Sunday, 31 August 2014

Fear the fear

"Debt isn't always bad, fearing inflation is stupid and governments should spend far more, suggest top economists", reads a headline in the Guardian. Reporting on proceedings at the Lindau Economics Meeting last week, Philip Inman highlights Christopher Sims's lecture "Inflation, Fear of Inflation and Public Debt", in which Sims argues that fear of both inflation and government debt is driving the developed world into a never-ending slump. As Inman explains, the timing and location of this speech are particularly telling:
Sims was well aware he was speaking in a Germany that fears inflation much as the villagers in the Asterix comic books fear the sky falling on their heads. Without naming Angela Merkel, he said anyone who feels threatened by inflation is stupid.

But actually it is worse than that. Fear of inflation is not just stupid, it is dangerous. And the Germans above all should understand this.

Popular mythology in Germany has it that the Weimar hyperinflation of 1922-23 led directly to the rise of Hitler. This is not true. The Nazi party was formed soon after the end of the First World War, but it struggled to achieve electoral success throughout the 1920s. In the German election of 1928, the Nazi party only managed to win 12 seats in the Reichstag. Four years later, in 1932, it was by far the largest party, winning 230 seats with 37% of the vote. What changed during that time?

Here is an excerpt from a speech given by German Chancellor Heinrich Brüning in 1931, at the height of the Great Depression in Europe (my emphasis):

"I will do my utmost to prevent any inflationary measure of any kind, not only in the spirit of justice, not only to protect the weak, but also because it is my opinion that the honest balance of the German economy has to be recreated, in spite of all bitterness, and that any attempt and any request for inflationary measures only can have the goal in mind to foil this process of establishing a clear balance, to pull another veil over the mistakes over the past. Successes in foreign policy can be achieved all the faster, if we are able to present to the world an honest and clear balance of the German finances and the German economy, for everybody to study.

This is the strongest and most efficient weapon the Reich government had, and to forget this weapon was the task of this administration in its first year. Because of it, public opinion all over the world, without exceptions, now takes a completely different point of view when it comes to the reparations, when compared to years past. Domestically it has to be similarly. Many social and professional tensions would have not become that acute, the political right-wing radicalism would not have gained that much strength, if certain healing processes would have been begun earlier, if the surgeon's knife would have cut earlier and more radically in the private as well as public economy.

Brüning used the memory of the earlier Weimar hyperinflation, together with popular hatred of war reparations, to justify extreme austerity measures. And because the scars left by that hyperinflation are so very painful, he got away with it. When the Reichstag threw out his austerity budget, it was imposed by presidential decree. Among other things, sickness benefits and pensions were cut, unemployment insurance was reduced and workers were required to pay higher contributions. There was also a brutal internal devaluation caused by deliberately tight monetary policy: during the two years of Brüning's chancellorship wages, salaries, rents and prices fell by 20%. The result was similar to the Hoover/Mellon liquidationism in the US: it made what was already a deep recession triggered by a financial crisis far, far worse. By 1932 unemployment was nearly 30%, RGDP was falling by 8% per annum and everyone had had enough. Hitler won the 1932 general election with a landslide. The rest, as they say, is history.

It was fear of inflation, fear of debt and fear of extremism that enabled the Nazi party to come to power.

Related reading:

Germany's hyperinflation-phobia - The Economist

The Greater Depression - Brad Delong (ProSyn)


  1. "Brüning used the memory of the earlier Weimar hyperinflation, together with popular hatred of war reparations, to justify extreme austerity measures. And because the scars left by that hyperinflation are so very painful, he got away with it."

    Even if you say it was the deflation that led to Hitler, you say it was the hyperinflation and scars from that that made the deflation possible. So with a simple extra step you are really still saying that hyperinflation led to Hitler.

    1. But it is the "extra step" that is crucial - the deliberate use of inflation and debt fears to push through economically destructive deflationary policies. That is what Germany chooses to forget and you want to ignore.

    2. hyperinflation -> war reparations -> war -> Sarajevo -> decline of Ottoman Empire. Hitler came to power because Turks stepped back from Balkans in the second half of XIX centruty. Simple as that.

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  3. "fear of inflation, fear of debt and fear of extremism"

    Look at Japan, NO fear of inflation (they are courting it!), NO fear of debt (they are becoming more and more indebted) and NO fear of extremism (Abe's arrows are still at work)

    But the question is "Is it working?"

    The problem is everyone wants growth without a cleanup. How is it possible?

    Take an example.

    If a person has a debt of 100000 USD. He earns less than what what it takes to repay interest (despite the fed-induced low interest rate), how do you think this guy can grow out of it. The best way to do it is clearing the debt through bankruptcy and starting all over again.

    The Fed is not willing to let this bankruptcy to happen because it fears it will wipe out the bank. So the guy trudges along becoming more and more indebted.

    So the mantra should be "clear mal-investment, restore price of money, enable growth (channelize money into productive investment)"

    This cannot happen till you allow a few banks to go bankrupt. Hence the status quo.

    1. This post is about Germany and the Eurozone, not America. The comparison is between German economic policies in the Great Depression and those in the current Greater Depression. And the implication is the potential consequences of those policies. You seem to think stagnation is a worse risk than war. I beg to differ.

      The best way of enabling that guy to get rid of his debt is to pay him more. Bankruptcy destroys people's ability to find and keep jobs. Someone who has gone bankrupt is not financially trustworthy, which bars them from many occupations. Bankruptcy is often the best solution for over-leveraged corporations, but it rarely is for highly-indebted individuals.

  4. "stagnation is a worse risk than war"

    I do not think that but I can bet that stagnation over a long period could lead to one, definitely a revolution. Once it pinches a lot of people and they stand together, it is a done deal.

    "The best way of enabling that guy to get rid of his debt is to pay him more."

    Pay him more is a good thought. But how? Where will the money come from? You cannot help him get rid of his debt just because he got himself saddled with it. After all it is likely no one has forced it down his throat. If he wants to live beyond his means, he should be ready to pay the price if it comes unraveled.

    The one way you can help the guy is to foster growth by creating jobs. Growth cannot be fostered with free money. Mal-investment is what you get with free money. Free money leads to speculation and asset bubbles. Not growth and investment in areas which create jobs.

    "Bankruptcy is often the best solution for over-leveraged corporations, but it rarely is for highly-indebted individuals."

    may not be good for highly-indebted individuals. But then the individual should have thought of this before becoming highly indebted.

    1. "the individual should have thought of this before becoming over-indebted".

      Suppose someone takes out a mortgage for a reasonable multiple of their salary - say 3x. Clearly they are not over-indebted and do not expect to become so. They pay their mortgage comfortably for a few years. Then there is a financial crisis, they lose their job and are forced to take a job at a much lower salary level. Suddenly they are over-indebted and struggling to pay the mortgage. You think they should have thought of that and not taken on the mortgage in the first place?

      This is how the majority of people who are struggling with debt become over-indebted. Job loss and reduction in real income. Not unwise borrowing.

    2. We are running around in circles.

      Central Banks (Fed, ECB, BOJ, BOE does not matter -- ECB has not done QE but then there are a lot of questions about QE -- after QE1 -- so maybe it is wise after all) have fostered this environment.

      Low interest (or ZIRP) --> leads to reach for yield by individuals and corporates --> take on more debt as money is free ---> rise in asset prices --> everyone tries to get in --> feels good till it bursts -- timing unknown (probably when interest rate rises) --> Job losses --> Indebtedness --> Low interest

      In this environment tell me how can you take a decision where you do not end up with the rough end of the stick. Basically you end up with an unstable system of boom and burst. What was a wise decision during boom time becomes indebtedness during the burst (unless you got out when the going was good).

      The solution is a stable system and growth.

      How do you get a stable system --- a start would be -- by not making it unstable by meddling
      How do you get growth --- by ensuring sound money and chanelizing it to productive areas and reduce speculation.

      The solution is definitely not creating asset bubbles by making money free, making everyone more indebted, making everyone reach for yields (in effect making everyone a speculator) and trying to clean up the act after it bursts -- as is happening now --- same characters running the show to boot!

    3. You are still completely ignoring what this post is actually about. Do please address the topic.

  5. Anyone who retires on a fixed income has every right to fear inflation. 3% inflation for 15 years steals 55% of your capital and income. Anyone who wishes to preserve the value of their savings is right to fear inflation. Only those who owe money desire inflation, as it transfers wealth from savers to borrowers.

    1. But economics is always about priorities. Ultra-low inflation rates prioritises existing owners of financial assets. That suits those owners (who are mainly not relatively poor pensioners) but builds sclerosis into the system - basically prioritising the rich over the poor.

      I'd like to think that there are other alternative solutions for poor pensioners.

  6. You make a very important point about Bruning and deflation. I can't read minds, but I sometimes wonder if one of Bruning's concerns was the way a previously disciplined population completed the destruction of the currency that the state had begun.

    Inflation in Germany goes back far farther than most people think. In 1914, the Mark was 20 to the Pound, so a mark was roughly a shilling. The wartime government multiplied the money supply by ten, from 2.6bn to 26bn, and by no surprise, in 1918 the mark stood at 200 to the Pound, so a Mark was roughly a penny, an inflation of 1000% in four years.

    In 1918 visitors to berlin already reported that Germans had lost confidence in the currency, and were exchanging any cash they had for Gold, Silver, foreign currency, real estate, art and furniture and were even stockpiling consumer gods. 1923 was just the blow-off phase in an inflation that continue for ten years.

    For someone of Bruning's generation, I think it must have been more than a currency issue. It was a serious loss of control in a society that prided itself on hard work, and it exposed the existence of clever profiteers.

    I think it's possible that Bruning was genuinely trying not just to restore the currency, but to restore the psychology of pre-war Germany. If so, it's all the more tragic what mistake he made, and what it led to.

    1. Hi Jon.

      Yes, I think that's a fair assessment of what Bruning intended. His speech suggests he was trying to restore the international reputation of Germany and the confidence of the German people. Such a pity that the medicine he prescribed led in exactly the opposite direction.

      But we in the UK have no right to criticise Bruning. The UK experienced depression throughout the 1920s because of the tight money policies of Montagu Norman and the deflationary fiscal policies of Geddes and Churchill. The Government was determined to restore the value of the pound to its pre-war value, and to that end kept real interest rates too high and ran fiscal surpluses throughout most of the 1920s. Britain rejoined the gold standard at too high a value in 1925. Its subsequent demands for monetary easing by the Fed because of persistent gold outflows is blamed by Murray Rothbard for inducing the US credit bubble that led to the Wall Street Crash. Rothbard has a sizeable chip on his shoulder about the UK, but he does have a point. And it is worth remembering that the UK had its own Nazi movement, too - Oswald Moseley's "Brownshirts". It could so easily have gone down the same road as Germany.

  7. The nazis kickstarted the economy with military-industrial complex keynesianism and soft currency economics (before keynes). Maybe this time we can both skip the hard money policies and warmongering and go straight to creating an economy fit for the 21st century, i.e. a sane one.