Sind Wir Die Weimarer?
August 23, 2004
Please pardon my high school
German if the title question is not grammatically correct.
With all the hoopla centered
on the inflation/deflation debate, the resurgent gold market, and the
decline of "King" dollar, we have begun to see references to Germany's
ill-fated Weimar Republic and questions as to whether hyper-inflation
could happen here in the USA, given that our currency is subject to the
whims of political favor over sound management, and it is not backed by
anything (read: Gold) that could cap this excess.
While much reference on the
Weimar Republic focuses on its fall, and the subsequent rise of Hitler,
I want to focus instead on the conditions that caused its
failure. When drawing parallels between the US and Germany of the
early 20's however, we need to keep in mind that this was the post-WWI
period and Germany was burdened with reparations for its role in the
war as well as major internal divisions between political parties and
the "Lšnder" or states, with Bavaria standing out notably. These
facts alone could invalidate any realistic comparisons between the two
situations. Professor Gerhard Rempel's essay
on the Weimar's economic and political problems, illustrates the
turmoil that existed in Germany at that time. But in the interest
of adventure, open-mindedness and curiosity, I'd like to push forward
with the comparison and see where it leads.
First, a passage from the
above noted essay, which shows obvious parallels to the current
situation in the US:
"Another reason for the
prominence given to reparations is their alleged contribution to the
runaway inflation of the early 1920s. In fact, however, inflation, far
from being the consequence of reparations, preceded them. Successive
governments then seized on it as a means of evading reparations
payments, as well as for internal social purposes. No German government
before 1923 made any attempt to stabilize the currency, because German
industrialists worked out a system of ''inflation profiteering.'' They
would obtain short-term loans from the central bank for improvement and
expansion of their plant, and then repay the loans with inflated
Similarly, the large agriculturists paid off their mortgages with
virtually worthless currency. By contrast, everybody with a fixed
income-broadly speaking, the middle class, was a victim of the
inflation. Even union wages always lagged behind prices. The
dislocation caused by inflation brought unemployment, despite the
apparent industrial boom. The inflation was obviously deeply divisive
in its social effects and contributed to lack of confidence in the
fledgling republic among large groups of the population."
Does any of this sound
familiar? Our bond market is currently running a similar
operation. "Industrialists" and speculators (I suspect mostly the
latter) of all stripes are playing the bond carry trade to the fullest
extent possible. Since the traumas of the tech stock crash,
recession and 9/11, the liquidity spigot has been wide open through
near rock bottom short rates, "vendor" financed long rates, tax
cuts/credits and global labor arbitrage. American consumers,
dutifully playing their critical role, have stepped up and tied it all
together. It's a virtuous circle.
But then there's a part that
the mainstream financial media seems to have forgotten about. The
part where all the cheap credit actually needs to be paid back.
Maybe this is our version of "reparations" that must be made. And
they are massive. The government can indeed pay its debts, as it
has direct control of Dr. Bernanke's inflation machine, the printing
press. But what about the linchpin of the "greatest economy on
earth"? What about the American consumer?
Again, we look to the bond
market. On the surface, all seems well. Rates are behaving
quite nicely and official inflation, aside from the oil price (which
can be conveniently blamed on geo-politics), is at reasonable
levels. But there is a huge counter party to the American
consumer and his debt load, and that party is made up of our collective
foreign bond holders. If the Fed tries to inflate its way out of
debt reckoning, our vendor financiers (Japan and China primarily) will
be none too pleased being paid back in increasingly worth-less
dollars. But assuming the game can go on indefinitely, the denial
by both parties will need to get deeper. An ending has to
come sooner or later, however. At least I think so. The
non-gold-backed, easy money dynamics sometimes make me wonder.
I find the yin/yang quality
of the situation very interesting. You can't talk about inflation
without mentioning the underlying force causing it to be created.
Namely, the big D; deflation. In many ways, I see our situation
as more complex, if not more dire, than that of the Weimar
Republic. Whereas Germany experienced a situation where the
country's tenuous position was exacerbated by the effects of the war's
aftermath, political in-fighting and industrialist exploitation, our
problem seems much less volatile (after all, we're still living the
American dream here in relative comfort) on the surface. But the
global components of production and consumption, credit and debt,
derivatives and currency creation are really quite awe-inspiring.
Inflation begets deflation, which in turn creates more man-made
This cycle has been playing
out for decades, as a look at home prices over the last 40 years will
show. It has played out thus far to the benefit of many. By
contrast, the Weimar Republic was a blip in time, it's dynamics much
different. Maybe our cycle will remain on a long, slow path to
hyper-inflation, or maybe we will never get there. But the
economic foundation is not a cement slab. It is actually a wooden
structure, on the Carolina coast, sitting atop four posts: 1) Continued
domestic and foreign credit expansion, 2) Consumer willingness to spend
as opposed to pay down debt, 3) The lack of a major, leveraged
financial "accident" and 4) Public confidence that all is as it has
been. The high risk nature of the global financial system can not
be denied. High risk does not mean a disaster will happen.
But it also does not mean it won't.
If you held hard assets in
the 1920's Weimar Republic, you did quite well. If you held paper
only, you wheeled a barrow full of it to the corner bread shop for a
loaf of what might be your meal for the day. Whether more extreme
inflation, deflation or status quo is right around the next bend, it is
wise to have some insurance.
Quo (continued creeping inflation)
gold, commodity, real estate and other hard asset exposure. Stock
market may or may not provide good returns and fixed income savers may
fall behind over time, depending on interest rates.
assets. Gold, silver, commodities. Possibly real estate. But this is a
slippery slope into...................
be addressed, prices will fall remarkably on most assets, including
gold in my opinion. But gold (and maybe silver) is the one asset to
hold (other than possibly your primary home if you can stand to see its
value cut to a fraction) outside of cash. Gold as insurance would be a
good idea, as your deflated dollars would eventually come to reflect
the full faith and credit of a federal government itself trying to deal
with declining revenues and cutbacks.
I truly have no idea whether
we will suffer a Weimaresque hyper-inflation. I am not a
financial alchemist and may be missing Mr. Greenspan's master plan on
how this is all going to end up okay. I certainly can not predict
deflation, since it has been fought tooth and nail by the Fed for the
last 15 years. I can only live life, enjoy my family, and do the
best I can to financially prepare for any and all events. I care
for my country, but fear that too many of its citizens have not
prepared themselves for anything other than a bull market in paper
assets. This is too bad for those citizens, but potentially
threatens the entire country and the future of our children as free,
enterprising Americans. Economic instability begets political and
social instability. This is something quite foreign to modern
America, which has stood for the opposite in a world more often in
turmoil than not.
I believe we are being
induced to throw caution to the wind at the exact time when the
opposite strategy should be employed. In traders' parlance, I'm
fading the liquidity bubble, paying down debt, and hoping for the best,
whatever the outcome.
PS: Further reference
on 1906 -1925 Germany can be found here.
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