest on foreign loans. Despite the Hoover Moratorium of June 1931, the German bank crash came in July 1931.
The bank supervisory authority owes its existence to a law which I instigated when I was Minister of Economic Affairs in 1934. National Socialist agitators led by Gottfried Feder had carried on a vicious campaign against private banking and against our entire currency system. Nationalisation of banks, abolition of bondage to interest payments, and introduction of state Giro 'Feder' money, these were the high-sounding phrases of a pressure group which aimed at the overthrow of our money and banking system. To keep this nonsense in check the president of the Reichsbank called a bankers' council which made suggestions for tighter supervision and control over the banks. These suggestions were codified in the law of 1934, which was strengthened in 1957 by increasing the powers of the bank supervisory authority.
In the course of several discussions, I succeeded in dissuading Hitler from putting into practice the most foolish and dangerous of the ideas on banking and currency harboured by his party colleagues.
Even by the end of March, 1933, Hitler had explained to the Reichstag 'In principle, the German government will safeguard the interests of the German people, not by means of a state-organised bureaucracy, but by means of the. greatest possible furtherance of private enterprise and respect for private property'.
For many decades Great Britain occupied the top position in the international banking world. It had the oldest tradition in international trade. The Pound Sterling was the most acceptable, most versatile trading currency. In the course of time France and the United States of America began to challenge Britain's preponderance. Today the American Dollar is the world reserve currency.
Before the war only two of Germany's big banks had branches abroad.
Foreign assets and overseas loans play a not inconsiderable part in politics. He who lends money gains an influence over the economy of the borrower, and the economy forms a substantial part of politics in general. The fact that the Deutsche Bank undertook the financing of the Turkish Baghdad railway at the tum of the century was athom in England's side, and increased her envy.
It is well known that after Hitler's take-over in Austria a large number of Jews from Vienna and Budapest managed to escape persecution by obtaining permission to emigrate in return for payments to the party. They bought their political freedom with substantial amounts of foreign exchange.
After the shameful events of November 1938 which culminated in the destruction of the Jewish synagogues, I publicly declared my repugnance at these acts of terrorism. My attitude makes it plain that I had the strongest desire to find a solution to the Jewish question which Hitler would find acceptable.
I put it to him that the terrorist treatment meted out to the Jews was a political error, and that he ought to use other means if he would be rid of the German Jews. I pointed out to him that the Reichsbank had estimated the value of Jewish property in Germany at around six billion Reichsmark.
I suggested that this Jewish property should be administered by an international trust committee, and that on the basis of the security of this property at its valuation of 6 billion, a dollar loan amounting to some 1,5 billion Reichsmark should be raised. Jews all over the world would be invited to subscribe to this loan. I thought that the taking up of such a 1,5 billion loan should not prove too difficult for the many well-to-do Jews living abroad.
Out of the Dollar proceeds of this loan the trust committee would give each German Jew who intended to emigrate a suitable amount which would enable him to make a new life for himself in another country. This would not only serve the interests of the emigrating Jews, but also those of countries which hesitated to grant entry to penniless Jews. The German Government would guarantee payment of interest in Dollars, and undertake to repay the loan within 20 years.
Hitler agreed to this suggestion, and authorised me to negotiate with my London friends in order to ascertain whether such a plan were feasible. Accordingly, early in 1939 I went to London, and first of all put the plan to Montagu Norman, governor of the Bank of England. He approved of my proposals, and arranged for me to discuss them with one of London's most prominent Jews, Lord Bearstead, the chief of the well-known firm of Samuel & Samuel. He signified his agreement to the plan, but remarked that he would have to discuss it with the spiritual leader of the London Jews, Chaim Weizmann. Two days later he returned to tell me that unfortunately he could not accept my proposal, because Weizmann had been vehemently opposed to the plan. No reason was given.
I have never understood why my plan was rejected. The fact that Hitler agreed to it shows that at that time, at the end of 1938, he was still prepared to reach a compromise. Whether the Jews of the world would have been in a position to save their German brethren from the fate which later overtook them will always remain a debatable point amongst people of good will everywhere. The monstrous idea of the 'Final Solution' obviously came to fruition only at a later date. Even if at that time there was no suggestion of such a thing, the desire of many Jews to leave Germany was understandable. The refusal of the leading Jews to entertain my suggestion led to much discussion and dispute in Jewish circles too.
[The New York Times on p. 27 of its January 15, 1939 issue, hence almost nine months before the outbreak of the war, published a lengthy article under the headline "Masaryk to Work for the Zionist Cause" where a certain Dr. Chaim Weizmann is mentioned as supporting this emigration effort of Jews to Palestine.
In 1936, the so-called Peel Commission, formed by the British government, was investigating the causes of Arab unrest in Palestine, which at that time was under British control. In that context, Jewish leaders were also heard, some of whom advocated the formation of a Jewish autonomous area in Palestine, or even an independent State.
The 1937 Peel Commission Report concluded as follows :
“Partition [of Palestine] offers a possibility of finding a way through [the difficulties], a possibility of obtaining a final solution of the [Jewish] problem which does justice to the rights and aspirations of both the Arabs and the Jews and discharges the obligations undertaken towards them twenty years ago to the fullest extent that is practicable in the circumstances of the present time”. As we know now, nothing came of it back then, but note the use of the term “final solution to the [Jewish] question”!
What is of interest is the testimony of one witness who testified in 1936 during the commission’s hearing : Dr. Chaim Weizmann. An article published in the London Times on November 26, 1936 with the headline “The Jewish Case” reports on Weizmann’s testimony. We read there that Weizmann spoke of “six million unwanted unfortunates [in Eastern Europe] who were condemned to be penned up in places where they could not live. Even those in Western Europe were now threatened. Second was the world problem created by the presence of these six million people without a future whose condition was a threat to Europe. A certificate permitting emigration to Palestine was regarded as a certificate of freedom”.]
The first inflation
The years between 1920 and 1924, which even today are still known as the 'period of inflation', are amongst the most difficult ever experienced by the German economy in peacetime. The fall in the value of money at this time meant reductions in property values, impoverishment of the upper and lower-middle classes, corruption in the government and the civil service, undernourishment, and the rise of doubtful personalities to sudden riches. This and much else is summed up by the word inflation. By the end of the war the Mark was worth about half as much as before its outbreak. A gold Mark (the standard by which the paper currency is measured) was worth two paper Marks. But by November 1923 a gold Mark was worth a trillion paper Marks. Written out in full the figure is : 1,ooo,ooo,ooo,ooo.
What faced the individual bread-winner trying to maintain his family was no game, but direst need !
Other languages have no equivalent for the word 'Währung'. They call it 'monnaie' or 'currency' and thus 'coin' or 'circulation medium'. The German word expresses most succinctly the real significance of the means of payment : it must 'last' (währen = to last) and it must have stability, i.e. it must maintain its value.
Before state-guaranteed paper money was invented, commodities which had value in their own right were used for money. The Latin word 'pecunia' is derived from 'pecus' a head of cattle, and dates from the time when the herds were the means of exchange which enabled one to purchase a wife and other goods. Most widely used as mediums of exchange were the metals gold, silver and copper. Gold was the most favoured of them and it has retained its rank as the best means of payment for thousands of years.
Before the war, bank-notes owed their value principally to the fact that the state or the note-issuing bank undertook on demand to exchange the paper money tokens issued by them for gold. Today this is no longer possible. All the gold in the world would not suffice to effect the exchange of paper money for gold coin. Even in former times it would not have sufficed had all owners of banknotes presented them for exchange into gold. But such a possibility never had to be allowed for. The bank note was accepted, because everyone had confidence in the state's ability to pay. Internationally the gold standard was maintained by the fact that the Bank of England was prepared not only to buy gold at a fixed price, but also to sell it at this fixed price at any time.
This trust was so great and so much a matter of course that no one ever gave a moment's thought to the fact that the Gold Standard, which the whole world adopted in the course of the last quarter of the 19th century, was not a currency standard which carried any international obligations. Each country, even if its central bank was under obligation to exchange paper for gold, had only a national currency i.e. one restricted by law to its own country. The obligation to exchange paper for gold was not of decisive importance for the internal circulation of a currency. At home the crucial fact was that money had been given the character of 'legal tender'. This signifies that by law all fmancial obligations contracted within one's own country, be they to private indiv,iduals or to public corporations can be settled by means of the paper notes and coins of the realm which constitute the country's currency.
This legal provision proved completely fatal to the German currency after the First World War. Due to the continuous and progressive devaluation of the Mark every long-term debt mean heavy losses for the creditor. Anyone who in 1918 raised a loan over five years and used it to buy land or other durable goods, or anyone who had long-standing debts, was able on the due date in 1923 to repay the nominal amount borrowed with a Mark worth only a fraction of the value of the goods bought with the borrowed money. The borrower obtained durable goods for his money, but the lender only received worthless paper Marks. Anyone with debts grew rich.
Other countries did not escape inflation. But Germany was hardest hit, and in Germany in particular it affected the mass of the people. As in all business and money matters, the educated classes notice and grasp the implications of changes in money value more rapidly than the uninformed man in the street. Anyone who recognized the inflation in time could safeguard himself against paper money losses by buying, as rapidly as possible, any commodities which, like houses, landed property, manufactured goods and raw materials, would keep their value in contrast to paper money. The flight into material goods enabled not only the well-to-do but also, and more particularly, all the sharks, to preserve and increase their fortunes.
The way these people pushed to grow rich by exploiting the ignorant majority led to a moral poisoning of every aspect of business life. All saving ceased. Anyone unable to fmd any durable material goods to buy spent all his money as rapidly as possible on all kinds of things giving immediate pleasure. The less money was worth, the quicker the pace of its devaluation. Great unrest and mounting embitterment afflicted the working classes, professions, the civil service, the office-workers and those living on fixed incomes, who often could not pay for the bare essentials.
Perhaps it will be asked why the workers accepted such devalued money. The answer is simple: because modern man can neither buy nor sell without money. In a natural or barter economy there is no need for money. The modern commercial and market economy with its highly-developed division of labour cannot effect the exchange of goods and services without a universally valid means of exchange and payment.
Throughout history there have been periods of inflation. Only rarely can they be ascribed to circumstances which are beyond human cognition and control. In the majority of cases inflation comes about through mistaken financial policy, or even more frequently because the costs of wars and armaments exceeded income from taxes.
Privy Councillor von Grimm, a member of the directorate of the Reichsbank, explored this question in his speech to mark the fiftieth anniversary of the bank's foundation on 2 January, 1926 : 'To an ever growing extent the Reich had to resort to the Reichsbank if it was to prolong its existence, and because the point at issue was the survival of the Reich, the Reichsbank did not regard itself justified in refusing even after the passing in 1922 of the law which gave it formal autonomy.'
The legislation of 1922, which was intended to free the Reichsbank from the claims of the State, came to grief at the decisive moment because the Reich could not find any way of holding its head above the water other than by the inflationary expedient of printing banknotes.
In 1922-23 a whole series of plans aimed at restoring stable money were published, and publicly discussed. I participated only to the extent of suggesting that a means of payment based on gold should be found, a form of money which would be usable only abroad, and which would provide the populace with an index of how far the value of the paper Mark had fallen since yesterday. I regarded the deception of the public over the value of the paper Mark to be particularly unjust socially.
The first step towards the stabilisation of the Mark was a decree issued by the Reichsbank on 17 November, 1923, whereby it would not accept any emergency money after 22 November. Holders of these notes were given four days in which to redeem the emergency money lying in the safe deposits of the Reichsbank.
The result was immense consternation amongst those who profited from the system of_emergency money. The emergency money vanished. If my firmness did not make me popular with the industrialists and the municipalities, this was a cross I had to bear. Hugo Stinnes went so far as to inform the Reich Government that the businessmen of the Rhineland would decline to have any further dealings with me. It took well over a year before my opponents recognised that my measures were justified - by then the stabilisation of the Mark had succeeded.
There were several other occasions in the course of my activities in the field of currency policy on which business circles, particularly big business, were dissatisfied with or divided about my measures. Although my policies were always directed towards the furthering of the economy, at times they must have been uncomfortable and troublesome in their effects. This lost me much sympathy. I have always appealed to the sense of responsibility of the captains of industry. Responsibility is the fundamental condition for the preservation of private property and of all private enterprise.
There was a second obstacle to the stabilisation of the Mark. On 20 November, 1923 the Reichsbank decided to maintain a rate of exchange of 4.2 trillion Marks to the Dollar. This rate was chosen essentially for accounting reasons. The peace-time exchange rate had been 4.2 Marks to the Dollar. Thus it was now only necessary to remove the noughts from the 4.2 trillion in order to achieve a simple conversion to the old gold Mark basis. By and large any other rate of exchange could have been chosen. The main thing was to fix the exchange rate.
The speculators, however, did not believe that the Reichsbank would be able to hold this rate of exchange rate for any length of time, and bought dollar after dollar . on time bargains at a much higher rate of exchange. Towards the end of November the Dollar reached an exchange rate of 12 million Marks on the free market This speculation was not only hostile to the country's economic interests, it was also stupid. In previous years such speculation had been carried on either with loans which the Reichsbank granted lavishly, or with emergency money which one printed oneself, and then exchanged for Reichsmark.
Now, however, three things had happened. The emergency money had lost its value. It was no longer possible to exchange it for Reichsmarks. The loans formerly easily obtainable from the Reichsbank were no longer granted, and the Rentenmark could not be used abroad. For amongst the stipulations governing the issue of the Rentenmark, there was one which forbade the surrender of Rentenmarks to foreigners. For these reasons the speculators were unable to pay for the Dollars they had bought when payment became due. They were forced to sell the Dollars back, and the Reichsbank was not prepared to pay more than the official rate of 4.2 billion Marks to the Dollar. The speculators made considerable losses.
This first success had also a favourable effect on the internal payments situation. Whereas at first small traders had preferred to deal in Rentenmarks they soon grew accustomed to Reichsmarks. Already by December, trade accepted Rentenmarks and Reichsmarks on equal terms. Yet all this still did not add up to the ending of inflation. Everything had to be done to prevent any new inflation in the future. The fact that the Reich government was no longer allowed to raise credits with the central bank contributed to this and the success of this restriction was in large part due to the Reich Finance Minister, Luther, who showed himself just as resolute in the face of pressure as the Reichsbank.
Yet the greatest impediment to a final stabilisation of the Mark was the growth of industrial credit. Industry and trade were bled financially dry by the inflation. To set the economy in motion again required a great deal of help from outside, which the Reichsbank was asked to an ever greater degree to supply. It was difficult to deny these justified claims for credit. The lost war and the subsequent years of inflation had seriously retarded the progress of the German economy. Economic reconstruction demanded considerable new resources. But all available capital had been spent on war costs and reparations. Thus there was no alternative to making use of credit. And the only authority which could grant such credit was the Reichsbank. But the Reichsbank could not print banknotes to its heart's content and put them into circulation without engendering a new inflation.
A certain willingness on the part of the Reichsbank to meet those who clamoured for credit legitimately halfway had the unfortunate result that the Reichsmark fell below par on the foreign money markets. At the end of 1923 the Reichsbank and the Rentenbank had outstanding credits of some 609 millions, four weeks later this had increased to 1,153 millions and by the end of March the amount stood at over 2,ooo millions. This rapid increase in the circulation of money in an economy which was still heavily in deficit not only pushed up the level of commodity prices, but also affected the exchange rates.
The Reichsbank's reserves of foreign exchange fell once again. Back in December 1923 the Reichsbank had been able to meet between 15% and 20% of industry's foreign exchange requirements but by the beginning of March the proportion was down to 1%. Fears that the Reichsbank would be unable to maintain the Dollar exchange rate were once again on the increase. The spectre of a new inflation re-emerged. Once more speculators began to hoard foreign exchange.
The Reichsbank was compelled to take energetic measures to force the banks to acknowledge their reliance upon the Reichsbank. Recalcitrant banks were excluded from using its clearing facilities, the Reichsbank refused to discount their bills until and unless they complied with the instructions. The fact that one of the four big banks was amongst those so reprimanded caused a great stir.
In the meantime the economy's need for credit increased to such an extent that whatever decision the Reichsbank reached would have serious disadvantages. It had to face the question whether to grant an increasing amount of credit to the economy - which would have meant a fall in the value of the Mark and a new inflation - or whether to maintain the stability of the Mark. The Reichsbank plumped for the stability of the Mark.
On 5 April, 1924, an edict was issued whereby as from 7 April no new credit of any kind would be granted, and all new discounting of bills of exchange would be suspended : from now on discounting would only take place to the extent to which repayment of credits would cause money to flow back into the Reichsbank's cash reserves.
Understandably enough this intervention, which contradicted all the traditions of central banking, caused a great outcry. The bank stood firm against this storm. It was vindicated by success. The difficult period of credit restriction lasted no more than two months. All speculators, who had once again hoarded Dollars, exchanged their holdings of foreign exchange for Reichsmarks and thus enabled them to be used to aid the economy. The bank's action saved not only the currency, but also confidence in the currency. This confidence was not based on tedious expositions of proof or exhortations, but was supported by the weight of action.
For the first time since the previous decade the German foreign exchange market functioned smoothly and properly. Only now, as was confirmed by public opinion, was there positive proof of the success of the stabilisation of the German currency. The Reichsbank's gold and foreign exchange reserves, which had at the beginning of April, 1924, amounted to 6oo million Marks, more than doubled by 7 August.
Strangely enough, a few years later a literary and political dispute began about the question of who should take the credit for stabilising the Mark. Since the large majority of laymen rarely understands the connections between financial matters, this dispute centred on the Rentenmark. Thus the name Schacht became associated with the 'invention' of the Rentenmark. The German Democratic Party, which I had helped to found, plastered an election poster with the legend 'Who was it thought up the Rentenmark ? Who other than Schacht, a democrat'. ('Wer hat die Rentenmark erdacht ? Das war der Demokrat, Herr Schacht.')
This was a completely incorrect description of the process which effected the stabilisation !
Nonetheless, it was a description which was easily grasped by the public at large. In actual fact it has never been established who really coined the word 'Rentenmark'. It was probably dropped casually in the course of parliamentary debate, and then perpetuated by habit. Indeed from the very first I myself always stated emphatically that I regarded the Rentenmark as a completely inadequate solution to the problems besetting currency policy. It was justified only by the party-political conditions then prevailing.
The nationalism of currency
The crucial criterion for the approval of the Rentenmark was that it should not be accorded the status of 'legal tender' which would have made its acceptance for payment legally enforceable. The notes issued by the Reichsbank did, however, retain their status as legal tender. Only the fact that the Reichsbank at once announced that it would accept the Rentenmark at any time at the same value as its own new Reichsmark, avoided a differentiation between the two currencies.
Modern paper money, the banknote, is backed by its creator, the State. Money, if it does not consist of tangible metal, is purely an internal affair of the national State.
Currency is the most nationalistic factor in political life. Every central bank responsible for issuing it is dependent on the government of the country by whose laws it was instituted, and which makes its notes legal tender in the country's home territory.
The granting of credit is unthinkable without a central bank. No central bank can be allowed to act against the government of the country. The government is over the central bank, and influences its policies. It is thus also in a position to inflate the currency by taking up too much credit with the central bank. No international central bank could countenance such a situation. It ca1mot permit one of the governments with which it is associated to misuse its facilities unless every other government is in agreement.
Standing over and above central bank and goveriunent, both of which are led and administered by changing personalities, there is a higher, impersonal, and substantially necessary law : the stability, the constancy of value, of money. This higher law has in the past granted the central banks an autonomous, independent position. Governments change, and can pursue good or bad currency and credit policies according to whether or not it is to the advantage of the party in power. We have seen that during the period of absolute rule even the princes forged their own coinage.
In a democracy the idea that a central bank might pursue policies hostile to the government is politically untenable. The only answer is that when an unbridgeable conflict between the currency conceptions of government and central bank arises, that conflict must be decided by the authority which makes the laws of the land. The populace must be informed of such a far-reaching disagreement.
The financial stringency which the French occupation brought to the Rhenish-Westphalian economy, gave rise to the idea that an independent Rhenish-Westphalian currency bank might be founded to cater for the credit needs of the province's economy. It is no longer possible to establish whether this idea originated with the French or the Germans. In any case the French occupation authorities took up the idea with diabolic glee. It offered a means of separating the economy of Rhenish-Westphalia from the rest of the Reich in a legal, seemingly friendly way, while at the same time seriously setting back the underground clamour for an independent state on the Rhine.
Many leading Ruhr industrialists saw in the foundation of such a bank the only way to keep their concerns in operation, and succumbed to the temptations offered by the French. They did not, or did not wish to, recognise the immense political dangers which were inherent in such a move, since the majority of the capital and thus a controlling interest in the direction of such a bank would be in French hands. The Rhenish interests were at that time reproached for a lack of patriotism almost amounting to treason.
Fortunately, the French intentions were not realised. By good luck I was given the chance to prevent them from being brought into effect. Shortly after my appointment as President of the Reichsbank at the end of December 1923 and prior to taking up my office, I went to London to discuss the German currency situation with Montagu Norman, Governor of the Bank of England, who had invited me to visit him.
Now Norman sat opposite the president of the German Reichsbank, his professional colleague, to whom he ascribed responsibilities similar to his own. His intelligence and fairness, which cannot be esteemed too highly, enabled me to explain the devastating consequences which would ensue for the German economy, and thus also for the peaceful reconstruction of the world, if the German currency were to be split into fragments. When I concluded with the remark that unfortunately the German government did not have the strength to prevent the French plan, Norman replied quite calmly 'In questions of currency I go by the views of the Reichsbank not those of the government'.
While it was still uncertain how soon the stabilisation of the Mark would succeed, I was able to realise my original idea of a currency bank working on a gold basis.
Trade agreements
In the second half of 1931 fantastically high tariff walls were erected by those countries which took four-fifths of German exports. This trend began in August 1931 in France which established the first import quotas at this time. In September 1931 Poland raised its industrial customs duties by up to 100%, and Italy imposed an all round 15% surcharge on customs' duties. In October 1931 France established further import quotas and in addition raised its tariffs. Six other countries joined this trend to restrict imports, and five others planned to restrict imports as from December 1931.
The new National government of England imposed a further 50% ad valorem duty mainly on German imported specialities, and thereby added yet a further impediment to the obstacles to imports already presented by the devaluation of the Pound.
To overcome the obstacles presented by these foreign measures was a matter of life and death for Germany. Two possibilities presented themselves. The first originated in the spirit with which the National Socialist party was imbued, and consisted in the attempt to become as far as is conceivably possible completely independent of foreign raw materials. Autarchy was the ideal. Germany was to live on German raw materials, foreign trade was to be restricted to the absolutely indispensable.
It was thus absolutely right to facilitate attempts to achieve a greater degree of autarchy, so longas this did not engender other unpleasant consequences. Yet unfortunately an excessive emphasis on the idea of autarchy results in weakening the friendly ties between the nations, and increases isolation and estrangement.
Exaggerated autarchy is the greatest obstacle to a world-wide culture. It is only culture which can bring people closer to one another, and world trade is the most powerful carrier of culture. For this reason I was unable to support those who advocated ·the autarchistic seclusion of a hermitage as a solution to Germany's problems. On the other hand, I had to break the short-sighted and · dangerous stranglehold which foreign countries were exerting on Germany. A way had to be found of conducting a trading policy which would ensure that Germany's requirements of raw materials and foodstuffs were met.
In September 1934 I introduced a new foreign trade programme which made use of offset accounts, and book entry credits.
My plan was to some extent a reversion to the primitive barter economy, only the technique was modern. The equivalent value of imported goods was credited to the foreign supplier in a Gennan banking account, and vice versa foreign buyers of German goods could make payment by means of these accounts. No movement of money in Marks or foreign currency took place. All was done through credits and debits in a bank account. Thus no foreign exchange problem came into being. So long as our creditors, despite the indications to the contrary given by the Dawes and Young plans, continued to think of reparations and loans solely in terms of transferring money, rejecting transfers of goods, the new plan was the logical as well as the natural answer. It was also a practical demonstration which had the pleasing effect of gradually giving our creditors a better insight into our situation.
For if these creditors thought they had found the remedy in controlling German exports, in clearing agreements, or even in impounding export proceeds to effect interest payments, the reaction in their own country must have come as an unpleasant shock to them. Those interested in the exchange of goods came into conflict with those interested solely in money. There was soon a battle royal between the exporters who sold goods to Germany, and the creditors who wanted their interest. Both parties demanded to be given preference, but the decision always went in favour of foreign trade.
I concluded special agreements with a number of states which were our principal sources of raw materials and foodstuffs. Anyone who wished to sell raw materials to Germany had to purchase German industrial products. Germany could pay for goods from abroad only by means of home-produced goods, and was thus able to trade only with countries prepared to participate in this bilateral programm. The whole of South America, and the Balkans were glad to avail themselves of the idea, since it favoured their raw materials production. By the spring of 1938 there were no less than 25 such offset account agreements with foreign countries, so that more than one half of Germany's foreign trade was conducted by means of this system.
This trade agreement system in which two countries - Germany and one foreign country - were always involved, has entered economic history under the name of 'bilateral' trading policy. It created much ill-feeling in countries which were not part of the system. These were precisely those countries who were Germany's main competitors in world markets, and who had hitherto attempted to effect repayment of their loans by imposing special charges on their imports from Germany.
The countries participating in bilateral trade were not amongst those which had granted Germany loans. They were primary producers or predominantly agrarian, and had hitherto scarcely been touched by industrialisation. They utilised the bilateral trading system to accelerate their own industrial development by means · of machines and factory installations imported from Germany.
The bilateral trading system kept the German balance of payments under control for many years, but it was not a satisfactory solution, nor was it a permanent one. It is true that it enabled Germany to preserve its industry and to feed its populace, but the system could not provide a surplus of foreign exchange. No more was ever imported than was exported. Import and export balanced out exactly in monetary terms. Thus this system achieved the very opposite of what I, in agreement with the foreign creditors, had deemed to be necessary.
The bilateral trading system was not ideal. Nor was it a spontaneous invention. It was merely a reaction to and a means of overcoming the discrimination against German products. Germany's creditors demanded payment in foreign exchange, but refused to let Germany earn foreign exchange through sales of her goods. What else was left to Germany but to take its trade to places which were prepared to accept German produce? Already at the time when I introduced the bilateral trading system I made it known that I regarded it ·as a most inadequate and unpleasant system, and expressed the hope that it would soon be replaced by an all-round, free, multilateral trading policy. In fact the system did have some considerable influence on the trading policies of Germany's competitors. The measures taken against German exports were gradually lifted.
So far as monetary policy is concerned, the crucial aspect of bilateral trade is the fact that it takes place without any transfer of money. An inevitable concomitant was the necessity to grant credit. The foreign supplier was not always able to obtain immediate delivery of the German product which he wanted. Often he had to wait until such a product was ready for delivery, and thus had to give credit for this period. The same happened from the other side in the case of deliveries of agricultural produce which was tied to the seasons. In such a case the German manufacturer supplied his goods in advance, and gave the foreigner credit until such time as the harvest would enable him to deliver the equivalent.
Here credit was not granted voluntarily for any private business reasons, it followed inexorably from the necessity to dispose of or acquire goods. Although the already-supplied or yet-to-be-supplied goods constituted the security for the credit, repayment was bound to the generalvolume of production, and thus the period over which the loan would be required was uncertain. This is also one reason why this system could not be extended in time and extent as freely as one would have wished. It was dependant on the mutual possibilities of delivering the chosen goods. In the course of the years Germany in particular found itself in arrears, because it could no longer supply sufficient industrial products. Hitler's rearmament took up too much of the productive capacity of German industry.
Bilateral trade is by no means the ideal instrument for world commerce. It does not supply foreign exchange for the purchase of such goods as cannot be obtained from the bilateral partner. Nor does it permit trade to be extended beyond the ability of one of the two partners to supply goods. Its possibilities of development are therefore limited.
The Dawes plan was able to function· for some seven years, from 1925 to 1931, because in that period Germany raised so many loans abroad that it was able not only to satisfy the needs of its own economy, but also to transfer the annuities due under the Dawes plan. That, however, by no means squared with the spirit of the Dawes plan.
In the autumn of 1929 the sensational crash on the New York stock exchange heralded the greatest world economic crisis ever seen. American willingness to grant loans to Germany came to an end. The total volume of world trade rapidly shrank to a third of its former level. At the same time it became apparent that Germany would be unable to fulfil its obligations under the Dawes plan.
Wall Street crash 1929
The new Young committee worked out a new plan, known as the Young plan. It retained the basic idea of the Dawes plan, differing from it essentially in that it reduced the figures fixed by the Dawes plan by a little. The Young plan did not inspire confidence for it could not dispel the general feeling that the problem of reparations had not been satisfactorily solved.
The loan instigated by the Young Committee (the Young loan) to bolster up German industry and the German currency, was not taken up in its entirety, remaining to a large extent on the hands of the issuing banks. This provided proof, if proof was needed, that excessive unilateral monetary demands made by one modern industrial state against another cannot be met. Germany's debt payments came to a stop, and even the one-year moratorium which was granted in June, 1931 at the instance of the American President, Hoover, could not prevent the total collapse of the German economy in July, 1931.
A year later, all claims to further reparations were finally buried officially at the Geneva conference.
The fools who after 1918 demanded war damages of 420 billion from Germany should have learnt the lessons of their own history. When Bismarck came to determine the reparations to be paid by France after she had lost the war of 1871, he sought and took the advice of an experienced banker, James Bleichroeder. The amount was limited to 4 billion Marks. This was the sum which in Bleichroeder's view could be paid without bringing the economy of France into insuperable difficulties, and without endangering French currency. France was a rich country, and jusdy had an excellent credit standing in the world. The damage to its industries occasioned by the war was inconsiderable, and the costs of the war had not been excessive.
In 1918 at the end of the First World War everything looked different. Where the war of 1871 had been fought with soldiers, in the 1914-18 war the emphasis to an ever greater extent was transferred from men to machines. Lives unhappily are cheap, but machines are expensive. The Franco-Prussian war of 187o-1 lasted seven months, the First World War took more than fifty months. The destruction wreaked on Germany's industry was tremendous, the fmancial condition of the state, and thus its creditstanding, was approaching zero.
The victors' claim that the losers should make good the enormous war expenditure was directed at a country completely incapable of paying. The total cost of the First World War was estimated at the time to amount to some 850 billion gold Marks. Germany's share of thisloss was estimated at 150 billions. The allies thus aimed at the restitution of 700 billions, which it was intended to squeeze out of Germany. In actual fact the first demand by the French Finance Minister, Klotz, was for 420 milliards. That it was senseless to accept such sums in German currency, and thus in banknotes issued by the Reichsbank, was self~evident. German Marks had purchasing power only in Germany, what was needed were Francs, Pounds Sterling, Dollars, which could be spent in one's own country. Germany had already spent its gold reserves in the course of the war. Nor did it have any Dollars, Francs or Pounds. The victors therefore reverted to the methods of compensation current in ancient history.
The ancients took their booty mainly in the form of slave labour abducted from the conquered lands. With our present day social system that was no longer possible. The unemployed of the victor states would certainly have protested against such a method. But material goods were of use. Germany could supply coal, potash, ships, waggons and locomotives, chemicals, steel and other industrial products. Of course, this too would soon rouse opposition in the victor states, whose industries wanted to make and sell these things themselves.
In November, 1925, the renowned Swedish economist, ·Professor Cassel, asserted that the prospects for further reparation payments were not good, because to effect them German exports would have to be raised to double the volume of the previous year. It was impossible to see who would accept these exports. Professor Keynes was even more pessimistic in his public utterances. It was very much to the credit of the Dawes plan that it transferred the reparations problem from the sphere of the political power game to that of economic possibility. Today it is of great interest to recall its basic ideas.
To transfer large sums of money from one country to another without providing any kind of equivalent value has proved to be impossible. In the barter economy, and in the restricted medieval money and payment system when coin still had the value of its own substance, this problem never arose. After 1918, however, it was proved publicly to be insoluble. No currency bank in the world has gold and foreign exchange reserves large enough to enable such a vast war debt to be settled. Such debts can be paid only by means of goods or services.
A currency can be used only in places where it is legal tender. Naturally in the normal course of international trade and commerce currencies are .carried hither and thither, but in the last resort they can be used only in the country in which they originated. No one will purchase a foreign currency unless he is obliged to pay debts in a foreign country, or wishes to buy its products. Once again we see currency to be the most nationalistic of all economic factors.
The financing of War
Before the First World War the general tone of the German economy was so good that no-one gave a thought to crisis, let alone to war. It was not until the assassination in Sarajewo at the end of July, 1914, that the possibility of war was taken seriously.
The war of 1914 provided telling proof of the fact that State guaranteed paper money, unlike gold and silver coins, does not represent any substantial value.
The war of 1914 isolated Germany from the greater part of the world market. Even at points where Germany bordered on neutral neighbours, the purchasing power of the Mark was limited to the amount which these countries were able to employ to purchase German goods. The Mark had become unusable on enemy markets. It had lost its purchasing power.
Raw materials and foodstuffs were not available in sufficient quantities. The principal material goods which, apart from manufactured exports, could be sent to the neutral foreign countries as payment were gold coins · and gold. The available funds were, however, quite insufficient to conduct a war which was to last four years. Thus in addition to the war effort, an export of goods had to be kept alive so that the proceeds might be used to pay for the required materials. The shortage of raw materials and foodstuffs led to existing stocks being allocated to consumers in strictly limited quantities. The State-managed economic system made its first appearance in modem economic history. Socialisation by public bodies entered into the free capitalistic market economy. War inclines to socialism.
In a war the state is the largest employer and buyer of goods. The state had to fmd money to pay the soldiers and the industrial workers, as well as for all the products required to fight the war. The normal State budget is not sufficient for such out-of-the-ordinary and one-sided needs. The State was thus compelled to resort to making inroads into the income and capital of its citizens. The mere multiplication of banknotes could result in nothing less than a general rise in the price of goods. For the quantity of goods does not increase merely because the quantity of notes in circulation increases. Fot this reason the savings of the population had to be mobilised. Such savings could be taken from the populace either by taxation, or by State loans to which the citizens would be exhorted to subscribe. In 1914 the German government fmanced the war almost entirely by the second alternative.
Through state loans it transformed the savings and movables of its citizens into claims on the state. Whether or not these claims would be honoured, depended on the outcome of the war. This method of fmancing was mistaken. A state which goes to war must come to terms with the fact that war is a matter of life and death, and that therefore every citizen must participate down to his last savings and last possessions. Taxes imposed upon the citizen in war-time bring him face to face with the true reality. The war loans given to him in the form of paper in return for his services, only serve to deceive him about the seriousness of the position.
The main slogan of war finance therefore remained the constantly repeated exhortation 'Buy War Loan'. By the war's end hundreds of billions of war loan had been taken up by the German public, billions which defeated Germany would be unable to redeem.
Germany's opponents, particularly England, availed themselves of the first alternative. There the war of 1914 was financed principally by taxes, directed in the first instance to those circles and concerns which profited from supplying materials of war. The taxation policy pursued by the English wartime government proved itself more socially just than the German policy of loans which lost their value after the war, and thus proved a great disappointment to those who had willingly made sacrifices by subscribing to them.
In Germany the numerous war profiteers were left to enjoy their gains !
Apart from the profits earned from war industries, high profits were to be made from trade. Often the import of quite ordirtary foodstuffs from neutral countries meant considerable gain for those concerned both inside and outside Germany.
The First World War had two crucial lessons to teach future warmongers. Firstly that it is necessary to possess or have ready access to a quantity of raw materials and foodstuffs sufficient to cover all needs throughoqt the foreseeable or possible duration of the war. Secondly that those waging the war should be prepared if necessary to devote the whole of the national income to the war effort, and that the necessary sacrifices should be spread justly and evenly.
Hitler had completely failed to learn the first lesson. It did not require the second sight of a prophet to forecast the unfortunate outcome of a war fought against opponents so rich in raw materials and foodstuffs as England and France.
When Japan ventured to make war on America I commented 'A country which produces 9 million tons of steel a year can never win a war against a country which has a steel output of 90 million tons per year'.
In 1934, in the course of a lecture which I had been invited to give before the officers of the war academy by their commanding officer, General Thomas, I said that weapons of war could not be made out of paper tokens. I also said 'The possibility of making and winning war is closely dependent on the economic strength and equipment of a nation. A modern war is unthinkable without a most highly-developed industrial technology and without the greatest efforts both in production and in distribution'. I referred to the fact that failure in a prolonged war was inevitable from the very beginning unless the continued supply of foreign raw materials could be guaranteed.
Hitler used neither taxation nor the raising of loans to fmance his war. Instead he chose to print banknotes. He paid for all homeproduced goods needed to wage war with banknotes which could never have held their original value. The consequence was another inflation. Legal goods quotas, price control, and restrictions on trade and commerce prevented this inflation from becoming immediately apparent. Its recognizable effects were postponed to the end of the war, but then they became apparent with correspondingly greater distortion.
My lecture to the Academy of War was thus of little avail. Most officers never learnt to understand the essence of money. Nor did Hitler have the least inkling of an understanding for money and the monetary system.
The prosecution at Nürnberg concentrated on the question whether the rearmament I had helped to finance was preparation for a war of aggression, or whether it was only a case of armaments to be used in defence. The actual level of armaments expenditure must have a decisive influence on the answer to this question. The statements of the witnesses Field-Marshal Milch, Admiral of the Fleet Doenitz, and General Jodi showed that Hitler did not have the slightest idea what was necessary from the financial and economic point of view to wage a modern war. The head of the war ministry, Field-Marshal Keitel, when called to the witness stand, declared under oath that the total expenditure of the Reich on armaments during the financial year 1935-36 amounted to 5 billion Marks, while in the following two years the amounts were 7 and 9 billion respectively. Such small sums were quite insufficient to prepare for a world war.
Things were no different where the stockpiling of raw materials is concerned. Until the middle of 1936 Hitler did not concern himself in any way with the economic preconditions for waging a war. But he was repeatedly told that I, as Minister of Economic Affairs, emphasized the need to maintain foreign trade at a high level. In my deliberations with the government and business circles I always harked back to the fact that it was senseless to replace raw materials which could be imported cheaply. with substitute materials expensively produced at home. At one time Goering exhorted a large gathering of leading industrialists to produce more without asking if it would be profitable to do so. I replied a few weeks later before a public of a similar composition that to do so would be to make the German economy into a robber economy which fed upon itself. It is quite without rhyme or reason to sow one barrel of corn if the harvest will amount to only three quarters of a barrel.
Hider's dissatisfaction with my economic policies led to his big speech at the autumn party conference of 1936 in which he announced the second four-year plan. In doing this he exposed to public view his utter ignorance of economic realities. In a discussion between my ministry and other government departments held a few weeks previously, figures for foreign exchange and raw material reserves were presented, with the caution that in the spring of 1936 the German economy's stocks of raw materials had shrunk to 2 months' supply. To increase the production of fuel oil substitutes would be a very slow process, and anyway the requirements of industry were too large in proportion to the present possibilities of production. Regarding the foreign exchange position, I remarked that a 25% increase in exports would be necessary to pay for the level of imports which was desirable. There was no chance of such an increase taking place in the foreseeable future.
In his Party speech Hitler vehemendy opposed my attitude. Yet this speech did not contain a single indication of how the stock of raw materials might be increased, it only made demands, accompanied by accusations and threats addressed at industry.
In his book Germany's economic preparations for war published by the Harvard University Press in 1959, Burton H. Klein gave a pregnant exposition of the manner in which Germany fmanced the Second World War. From Klein's expositions it is clear that Hider's financial and economic preparations for war were quite inadequate, and that the real exertions began only after the outbreak of war. Klein takes the view that subsequently Hitler and his general staff would have preferred better economic preparations for war.
Hitler's diatribe against industrialists in his 1936 Party speech raises the question whether it is at all true that the banks and industry and none other than they are to blame for the fmancing of war. It is not they but politicians and military men who decide about war and peace.
In January, 1933, after Hitler had been entrusted with forming a government there still remained the possibility of testing and influencing the governm~nt's sense of responsibility because it was answerable to parliament. Hitler had to reckon with this possibility. And it was with this reservation too that Wels, the chairman of the Social Democratic party, a Hitler government as inevitable. It will always remain a mystery on what grounds the middle-class minority parties passed an enabling law which gave Hitler the power to change the constitution of the Reich exactly as he wished. The parliamentarians who perpetrated this act of political irresponsibility have never been brought to justice.
In the session of Reichstag on 17 May, 1933, Hitler made a speech in which he declared that the German government was prepared to disarm if all other powers also disarmed. But if all the other powers did not want to disarm, then Germany would regard it as its right to take the same military measures as the others. Only after one and a half years, during which time the other powers showed no willingness to come to terms on the question of armaments, did Hitler begin to rearm. Hitler's declaration in the Reichstag session of 17 May, 1933 was approved by all parties without exception, including the Social Democratic patty. The decision of this Reichstag was unanimous. Thus if the Reichsbank in operating the MEFO bill system also granted MEFO bills which were used, for weapons of war, it did so by the unanimous resolve of the Reichstag.
The second inflation
How far the purchasing power of the Mark had once again fallen as a result of this second inflation emerged only after the end of the war, and the renewed collapse of the German economy. Impoverishment and misery was far worse than after the First World War. A huge number of houses, offices and factories had been destroyed. A stream of 10 million refugees from the East clamoured for resettlement. The restrictions of the war years were made even more stringent : rations were even shorter.
Nonetheless, the extent of the inflation could not be compared with that of 1923. Although the number of notes in circulation at the end of the war was never determined exactly, it is generally estimated at between 40 and 60 billion Marks. The task which presented itself after the war was to ensure that this level was maintained and not exceeded. In other words, the inflation had to be kept in check, it could not be allowed to spread.
The second inflation was a direct result of the war. Until then, currency policy was well run, and the economy was properly under control.
Hitler's most urgent task after taking over the government in 1933 was to get rid of unemployment. 6,5 million people had to be brought back to productive work. The problem consisted not only in the provision of the necessary fmancial backing, but also in fmding productive work to employ people in the regions in which they lived. Public works - building roads, tunnels, canals and dykes-were an excellent source of employment. But when such works began to be carried out on a large scale it meant that large numbers of labourers had to be brought together, with all the attendant problems of the need to build hostels, estrangement from home surroundings, and many other social and cultural disadvantages.
Jobs had to be found which were not tied to any one place, but which would bring orders to as many factories and workshops as possible all over the Reich. Three main methods were used.
The first was an extensive programm of repairs devised by Reinhard, the state secretary of the Reich finance ministry. Loans were granted for repairs to houses, factories, machines. They were very welcome, since during the deflation years of the Brüning era many plants and installations had suffered, because daily maintenance had been neglected. Much needed to be done in the private as well as in the public sector.
The second method was the building of the autobahns, and already in the summer of 1933 work began with the building of the stretch connecting Frankfurt/Main with Darmstadt. As the number of employment opportunities grew perceptibly, the Reichsbank began to grant direct loans for both these activities.
The third method was the defence programme. The building of barracks and the equipping of troops brought orders to concerns spread over the entire country. As the cost of this part of the programm to secure employment for everyone was so great and the repayment period so long, the method by which credit was granted directly to the Reich could not be used here. There was too great a danger that the Reichsbank, in granting direct credit, would lose control of currency policy. A way had to be found which would ensure that the Reichsbank was able to restrict and limit the amount of money in circulation. It took us in the Reichsbank a year and a half to fmd a system which was suitable, and would still enable us to pursue a responsible currency policy.
The provision of money for defence did not therefore begin until the late summer of 1934.
The system worked in the following way : a company with a paid-up capital of 1,ooo,ooo Marks was formed. A quarter of the capital was subscribed by each of the four firms Siemens A.G., Gutehoffnungshütte, Rheinstahl and Krupp.
Suppliers who fulfilled state orders drew up bills of exchange for their goods, and these bills were accepted by the company. This company was given the registered title of Metallforschungsgesellschaft (Metal Research Company, 'MEFO' for short), and for this reason the bills down on it were called MEFO bills. The Reich guaranteed all obligations entered into by MEFO, and thus also guaranteed the MEFO bills in full.
The Reichsbank declared itself ready to prolong the bills, which true to the form laid down were drawn on 3 months' credit, to a maximum of five years, if so required. Each bill could thus be extended by a further three months, nineteen times running. This was necessary, because the planned economic reconstruction could not be accomplished in 3 months, but would take a number of years.
In all, MEFO bill credit transactions took place over a period of 4 years, and had by 1938 reached a total volume 12 billion Marks. This amount was not issued all at the same time, but in step with the progress in production. On average, bills to the value of 3 billion were issued each year.
In 1937 the first price increases became evident, and full employment had nearly been achieved. Employers began to compete with each other for workers. In the beginning of 1937 I therefore informed Hitler that I would be suspending the MEFO credits. A long-drawn-out dispute ensued. I threatened to resign from my post as President of the Reichsbank if Hitler did not sanction my proposed action. A compromise was reached, whereby I would continue in office for another year, that being conditional upon the suspension of the MEFO credits once they had reached a total volume of 12 billion. Hitler agreed, and kept his word.
The MEFO bill system was not and could not be a perpetuum mobile. As soon as full employment had been reached every further granting of credit could only lead to an excess in the circulation of money, and to a rise in the price level, and thus to inflation. This had to be avoided at all costs.
Great care was also needed to ensure the repayment of the bills at the latest by their definitive due date five years after their issue. When the MEFO system was introduced I fully expected that the revitalisation of the economy would result in such progress in the growth of incomes and in capital formation that repayment would be made possible by growth in taxation yield together with loans. This expectation was not only realised in full, it was also widely exceeded. In the years between 1933 and 1938 the Reich's income from taxation rose by over 10 billion Marks. In the same period I succeeded in placing no less than 8 billion in Reich loan stock with the general public. The means to repay the MEFO bills guaranteed by the Reich thus existed in plenty, particularly since repayment was not due all at once, but was synchronised with the growth of the economy. The reason why the system could be abandoned, is that the rising taxation revenue and growth in savings made it possible to cover expenditure by the normal means of taxes and loans. The Reich's revenue from taxes increased from 6,5 billion to 14 billion between 1932 and 1937.
The MEFO system was a noteworthy example of the fact that it is possible to make up for a lack of capital by means of credit without any risk of engendering an inflation which causes price rises.
The risk in the whole process lay in two· directions. Had it not proved possible to arrange things in such a way that a large part of the issued bills would be retained by the market and thus not presented to the Reichsbank, then an excessive use of the bank-note printing presses would have been unavoidable. This danger was avoided by making the bills rediscountable at any time, and by paying four per cent interest on them.
The second danger lay in the eventuality that production might not have increased to a degree where it would yield a greater quantity of material goods and higher taxation revenue. Both dangers were foreseen, both were forestalled.
After the collapse in 1945 it was repeatedly asked whether the success of the MEFO bill scheme did not mean that whenever there was a shortage of capital savings one could compensate by replacing such capital savings with credits granted by the central bank, and thus by money specially printed for the purpose. The English economist J. M. Keynes has dealt with the problem theoretically, and the MEFO transactions proved the practical applicability of such an idea.
But the conditions under which the scheme can be applied without disadvantages are not always present. They were indeed present in Germany during the depression of the thirties. Then there were no more stocks of raw materials, factories and warehouses layempty, machines were idle, and six and a half million willing men were unemployed. Liquid capital savings which could have been invested were not available. Production was restricted to such a degree that accumulation of capital could not take place. If rapid capital formation was once again to become possible, the powerful but stagnant productive resources had to be brought back into operation. The capital which could be expected to result from such developments was used in advance to grant credit through the MEFO transactions.
The MEFO system functioned and played its role in currency and financial policy for five years between 1934 and 1938. It would certainly have been wound up according to plan; it was Hitler's war craze which brought it to an unsavoury end. The Reich Finance Minister's letter did not make the least impression on Hitler. He was instructed not to pay the MEFO bills amounting to three billion which became due in 1939. In a few terse words the Minister informed the Reichsbank at the end of 1938 that he was not in a position to honour the bills as provided by contract, and agreed by solemn promise. This happened, despite the fact that the Reich had the means to honour the bills. But Hitler used these means to produce yet more weapons of war, and did not shrink back from protesting bankruptcy as if he were really unable to pay.
In the first days of January 1939, the Reichsbank handed Hitler a memorandum in which it indicated its refusal to grant the Reich any further credits. The consequences were drastic. On 19 January I was dismissed from my office as president of the Reichsbank with immediate effect. On the following day Hitler issued an edict which ordered the Reichsbank to grant the Reich all credits for which the Fuhrer asked. It is true the MEFO bills were now honoured when they became due, but only with the inflated money produced by the printing presses. The second inflation had begun.
Five months after my departure, on June 15, 1939, the edict of 19 January was made public in the form of a law. Inter alia it determined that the Reichsbank's independence was revoked. The directorate of the Reichsbank was subject to the dictates of the government.
The Fuhrer decided the level of credit to the Reich. This left the gate to the second inflation wide open.
The origin course and consequences of this second inflation have not always beeil identified correctly. It is in nearly all respects quite different from the first. The first inflation of the years between 1918 and 1923 came upon us like an inescapable thunderstorm. The war left Germany completely exhausted financially. Then the country was encumbered with paying billions in war debts.
Where was the money for economic and social reconstruction and for the war tribute to come from ? It would have required decades of peaceful economic development. Instead Germany lived under the constant pressure of the demands for goods and money made by the victorious powers. Only in 1924 with the Dawes plan were they brought into a sensible relationship with the possible. Germany could do nothing to avoid the first inflation, the blame for its monstrous proportions cannot be laid on Germany's door.
It is quite different with the second. The National Socialists took over the reigns of government at a time when unemployment had paralysed the German economy. Amongst the credit policy measures undertaken to start production moving again, were some directed towards the reconstruction of military defences. Hitler informed me that this part of the measures taken would probably be completed by 1936. Until that time Hitler left all measures involving economic policy in my hands. He did not trouble himself with any of them, since he understood precious little about economics.
The second inflation did not come as a surprise. It was a conscious and intentional measure taken by the political dictator. The Reichsbank did its utmost to prevent it, but it was politically powerless. From the day of the decree of 19 January the Reichsbank was nothing more than an administrative organ subject to the government, deprived of its own responsibility for currency policy.
Other people's money
The French have a malicious proverb : 'Les affaires, c'est l'argen des autres' - business should be conducted not with one's own, but with other people's money.
Credit presupposes confidence and responsibility. Credit is not only dependent on the borrower's ability to pay, thereis also the danger that it will be either frivolously or maliciously misused.
The borrower in accepting a loan also accepts a great responsibility, that of ensuring that he is in a position to make a profit with the loaned money. The lender runs the not inconsiderable risk that the borrower may not succeed in his enterprise, and thus be unable to repay the loan on time and to pay interest during the term of the loan. The smooth course of a credit transaction is not always dependent solely on the personal standing of the borrower or lender. Often the general economic situation and its development has a disturbing influence on the course of business.
Economic history teaches us that crises occur from time to time. The first modern economic crisis which hit the new Germany occurred in 1873. It was the crisis which marked the end of the so-called 'founder's era' (Grlinderzeit). A great deal of money had flowed into Germany by way of French war reparations, and had led to the founding of numerous businesses. Many of these did not earn the hoped-for profits, and a large number of failures ensued. This led to default on loans and capital losses.
So far as Germany is concerned, the war and post-war years 1914 to 1924 can best be regarded as one single continuous economic crisis. I went through it as governor of one of the big banks. Towards its end I became currency commissioner and president of the Reichsbank.
Apart from crises brought about by political events, general economic crises, as well as the collapse of individual businesses, can almost always be ascribed to a faulty credit policy. The flooding of Germany with the monies arising out of the French reparation payments in 1871, the overstretching of credit linked with it, and the flooding of Germany with foreign credits between 1924 and 1929 are the best examples of this axiom. But the crises of 1901 and 1907, which were sparked off by the collapse of individual concerns, also arose out of a wrong policy of granting credit.
It is easy to understand that it is the endeavour of every economist to avoid every kind of crisis. Since the misuse of money and credit plays a large part in such crises, monetary policy is particularly important in this respect too. Even if an erroneous financial policy pursued by the government cannot be compensated or merely by currency manipulations, the policy of the central bank can yet intervene in many ways to influence the development of a crisis.
The ideal of all economic policies is a level of employment of the entire working population, which is constant and keeps pace with the growth of population.
The post-war crisis of the 'twenties was temporarily solved by the import of massive foreign credit. The robbery with violence perpetrated on Germany by the French occupation of the Ruhr was checked by the adoption of the Dawes plan. The leading idea of the Dawes plan consisted in the attempt to discharge the billions demanded by the allied victors as reparations out of the economy's earnings.
The hopes on which the Dawes plan was built rested on Germany's peaceful development. For this reason foreign countries, particularly America, granted Germany large amounts of credit in order to help the economy to its feet. Despite this, in the six years between 1924 to 1930 there was not a single year in which Germany was able to achieve an export surplus large enough to pay the annuities due on the Dawes plan. These annuities were paid with credits. Taken all in all, in these 6 years Germany took up loans in foreign currency to a value of some 20 billion Marks.
One half of these foreign monies were changed into German Marks and used for internal purposes. The other halfwas used to pay the Dawes annuities. This half of the loans granted was thus in no wise used for those productive and profitable investments, which are of the essence of any credit; instead, this money was spent without the least economic effect or benefit. Here, we may well have the crassest conceivable example of how not to use credit, and thus also how not to grant or accept credit.
From 1924 onwards the Reichsbank, year in year out, at every opportunity, clamoured with increasing fervour for a limitation of foreign credits. No German government between 1924 and 1930 could make up its mind to take the decisive measures required, since they all feared the political consequences. Thus nothing intervened to prevent this excessive taking up of foreign credits for what were often very unsatisfactory purposes. In 1931 all this finally resulted in the greatest financial crash Germany has ever known.
One must recall the severity and extent of the crisis in order to comprehend its momentous impact. Germany's financial and economic emasculation which had begun with the war continued after the cessation of hostilities. The reparations rendered by Germany between 1919 and 1923 in terms of goods and services, were estimated by the Americans to amount to 38 billion Marks. The official German estimate is 54,4. Until 1924 it was impossible to think of reconstruction.
In the spring of 1931 the largest Viennese bank, the Österreichische Kreditanstalt (Austrian Credit Institute) was compelled to suspend payments. This failure also increased the mistrust foreign lenders felt towards Germany. Many short-term loans were called in as a result. Week by week the Reichsbank saw its reserves of gold and foreign currency shrink, and this in its tum led to an acceleration in the withdrawal of loans on the part of foreign creditors.
On July 1, 1931, Norddeutsche Wollkammerei in Bremen suspended payment, and this resulted in its largest creditor, the Darmstädter und Nationalbank, also suspending payment.
A considerable number of banks all over the Reich suspended payments. A hundred co-operative society banks had to be given fmancial support. Countless industrial concerns failed.
In the course of 1932 a large number of companies were forced to use their reserves, and on top of this to eat into their capital. A special emergency decree was passed making it easier to reduce capital. In the flrst nine months after this decree became law 659 companies reduced their capital by a total of one and a half million Marks.
A number of municipalities, including cities such as Dortmund and Essen, had to discontinue interest and amortisation payment on their loans. The social consequences of the crisis became evident in the following years. By the end of 1932 a third of the working population was unemployed and had to be maintained on a subsistence level by means of state funds.
The political consequences did not stay far behind the social ones. The National Socialist movement grew by leaps and bounds.
All attempts to stave off the crisis failed. Most astonishing was the central bank's passivity in the crucial months of 1931. The influence which the Reichsbank had over the business behaviour of the private banks should have enabled it to see the red light in the withdrawal of foreign short-term monies. The Reichsbank itself had after all drawn attention to the dangers inherent in the excessive foreign loans for years. But even if the Reichshank was not absolutely in the clear about the position in which the banks found themselves in regard to their foreign obligations, it could not fail to see from its own weekly returns that foreigners were to an increasing extent recalling their loans - the resulting transactions would have been easily discernible as outside the context of the normal transmission of payment.
A central currency bank can meet any internal run on the banks, and every payment difficulty encountered by trade and industry, so long as it involves only the home currency. The central bank is in a position to create as much currency for home circulation as it wishes by resorting to the bank-note printing presses. Obligations expressed in foreign currency can however be settled only by means of foreign assets and out of gold reserves.
All banks should, for their own sakes, have been interested in helping each other. They could not but have known beforehand that the results emanating from the most resounding bank crash in German history, would be to the detriment of the entire banking system.
The Reichsbank was unable to supply or acquire sufficient quantities ·of foreign exchange. Every foreign creditor could predict, on the basis of the weekly returns, when the Reichsbank would reach the stage where it had no more foreign exchange at its disposal. The over-anxious efforts on the part of the Reichsbank to obtain foreign stand-by credits in gold or foreign exchange could do nothing but increase the anxieties of foreign creditors - with the result that all who were able to call in their loans without any breach of contract did so.
The Reichsbank, although it clearly foresaw that its ability to pay would soon come to an end, continued to pay every foreign creditor whose contractual obligations enabled him to call in his loans, while those creditors whose loans were not due for repayment until a later date received nothing.