Exchange, Prices, and Production in Hyper-Inflation

CHAPTER V

PRICE AND EXCHANGE RATE THEORY AND THE FACTS IN GERMANY (CONTINUED)

ANALYSIS OF FOREIGN EXCHANGE MARKETS

§ UNITY OF THE MARKET

THE market for the exchange of one money against another normally comprises at least two loci, one in each of the countries concerned. In each of these loci there will be buyers and sellers of both moneys. Since, however, the buyer of one currency on the exchange market is necessarily the seller of another it will be convenient to concentrate attention on a single currency. Let us take the German mark. The mark will be sold in Berlin by those who, for any reason, want pounds, dollars, or other currencies, and will be sold in London, New York, and other centers by those who, having marks, wish to dispose of them. The mark will, on the other hand, be bought in Berlin by those who, having foreign currencies, wish to dispose of them and will be bought in London, New York, and other centers by those who for any reason desire marks. Whether transactions occur in one locus or another is determined by trade practices and is a matter of almost complete indifference in establishing rates of exchange. A German exporter to the United States may draw a bill on the American buyer or he may ask the buyer to remit. In the one case, the German sells dollars in Berlin and, ipso facto, buys marks in that locus and, in the other, the American sells dollars and buys marks in New York. Either operation will increase the offer of dollars against marks. Similarly, an American exporter of goods to Germany may draw on the German buyer or he may request the buyer to take the initiative in paying. If the former practice is followed, marks are sold and dollars bought in New York and, if the latter, marks are sold and dollars bought in Berlin. Either operation will increase the offer of marks against dollars. Since a German export to the United States is an American import, and an American export to Germany is a German import, the illustrations just given cover the whole range of commercial transactions between the two countries. If one of the centers accumulates an undue share of bills on the buying or selling side of a given currency the matter is quickly taken care of by arbitrage operations. The “market” for exchange is thus unified and, though dealing is scattered among several or many centers, communication is now so rapid that substantially the same results occur as if the loci, instead of being separated by oceans, were on opposite sides of the same street.

The single schedule which results may be thought of as the demand for, and supply of, any given currency against other moneys, or as a reciprocal demand (or reciprocal supply) schedule of the various currencies against one another. The mark demand for foreign currencies and the supply of foreign currencies against marks may be alternatively described as the mark demand for foreign currencies and the foreign currency demand for marks or as the supply of marks against foreign currencies and the supply of foreign currencies against marks. For the moment it will be convenient to adopt the concept of reciprocal demand.

§ IRREGULAR CHARACTER OF FOREIGN EXCHANGE RECIPROCAL DEMAND SCHEDULES

Reciprocal demand schedules for an inconvertible paper currency are by no means smoothly sloping curves. It is possible that a rising exchange value of a depreciated paper currency, instead of reducing the amount of that currency demanded by holders of foreign moneys, may increase it, and, instead of increasing the amount of the cheapening foreign currencies demanded by holders of the said currency, may reduce it. Similarly a falling exchange value, instead of augmenting the amount of that currency demanded in exchange for foreign moneys, may lead to a diminution, while, at the same time, the amount of foreign currencies demanded in exchange for the given money may be enlarged.1 This phenomenon, which is common on all speculative markets, very much increases the range of paper currency exchange rate fluctuations. It is due to the fact that with paper exchanges there are no fixed pars. Under gold standards this negation of the usual operation of supply and demand can occur only within the very narrow limits of the gold points. With paper currencies, however, the stimulus of potential speculative gains, when the paper currency exchange shows a rising inclination, or the fear of losses, when it falls, frequently leads away from rather than toward the establishment of an equilibrium. The equilibrating forces are not abolished; they are merely in temporary abeyance. When the movement of exchange rates has gone far from the “intrinsic” values of the respective currencies, as established by current relative purchasing power in their domestic markets, buying of the relatively depreciated currency will pick up and purchases of the relatively appreciated currency will decline. The “humps” in the reciprocal demand schedule will then be broken through and equilibrium will ultimately be established just as on the produce exchanges the vague but real value of commodities for consumption purposes imposes limits on price fluctuations.

There is, however, one aspect of the market for inconvertible currencies which has no parallel on the produce exchanges. With commodities other than exchange, a seller, having once disposed of his product, cannot sell again without first shifting to the buying side, or if “futures” are being dealt in, without incurring obligations to deliver which he must eventually cover by purchases. There is no prospect that he will be able indefinitely to make these purchases at continuously lower prices. But note issuing authorities can, if they are so minded, sell the domestic currency ad infinitum. It costs nothing to obtain;2 it can be manufactured at will. Whether or not the authorities are selling the domestic exchange makes but slight difference if note issues are, in any case, steadily increasing, since holders or prospective holders of the currency can with some confidence count on obtaining future supplies at ever cheaper prices. They will therefore be disposed to sell freely for later delivery. The total amount of the domestic currency offered for foreign exchange may thus increase to any extent as the price of foreign currency rises. There is no limit on supply such as is imposed by nature in the case of produce and therefore not even a potential limit on the possible fall in price.3 This risk is presumably in the mind of speculative sellers and prospective buyers of the inconvertible currency and will keep them on the bear side of the market longer than would otherwise be the case. The exchange value of such a currency can therefore fall far below the current purchasing power par without provoking any considerable support. When panic develops the “bottom may drop out of the market.”

§ ABSOLUTE AND CONDITIONAL DEMAND FOR EXCHANGE

The word “speculative” has been employed in the foregoing discussion in no disparaging way. It is used in the broadest sense to cover the activities of all individuals whose entry into the market is dependent on the rate of exchange. Reciprocal demand schedules are at any given time made up of two classes of buyers. The demand of one group is absolute and arises out of the need for foreign money with which to meet obligations already incurred. This class of buyers is in the market without reservation and must purchase regardless of price. The demand of the other group is conditional. They will buy only at certain rates. Many such buyers are not speculators in the narrow sense of that term since they may intend to use immediately in the purchase of goods, securities, or services, in the foreign country, such exchange as they may acquire. Or they may be residents of the country whose exchange they buy who are selling their more or less permanent holdings of foreign assets. All these are speculators merely in the etymological sense of the word, in that, before they are eliminated from the demand schedules by the act of purchase, they are looking forward to new transactions on condition that they can buy exchange at a price which suits them. On the other hand the absolute demand comes from those who are completing old rather than contemplating new transactions.

§ CONDITIONAL DEMAND THE EQUILIBRATING FACTOR

It will later appear that while the reciprocal absolute demand represents compulsory purchases of exchange it does not necessarily require the acquisition of fixed amounts of the currencies demanded. According as the monetary medium in which the contracts are expressed is or is not the same as that in which they must be paid, the amount of the respective currencies necessary to extinguish the respective absolute demands may vary, in either direction, with any given change in the rate. This matter will presently be discussed in greater detail. Since the variation may be in either direction according as existing contracts run in one currency or another it is clearly possible that the contracts may be such as to cause the variations to cancel out, and, for the sake of clearness, this will for the moment be assumed to be the case. The effect of alterations in exchange rates in at least ultimately inducing inverse shifts in the amounts of the currencies reciprocally demanded can then express itself only through the conditional portion of the respective demands. If, at any moment, the absolute foreign currency demand for a given money be small relative to the absolute demand in that currency for foreign moneys, and if the conditional demand at existing prices is not equally weighted in the opposite direction, exchange rates must move adversely to the former currency. This movement of rates will persist until the conditional demand for the depreciating currency grows, and the conditional demand for the appreciating currency shrinks, to the point where the discrepancy in absolute demands is exactly compensated by a like discrepancy in the opposite direction in the volume of the respective currencies actually bought (and sold) in response to the conditional element in the reciprocal demand schedules.

§ DISTINCTION BETWEEN ABSOLUTE AND CONDITIONAL DEMAND UNIMPORTANT UNDER GOLD STANDARDS

The distinction between absolute and conditional demand is of no great importance under gold standards since, at the gold points, gold becomes a perfect substitute for foreign exchange as a means of meeting international obligations. At the gold points, therefore, the whole of the demand for the appreciating currency becomes conditional; there is no demand whatever for bills in this currency at any exchange rate in excess of the cost of transporting gold. Within the gold points, however, both absolute and conditional demands are present and important. Some exchange must be bought and some will be bought only if the price is “right.” Any excess in the momentary absolute demand for foreign moneys as opposed to that for a given domestic currency will usually be fully neutralized by a contrary shift in the respective conditional demands somewhat before the gold point is reached. For, as that point is approached, new purchases of the depreciating (sales of the appreciating) exchange become numerous while potential buyers of the appreciating (sellers of the depreciating) currency tend to withdraw from the market.

The buyers of the depreciating (sellers of the appreciating) currency may be citizens of either country concerned. Residents of the country whose exchange is depreciating may sell property, such as securities held in the other country, to residents of the latter, and then buy their own exchange with the proceeds, or they may sell, in the same way, securities held at home. The initiative may, on the other hand, be taken by the buyer of such property. Short-term loans will also be made by holders of the appreciating currency who, in effect, transfer assets from the temporarily dear to the temporarily cheap currency in the confident expectation of transferring them back again at a later date and at a profit. Residents of the country of appreciating currency will tend to increase commodity purchases in the other or will buy exchange for later use in the purchase of commodities in that other country. On the other hand, residents of the country of depreciating currency will restrict their purchases abroad and will refrain from making purchases of the appreciating exchange which they would make if its cost in their own currency were lower.

The chance of loss of capital in purchasing foreign gold exchange at the lower gold point is nil since the purchased exchange can at any time be turned into gold and imported, with a net yield in the domestic currency equal to the amount expended on exchange. As the gold point is approached purchases of the depreciating exchange are thus wellnigh a “sure thing,” since the sole substantial movement in its exchange value must be upward. This type of speculation seldom lacks takers. On the other hand, no one will purchase the appreciating currency in the expectation of making a speculative profit and any potential buyers of this exchange, whose requirements are not absolute, will postpone their purchases to a more favorable occasion.

Whatever the purpose animating buyers, conditional demand on both sides of the market, at any rate of exchange near either gold point, thus always operates in the equilibrating direction. So far as capital transactions (property rights of any sort whether it be title to real property or other claims to future income) are concerned, the adjustment, while prompt, is nevertheless likely to be but temporary, even if there is never a reverse transfer. The payment of the annual yield to the purchasers of the property rights, that is, in the main, to residents of the country of appreciating currency, will eventually increase the absolute demand for that currency. If the causes of its present appreciation are continuous and not merely seasonal, and if the purchases of property abroad do not continuously show an accretion in excess of the growing interest bill, final equilibrium must be attained through a shift in merchandise and current service transactions. The movement in exchange rates may be adequate to effect the necessary shift but, if not, gold must eventually flow toward the country of appreciating currency, and it must continue to do so until price levels in the two countries are so changed as to bring about the requisite alteration in the situation. The reciprocal absolute demand for exchange will then gradually change and bring equilibrium without greater shifts in the conditional demand than will normally be attained by exchange rate fluctuations within the limits of the gold points.

§ ABSOLUTE AND CONDITIONAL DEMAND UNDER PAPER STANDARDS

Where inconvertible paper currencies are involved the essentials are the same, with one important exception. Exchange rate fluctuations are then the sole reliance for equilibrating reciprocal demand. Since there is no substitute for exchange, such as is furnished by gold where gold standards prevail, absolute demand remains absolute regardless of exchange rate fluctuations, and conditional demand does not show as sure, smooth, or prompt an inverse response to changes in the exchange value of the currencies as under gold. With reasonably stable commodity prices, however, the range of exchange fluctuations will tend to be not much greater than the sum of the possible fluctuations under gold standards plus the percentage alteration in relative price levels which would bring permanent equilibrium were gold standards in operation. The conditional demand from individuals seeking bargains, whether in capital or consumers’ goods, will lead to purchases of the depreciating exchange when it has fallen far enough to make such bargains obvious, while potential buyers of the appreciating exchange will prefer to keep their assets in the currency which is worth less on the exchange markets than in its purchasing power over goods in its own sphere of circulation. Even when prices are changing fairly fast, a sharp cleavage between the exchange value of currencies and their current purchasing power in the respective domestic markets will ordinarily soon set forces in operation which will reduce the differential. If the exchange value of a given currency remains long below its purchasing power in its domestic market the consequent increased foreign purchases in that market, and the reduction in foreign purchases by holders of the money in question, will presently alter the absolute demands in such a way as no longer to require a large compensating shift in the conditional portion of reciprocal demand.

Such is the usual course of events. It may happen, however, that a country on an inconvertible paper monetary basis must steadily purchase so large a volume of foreign exchange as to cause its absolute demand for foreign money at any given moment far to exceed the current absolute foreign money demand for its own currency while the conditional foreign demand is weak owing to the inability of the country to furnish a profitable use for such of its currency as might be purchased. Though its own conditional demand for foreign currencies be cut to the bone as exchange rates move adversely, yet, if the conditional foreign currency demand for that country’s money does not grow in adequate measure, the discrepancy in absolute demand may remain without full compensation. Foreign exchange rates will then pursue their upward trend indefinitely.

§ IMPORTANCE OF ABSOLUTE DEMAND IN THE GERMAN INFLATIONARY EXPERIENCE

From the middle of 1921 onward the German government was bound to purchase large amounts of foreign exchange to meet cash reparations payments. Unlike the ordinary absolute demand arising from past commercial transactions which, while unaffected in the present by any change in rates, is modified in the future as the exchange value of the currency alters, this demand for foreign exchange was persistently independent of exchange fluctuations. The absolute mark demand for foreign currencies, so increased by the- cash reparations burdens, was far in excess of the current foreign currency demand for marks. In this situation the exchange value of the mark was bound to fall (foreign exchange rates rise) until the conditional reciprocal demand should show an equal discrepancy in the opposite direction. But the means of stimulating the conditional demand for German (supply of foreign) exchange4 other than from the sale of non-capital goods—means which are of the utmost importance as quick resources and which are ordinarily provided by the transfer of property or securities or the placing of temporary or permanent loans abroad—were all unavailable. The Reichsbank, it is true, had a not inconsiderable volume of gold which it could have sold against foreign exchange. But to this it then clung tenaciously as a last resource for which the need would be still greater when currency reform should be undertaken. Properly enough deeming it useless to throw its gold stocks on a market which would quickly swallow them without showing any substantial improvement, it pursued a policy of caution and refrained from any vigorous support of the exchange.5 Foreign loans were impossible owing to the threatening political situation. There were very few foreign securities, or other claims to foreign property, held in the country, from the sale of which foreign exchange could have been secured. The sale abroad of domestic securities of any type was inhibited by the same lack of confidence as made new governmental borrowing impossible while foreign investment in real and other forms of fixed property in Germany was not only subject to the prevailing general distrust but was also practically precluded by rent limitation laws and the possibility of confiscation.6 Almost the whole burden of provision of the required supplies of foreign exchange was therefore thrust on commercial, rather than on financial, transactions. A great part of the existing transportable capital goods, however, such as the mercantile marine, a considerable portion of the rolling-stock of the railroads, a large number of farm animals, and equipment of various types had, as we have seen, been delivered to the Allies under the terms of the Treaty of Versailles, and, as a consequence, almost the sole means of procuring foreign exchange was through the export of current commodity production or through sales of the currency for whatever price it would bring.

Now a large and continuing excess of commodity exports cannot be developed overnight. A transformation of the internal economic organization must first be achieved through a shifting of industry from production for the home market to lines which are capable of export. Of necessity this is a matter of years. But the trouble was that the Allies wanted reparations and they wanted them in a hurry. The supply of immediately available exportable goods was insufficient to cover their demands. Exchange rates being proximately determined by existing reciprocal demand schedules, and by these alone, the possible future supply of exportable goods was irrelevant except as it led to the present purchase of German exchange for later use. The conditional demand for German exchange was consequently dependent not upon the prospect of immediate and certain gains but upon a risky investment for an indefinite term. Even if an adequate export surplus should develop, progressive inflation would raise prices and reduce the value of any mark exchange which might be bought at the moment and held for later use. Before the conditional demand for marks would expand enough to cover the difference in reciprocal absolute demand the exchange value of the mark had therefore to fall to a discount on its current domestic purchasing power sufficient to convince a large group of “investors” in the German currency that the risk in this long-term investment was worth the taking.

§ THE MARK DEMAND FOR FOREIGN EXCHANGE AS AFFECTED BY NOTE ISSUES

In order to meet its foreign obligations there was no course open to the Reich administration but to secure (through the Reichsbank) the necessary foreign exchange by selling marks. The Reichsbank, late in 1921, denied that it was or had been selling marks abroad. This statement came in response to the charge that the Germans were deliberately depreciating their own currency. There is no doubt that the denial was honest. But though the Reichsbank was not selling marks abroad it was selling them at home. Where the sale was made did not at all affect the result. In purchasing foreign currencies on behalf of the government the bank was, ipso facto, selling German money, and it was, in addition, manufacturing the money which it sold. This enlarged supply of marks reduced their purchasing power at home and, while still further checking the growth of the conditional foreign currency demand for German money, prevented the decline in the private conditional mark demand for foreign exchange which would normally have attended the increase in the mark price of foreign moneys. The result was an exchange rate which bore a very remote relation to current relative purchasing powers of the mark and the foreign currencies against which it was exchanged.

§ DIFFERENCE BETWEEN CONDITIONAL AND ABSOLUTE DEMANDS AS EQUILIBRATING FORCES

However tardy may be the response of conditional demand to changes in exchange rates, the long-run tendency is always toward the establishment of equilibrium. So far as conditional demand is concerned a fluctuation in the rate is therefore essentially self-limiting. Such is, however, not the case with absolute demand. According to the tenor of the contracts for the payment of which exchange is necessary, movements in exchange rates may be self-limiting, self-inflammatory, or simply neutral.7 Under one set of conditions a given exchange fluctuation, resulting from a disequilibrium in international debits and credits, will tend toward an immediate adjustment of existing claims and counter-claims and, quite apart from the influence of conditional demand, will itself operate to restore equilibrium. Under another set of conditions it will have just the opposite effect and will exaggerate rather than diminish the original disequilibrium. Under a third it will have no effect at all. A few examples will make this clear.

Let us suppose, first, that, with a rate of exchange at the old (and present) gold pars but with the United States on a gold and Germany on an inconvertible paper monetary standard, Germans trade with Americans in the following fashion:

Case I (a)

Germans sell to Americans goods quoted in dollars to the amount of

$1,000,000.

Americans sell to Germans goods quoted in marks to the amount of

4,200,000 marks.

The German exporters (or American importers, according as payment is made by draft or remittance) will have dollars for sale and will be in the market for marks and the American exporters (or German importers) will have marks for sale and will be in the market for dollars. Equilibrium will be reached at 4.2 marks to the dollar, that is to say, without any disturbance of the par rate.

Now, suppose that the American export of goods to Germany suddenly doubles in volume, on the same terms of the sale, while German sales to citizens of the United States remain the same. We then have:

Case I (b)

Germans sell to Americans goods quoted in dollars to the amount of

$1,000,000.

Americans sell to Germans goods quoted in marks to the amount of

8,400,000 marks.

American exporters and/or German importers will now have 8,400,000 marks for sale against a dollar demand for these marks of only $1,000,000. If no other buyers of marks come into the market8 the mark must fall in value to 8.4 to the dollar. Such a rate will bring the accounts into equilibrium; the movement of exchange will be self-limiting. Expressed in terms of dollars the obligations of the German importers (the assets of the American exporters) will have shrunk in strict proportion to the decline in the dollar value of the mark (that is, to $1,000,000, or one-half their amount before the decline in mark exchange) while the obligations of the American importers (the assets of the German exporters) remain the same. Expressed in terms of marks the obligations of American importers (the assets of German exporters) become twice as great while the obligations of German importers (the assets of American exporters) remain unchanged. Expressed in either currency, the assets of Americans, being claims to a fixed sum of marks, automatically diminish in relative value with a decline in the exchange value of the mark, and the assets of the Germans, being claims to a fixed sum of dollars, automatically increase in relative value from the same cause.

The liabilities of the Germans, while expressed in marks, are of course ultimately payable to the American exporters in dollars, and the liabilities of the Americans, while expressed in dollars, are ultimately payable to the German exporters in marks. But—and this is the significant point—the German liabilities are at any moment a fixed sum of marks but a variable amount of dollars and the American liabilities are a fixed sum of dollars but a variable amount of marks. When the American exporters bring the proceeds of their sales home they will obtain dollars in inverse proportion to the appreciation of dollar exchange; the German exporters, on the contrary, will obtain marks in direct proportion to that appreciation.

The upshot of the matter is that, when the transactions are completed and payment has been received by the exporters in their own currency, German exporters will have gained and American exporters will have lost through the exchange fluctuation while importers in both countries will be unaffected.9 The Germans, taken as a whole, will get twice the physical volume of imports for a given volume of exports that they obtained before the decline in mark exchange, or, to put it in another way, they will have had half their liabilities wiped out. In the situation as outlined the Americans are mulcted as a result of having acquired their assets in marks and the Germans receive an undeserved windfall through having acquired theirs in dollars. Any individual buyer or seller could, of course, hedge on his transaction, but this would simply mean a shifting of the loss on exchange and not its elimination. It might however redistribute the national gains and losses. If, before the fall in exchange, Americans had sold mark futures to Germans, or Germans had sold dollar futures to Americans, the losses of the Americans and the gains of the Germans, taken as a whole, would be diminished; but if both had dealt in futures with their own nationals the national gain and loss would obviously be unaltered.

The situation just described would, of course, be reversed if mark exchange should appreciate. If, for instance, Cases I (a) and I (b) should be reversed in time sequence, the Americans would gain at the expense of the Germans. Under the assumed conditions of sale a movement of the exchanges operates to diminish real obligations pan passu with an increase in their nominal amount and to increase real obligations pari passu with a diminution in their nominal amount.

The point should perhaps be noted that, in the case first assumed, neither the German importers nor exporters have any interest—any immediate interest at any rate—in preventing the fall in mark exchange. On the contrary, so far as contracts in being are concerned, the German exporters have much to gain by its fall while the importers will be indifferent since they have a fixed amount of marks to pay regardless of the fluctuations in exchange rates. American importers will also be indifferent, since they have to pay a fixed amount of dollars, but American exporters will have a very intense interest in preventing the fall in the exchange value of the mark. Under normal conditions they would, of course, refuse to sell their claims to marks at the sacrifice involved in Case I (b) and they would ordinarily find plenty of new purchasers—purchasers, that is, other than the original American importers—to take the marks off their hands. The presence of such buyers will prevent any considerable decline in mark exchange, but purchases of this type, as has been pointed out above, are by no means in every set of circumstances inevitable. In any case the effect of their presence or absence is entirely distinct from the effects of the exchange fluctuation on absolute reciprocal demand. Under the conditions of sale above assumed the movement in exchange rates itself, quite apart from any motivation to new purchases or sales, tends to be self-limiting. In the degree of its influence, which is strictly proportional to the magnitude of the movement, it will necessarily reinforce any other factors working in the direction of restraint on exchange deviations and will counteract those which may be working in the opposite way.

If now we turn to sales of goods in opposite terms we shall find that exchange movements, in and of themselves, far from being self-limiting, are then self-inflammatory. Let us suppose, instead of the situation described in Case I, that the matter stand as follows:

Case II (a)

Germans sell to Americans goods quoted in marks to the amount of

4,200,000 marks.

Americans sell to Germans goods quoted in dollars to the amount of

$1,000,000.

Here, as in Case I (a), equilibrium would be reached at an exchange rate of 4.2 marks to the dollar. But if, on the same terms of sale, there be a doubling of German orders for goods in America while American orders for goods in Germany remain unchanged, the matter assumes an aspect very different from that of Case I (b). We should then have the following state of affairs:

Case II (b)

Germans sell to Americans goods quoted in marks to the amount of

4,200,000 marks.

Americans sell to Germans goods quoted in dollars to the amount of

$2,000,000.

Under these circumstances American exporters and/or German importers will have marks for sale10 to such an amount as will, at the rate of exchange which becomes established, provide them with $2,000,000. But the dollar demand for marks from American importers and/or German exporters amounts to only 4,200,000 marks. If no new buyers of marks come into the market, the price of marks must fall. Let us assume that, as in Case I (b), it falls to 8.4 marks to the dollar. Far from such a rate bringing the accounts into equilibrium it will merely make the disequilibrium so much the greater. At 8.4 marks to the dollar the mark claims on Americans will provide $500,000 only while Germans need $2,000,000 to meet the American claims on them. The mark will then fall farther. But every decline only makes the situation still worse unless new buyers of marks with dollars are eventually attracted by the bargain rates. If, to repeat, the mark were reasonably stable in domestic purchasing power, and if goods were freely available for export from Germany, such purchasers would certainly appear. But, in the absence of such conditions, a heavy fall in the exchange value of the mark may frighten away such purchasers as would otherwise be disposed to buy. The fall in the exchange value of the mark, instead of reducing the dollar value of American claims on Germans and increasing the mark value of German claims on Americans, as in Case I (b), will reduce the dollar value of German claims on Americans and increase the mark value of American claims on Germans. Under the former terms of sale the exchange movement resulted in a diminution of the real burden of the nominally larger claims and in an augmentation of the real burden of the nominally smaller until equilibrium was reached. But, under the present terms, the larger (American) claims are augmented while the smaller (German) claims suffer a decline. The fall in mark exchange is thus self-inflammatory and cumulative, and, in the absence of new buyers of the mark, will have no bounds whatever until a large part of the American claims are extinguished by the bankruptcy of the German debtors.11

The American importers will now be the gainers and the German importers the losers, the exporters in both cases being unaffected. But how much the American importers will gain and how much the German importers will lose it is impossible to say since this depends on the extent of the exchange fluctuation. That fluctuation is quite indefinite and, indeed, theoretically infinite. The only thing that can check it is the operation of conditional demand.

The fall in the dollar value of the mark brings equilibrium in Case I while it increases the disequilibrium in Case II because, in Case I, the claims on both sides are expressed in a circulating medium other than that in which they are ultimately to be extinguished, while, in Case II, they are expressed in the same medium in which payment is to be made. In Case I the claims of Americans, having first grown relatively to those of the Germans as a result of the increased export of American goods, suffer a reduction proportionate to the decline in the exchange value of the unit in which they are expressed, a decline for which the growth of the American claims is itself responsible. The German claims, on the other hand, are proportionately increased. In Case II the German claims are proportionately reduced when the mark falls in exchange value and the American claims are increased. The original fall in the exchange value of the mark having been due to an excess of American claims the situation thus becomes worse and worse.

Continuing the comparison of Case II with Case I, it is the German importers, instead of the American exporters, who will now have a lively interest in preventing the fall in mark exchange (all other parties being indifferent or favorably disposed to that fall), and they will seek to secure dollars from new sellers of that currency. But there may be few or no individuals, other than the original exporters, who have, or can secure, claims against dollars. This was not far from being the actual case in Germany in the inflation period.

If we assume a change in the conditions of Case II with regard to the volume of purchases, such as would be involved if the German purchases declined instead of increasing, the course of the mark, under the same terms of sale of goods, would tend indefinitely upwards. This is however of little practical importance for the later consideration of actual phenomena since American importers were always in a position to secure marks by exporting gold, goods, property claims, or securities to Germany, though the necessity for doing so never arose owing to the fact that the Germans were constantly in arrears on reparations account and therefore always exigent buyers of foreign exchange. The conditional reciprocal demand would, in any case, have been promptly operative.

Though no one method of quoting prices is universal in foreign trade perhaps the more normal practice is that described in Case In12 This works well enough under stable exchanges but, when the exchanges become unstable, the sellers of goods in the country of the relatively appreciating currency quickly learn to quote in their own exchange in order to avoid losses. So far as the sellers in the country of relatively depreciating currency have been quoting, and continue to quote, prices in their own unit we then have the conditions of Case II. So far however as they have been quoting in the buyers’ currency, or go over to that practice, we should have still another set of conditions under which existing contracts, on one side, are expressed in the monetary unit in which they are to be paid and, on the other, are not. These are the conditions set forth in:

Case III

Germans sell to Americans goods quoted in dollars.
Americans sell to Germans goods quoted in dollars.

Under this method of invoicing, a fall in mark exchange arising from an increase in the sale of American goods in Germany will increase the mark liabilities of the German buyers but will also increase the mark assets of the German sellers. The decline in the value of the mark will then, of itself, make the German position neither better nor worse. A downward movement of the mark will not, in the absence of new buyers of marks (sellers of dollars), be arrested or even retarded, but it will not, by its own fall, be accelerated. If the downward movement has been due to an increase in German purchases abroad the Germans will need more dollars to pay for this increase than are available from their sales of goods and, if these dollars cannot be obtained by increasing the offer of marks per dollar, mark exchange may, as in Case II, continue in an unchecked decline. But in order to check it the volume of new demand for marks (sale of dollars) will be the same after as before the decline occurred, while, under the conditions of Case II, it must needs be greater.13

It is unlikely that the demand for goods would expand quite so suddenly as has here been assumed. But an expansion, from whatever cause, in the requirements for foreign exchange would have, in the degree of its importance, the effects above described. Such an expansion in German demand for foreign exchange occurred with the lifting of the blockade and the release of the pent up demand for foreign goods in 1919, with the inception of cash reparations payments in the summer of 1921, and with the “flight from the mark” which reached large proportions in the middle of 1922. For a surprisingly long time after 1919 every downward movement in mark exchange tended eventually to be checked by purely gambling purchases (conditional demand) on the part of lambs who bought blindly. This support gradually weakened and practically disappeared during 1922 when it became obvious even to the most unsophisticated foreign buyer that a restoration of the German currency to anything like its former purchasing power was a possibility infinitely remote. When this mode of supply of foreign exchange vanished there were few ways in which it could be obtained, scant emergency resources of any kind, and therefore but a weak tendency for a fall in the mark to evoke sustaining forces.14

In general, it may be said of this phase of the exchange market that, when conditional demand responds promptly to a shift in rates, the influence of absolute demand, either in checking or in exaggerating the fluctuations in exchange according as the tenor of contracts in being runs in one currency or the other, is slight. A favorable or unfavorable balance of payments15 is then of no great importance in effecting even temporary changes in the rate. A balance either way will be quickly compensated by a shift in that part of the volume of conditional reciprocal demand which is actually realized in purchases. But, when there is little conditional demand for the depreciating exchange, the rate may not only move adversely to that currency to an indefinite degree but, under certain types of invoicing, will automatically so alter absolute demand as to accelerate the fall rather than release forces to check it. There is reason to believe that this happened in the case of German exchange. The requirements for cash reparations payments were for a fixed amount of dollars, or their equivalent in other foreign exchange, and this was also true of a very large share of the payments for German imports. On the other hand a considerable share of German exports were invoiced in marks. Any decline in the exchange value of the mark therefore tended to induce a further fall.

§ EFFECT OF CHANGES IN THE VALUE OF THE MEASURING ROD

The effects on the exchange value of an inconvertible paper currency consequent upon recurring requirements for a fixed sum of foreign moneys are further influenced by an increase in the general purchasing power (fall in prices) of the currency in which the obligations must be paid. The volume of dollar exchange necessary to cover a given quantum of fixed obligations expressed in dollars would, of course, be unaffected by a fall in dollar prices but the supply of dollar exchange issuing from exports to the United States would tend to decline. The fixed demand for dollars having then grown in relative importance, the dollar would tend to rise more than in proportion to its increase in internal purchasing power, and this movement, in accordance with the principles just stated, might well prove cumulative. The effects would, of course, be reversed if the medium in which fixed obligations were payable should fall in domestic purchasing power. The facts are that the internal value of the dollar rose at a rapid rate from mid-1920 to the end of 1921 and that dollar exchange against the mark synchronously rose relatively to the respective domestic purchasing powers of the two currencies. But most of this rise occurred before cash reparations payments were initiated and, since the Germans had then but few fixed obligations in dollars, some other cause must have been principally operative. An alteration in reciprocal conditional demand leading to an enhanced desire for the appreciating currency, the dollar, was probably responsible. It is interesting to note that, under opposite circumstance, the increase in the internal purchasing power of the dollar resulted in a relative fall in its value in terms of another paper currency, the English pound. In the latter half of 1920 the exchange value of the dollar against pounds did not rise in anything like the degree of relative augmentation in purchasing power over goods at home. This is perhaps explained by the fact that the British had a fixed pound income on foreign investments while their outlay for a given quantum of imports varied not only with the exchange rate of the pound against foreign currencies but with prices prevailing in other parts of the world.

§ EXCHANGE AND THE PARADOX OF VALUE

One further possible result of rising foreign exchanges should be noted. A sharp rise in foreign exchange which is not paralleled by a corresponding upward movement of domestic prices will ordinarily lead to an increase in the physical volume of exports relative to imports, but the increased physical volume of exports, sold at the prevailingly low domestic prices may, at the new rate, fail to provide as much foreign exchange as formerly issued from a smaller export volume. Any absolute reduction in the volume of imports, on the other hand, may be insufficient to bring equilibrium in demand for and supply of foreign exchange at the new rate level. The inadequacy of the supply of foreign exchange at the old rate, which was responsible for the upward movement, may thus very possibly be exaggerated by the rise. The result is a further upward movement and a possible indefinite repetition of the phenomenon. If, for example, foreign exchange rates should double overnight, while no change had taken place in internal prices, it is most unlikely that the physical volume of exports of commodities could be suddenly doubled even at the bargain prices to foreigners which would then be in effect. But unless they are at least doubled they will fail to provide as large a supply of foreign exchange as did the original volume of exports. The entire burden of adjustment will then fall on exchange demand. If this, in large part, is incapable of reduction, as is the case with interest or tribute payments,, there is no limit to the rise in exchange short of the point where new buyers of the depreciating currency appear in sufficient strength to check the movement.

It is only under unusual conditions that this case is of much practical importance. A rising exchange rate is almost certain to be accompanied by rising internal prices of all exportable goods of a standard type with a world market, and, somewhat more tardily, of other exportable goods. The considerably increased physical volume of export of these goods, which takes place owing to the fact that while there is a rise in internal prices toward the world level as determined by existing exchange rates, the rise falls short of complete correspondence with world prices, is almost certain to increase the supply of foreign exchange. Similarly, under ordinary conditions, the demand for foreign exchange will decline somewhat by reason of the high prices of imports measured in the domestic currency. The elasticity of demand for the country’s exports is here of great importance but, while the total world demand for any given group of exportable goods may be highly inelastic, this is most improbable with regard to the exports from any one country, at least with respect to all commodities which are not solely produced in that land. The world demand for wheat, for example, may be very inelastic but let wheat be sold in any one country at a price which will permit it to be laid down in importing markets at a very slightly cheaper rate than that at which wheat can be obtained elsewhere and the whole world import demand will be directed toward that country. The elasticity of total demand for each of the exportable goods of any given country is therefore irrelevant and a rise in foreign exchange which makes the exports of the said country cheap to foreign buyers, and imports dear to domestic consumers, will ordinarily so affect the demand and supply relationship in the foreign exchange market as to prevent the occurrence of any cumulative tendency in the movement of exchange rates. But, if the domestic consumption of exportable goods is already small and there is, in consequence, little opportunity to increase the volume of exports, and if imports are already at a very low level, movements in exchange rates may, of their own momentum, easily become cumulative from this as well as from any of the other factors which have been described. It will later appear that, while the response of German exports and imports to changes in the relation of exchange rates to the internal purchasing power of the mark took place, it was not immediate, and it seems entirely probable, therefore, that foreign exchange continued to rise because it had already risen, not only as a result of the immediate but also of the later effects of the original movement.

§ RELATIONSHIP OF EXCHANGE RATES TO PRICE LEVELS RECONSIDERED

Enough has been said to make it clear that, in certain circumstances, the tie between general price levels and exchange rates may be almost completely broken. Exchange rates at any given moment settle at the point which will equilibrate actual bids and offers. The fluctuations in the rate are unpredictable and frequently cumulative. They will be held in the neighborhood of purchasing power par only when conditional demand responds promptly to the stimulus which deviations from that par provide. In the German case conditional demand did not so respond and its failure to do so increased the strength of the forces operating through absolute demand. The respective weight of the several forces from time to time in operation it is impossible to determine. All the influences cited tended at one time or another to depress German exchange and, taken together, account for the unique character of the relationship of prices to exchange rates which appears in the case of the mark.

The price level was so far from dominating exchange rates that, on the face of the phenomena at least, it often seemed as if the causal sequence lay the other way. The actual sequence will be investigated statistically in the chapter to follow. It will be sufficient here to point out that some prices were directly affected by a fluctuation in the exchange value of the currency. This was true almost immediately of the prices of imported goods and, with a measure of retardation, of many exports as well.16 To determine the effect on other prices it will be enough to consider the consequences of an upward movement in the foreign exchange. An increase in export and import prices as a result of rising foreign exchanges tends of itself to augment the rate of monetary turnover and so to permit other prices to rise. Rising prices of imports will first cause importers to reduce their monetary balances and will also encourage banks to lend larger amounts on the basis of a given stock of imported goods. Both phenomena will operate to increase the speed of monetary turnover. Similarly, on stocks of exportable goods, more money will be lent by banks. If the total lending power of the banks were strictly limited, a general rise in prices might not ensue, but otherwise it is almost certain. Importers and exporters distribute their increased funds in the course of their business operations and the increase in prices is thus transmitted to other goods. This raises the monetary value of the security back of all collateralled bank loans and leads to larger loans. The statistics of German inflation later to be examined leave no doubt whatever that, in the post-war inflation period, the chronological, if not the logical, sequence of events often ran from exchange rates to prices to volume of circulating medium.

A rigid control of money and credit might have kept domestic prices down. But, so long as reciprocal demand did not balance at purchasing power par, foreign exchange would not have remained low. If it be admitted that the demands of the Allies for immediate cash reparations could not be covered by the then available supply of exportable goods in Germany, and that borrowing abroad was impossible, exchange rates would have risen no matter what had been done with the domestic currency. If the Germans had been on a gold standard they would have been forced to abandon it through the complete exhaustion of their gold.

If they had kept the issues of paper currency down, and with them domestic prices, they would have been denuded of all goods which could have been transported, and even then foreign exchange rates would not necessarily have fallen. On the contrary it is probable that Germany would have had in so exaggerated a form the phenomenon of two distinct price levels in foreign and domestic trade that complete industrial dislocation would have occurred. Though distinct internal and external price levels did develop the difference between them was constantly being diminished by rising prices in the domestic market. If such increase in domestic prices had been prevented it seems certain that the spread between the high prices on the foreign market, as measured in marks at the current exchange rate, and those prevailing at home, would have been greater than it was even though the absolute rise in foreign exchange had been somewhat curtailed.

It cannot be maintained that fluctuations in exchange rates ever absolutely dominate the internal price level of a country with a highly depreciated paper currency. But, on the other hand, it cannot be denied that they may occur in practically complete independence of the domestic value of the paper currency nor that a persistent tendency for foreign exchange to rule far higher than purchasing power par exerts a very strong upward pressure on domestic prices. The rate of monetary turnover will first be accelerated and, when this rate has reached its limit, the alternative to further note issues is a wellnigh intolerable spread between internal and external prices and consequent chaos in the whole price structure.

It should be noted, also, that equilibrium in foreign trade is more directly and readily reached under paper than under gold standards provided the movements in exchange rates under paper standards are not extreme. Where, on the other hand, the movements are extreme the achievement of equilibrium may very gravely be retarded.

§ REVISED THEORY OF RELATIONSHIP BETWEEN VOLUME OF CIRCULATING MEDIUM, PRICES, AND EXCHANGE RATES

In summary it may be said that there is an essential if not always a close numerical relationship between the volume of circulating medium and prices, while between prices and exchange rates, the numerical relationship, though normally close, is not at all essential. If ineluctable and regularly recurring obligations in foreign currencies should exceed any possibility of acquiring those currencies, then the exchange value of the domestic currency would fall to zero regardless of its internal purchasing power. So far as causal sequence is concerned it may properly be held that though, under an inconvertible paper monetary system, note issues do in fact tend to be increased as a result of rising prices (in contrast with what happens under a gold standard where the gold supply tends to fall off), and though prices do not always respond to an expansion or contraction of the currency, it is none the less true that prices are fundamentally a resultant of the volume of circulating medium. The latter is, though with difficulty, subject to control. Exchange rates, on the contrary, are a resultant of a number of forces of which relative price levels are one. Usually this one force is dominant but at times it plays but a subordinate role. Exchange rates may in turn affect prices, regardless of the volume of note issues, through changing the rate of monetary turnover. It can scarcely be said therefore that the causal sequence runs any more strongly in one direction than in the other. Prices and exchaiige rates are in part determined independently of one another, in part react upon one other, and in part are self-determined. Fluctuations in either may be the cause of further immediate as well as future movements in the same index and may or may not affect the other. With a sufficiently great change in general prices exchange rates will move in correspondence. The converse is not necessarily true. In this sense alone are prices the controlling factor.

 

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17 This may appear to be a confusion of the static with the dynamic. Under static conditions, it might be argued, reciprocal demand curves will never show “humps.” Yet it is conceivable that, at any given moment, a prospective buyer would be ready to purchase more exchange at a higher than at a lower price. One might then resort to casuistry and contend that, if the price were different, the premises would be altered, or that the commodity offered (the foreign ex-change) is not the same thing when its price is changed. In any case it is the dynamic situation which is of practical importance and there is no doubt of the fact that buyers frequently do purchase more at a higher than they would have taken at a lower price.

18 Except the price of paper, ink, and printing. This can always be reduced to a negligible proportion of the value of the note simply by raising the denomination. It costs no more to print a note for 100 million marks than for one of the 1 mark denomination. The commodity dealt in is here, of course, constantly changing in character.

19 This fact has been commented upon by the late Professor Allyn A. Young in his preface to The French Franc, 1914-1928, Eleanor Lansing Dulles, The Macmillan Company, New York, 1929. Professor Young pointed out that the effects of speculation in inconvertible money are not necessarily short-lived nor do the ultimate determinants of the value of the money necessarily remain unaffected by the speculation,

20 It will be more convenient here to take a fixed point of view, the German, and speak of “the supply of foreign exchange” rather than of the “demand for German exchange.”

21 When, in 1923, it was lured from this policy the results were such as to provide a complete justification of its former refusal to use its gold reserve in support of exchange. This justification was obtained in spite of the fact that the chance of success in 1923 was considerably better than it would have been in 1921, since, in 1923, cash reparations had been suspended.

22 The fear of the Germans that control of properties would on a large scale pass into the hands of foreigners (Überfremdung) and the measures adopted to prevent this happening were unnecessary.

23 What is here said is a partial repetition of my former treatment of this matter in an article entitled “Self-limiting and Self-inflammatory Movements in Exchange Rates,” Quarterly Journal of Economics, Vol. XLIII, February 1929, pp. 221-49. The editors of that journal have very kindly permitted me to reproduce parts of the article.

24 Only passing attention will be paid in this treatment of absolute reciprocal demand to the influence of conditional purchases and sales of exchange. Where those conditional purchases are very tardy, as was the case with mark exchange in the inflation period, the effect is similar, though less exaggerated, than that which would occur if there were none at all.

25 Abstraction is made here, and throughout the discussion, of shifts in the internal purchasing power of either currency through inflationary or deflationary movements concurrent with the movements in exchange rates. To include them would not alter the essential conclusions but would unduly complicate their presentation. The matter in hand is a consideration of exchange fluctuations only. It is presumed that no one will deny that exchange rates may, at least temporarily, move far out of line with the internal purchasing power of the currencies concerned.

26 Though the goods are quoted in dollars American exporters will really have for sale marks to an indefinite amount corresponding to the number of marks for which their dollar claims on German importers will exchange.

27 They may avoid bankruptcy if marks in unlimited supply are furnished by the issuing authorities, provided some foreign buyers of marks enter the market. It would seem that this was, in fact, the case in Germany in the inflation period.

28 cf. “Equilibrium in International Trade: The United States, 1919-26,” J. W. Angell, Quarterly Journal of Economics, Vol. XLII, May, 1928, p. 397. It is doubtful, however, whether German foreign trade follows this practice as fully as does that of other nations.

29 German exchange rate movements in the period of inflation were tested to determine whether the theory here advanced was corroborated by the facts. The degree of verification obtained was very considerable. See “Self-Limiting and Self-Inflammatory Movements in Exchange Rates,” op. cit. pp. 245 ff.

30 It would, of course, never be impossible to acquire by one means or another some foreign exchange. If none whatever had been available at any price a downward movement in mark exchange would probably have been interminable. The difficulty of procuring foreign exchange appears to have been sufficient to increase the range in fluctuations but it did not extend it ad infinitum.

31 The phrase is used in the sense in which it alone has any meaning, viz. a decrease or increase in more or less involuntary short-term credits from foreigners.

32 Whether import or export prices will be first affected in cases of this sort depends on the nature of the trade. Standardized goods with a world market are the first to respond, if imports are predominantly goods of this character, and exports not, imports will show the effect of changing exchange rates before exports will and vice versa if the premises are the opposite.

• 1CLIFFE-LESLIE once remarked that in social matters the greatest scientific progress is made when economic disorders raise vexing questions as to their causes. In the study of social phenomena, disorder is, it is true, the sole substitute for the controlled experiments of the natural sciences. But it sometimes happens that, in the midst of disorder, events move so rapidly that we are not able properly to observe them; disorder may be excessive even to the most detached of scientists. The course of inflation in Germany in the first post-war quinquennium had so much of this character that it has seemed to many to be incapable of throwing any light upon monetary problems. This most striking of monetary experiences has, in consequence, evoked a minimum of scientific curiosity. In spite of the fact that statistics—those notes of process on which the social scientist must so heavily rely—were for some phenomena abandoned in Germany in this period and for others are open to grave objection on the score of accuracy, it has seemed to me that such an attitude implies an unwarranted surrender in the face of difficulties which might with perseverance be surmounted. This book is an attempt, therefore, to discover what actually happened in Germany and either to bring the observed phenomena within the fold of accepted theory or else so to modify that theory as to give it a more catholic character. The actual course of events during inflation has not merely an historical and scientific interest but is of considerable practical importance. Germany’s present position as a nation with heavy international obligations has led to apprehension, both within and without the Reich, as to the future in international finance. The fears of such German competition as may issue out of the debtor status may be dismissed as but thinly-veiled mercantilism but the question as to the possibility of ultimate transfer of the large sums involved in reparations and interest payments must, perhaps, be treated with more respect. The ability of the German economy to provide, within Germany, the funds required, is, on the other hand, no longer seriously doubted. It is hoped that the sequel will throw some light on the disappearance of the latter doubt as also on the prospect of future transfers undisturbed by any serious economic friction.
• 2in Germany. It is based very largely on official German statistics as published by the Statistische Reichsamt and the Institut für Konjunkturforschung. These statistics, for the period studied, are, no doubt, far from perfect, but nothing is gained by attempting to go behind them and there is no reason to suppose that such alternative sources as are available are at all superior. The hope is cherished, perhaps not without justification, that such errors as are involved do not vitiate the conclusions reached. The immense nominal magnitudes attained by all -monetary phenomena in Germany in the inflation-time tend to dwarf the influence of even very considerable imperfections in the statistics. I am far from supposing, nevertheless, that the results obtained are to be taken as clearly proven and I trust that the reader will be no more credulous. They are merely hypotheses
• 3The publications of the Statistische Reichsamt which have been principally used are : Statistisches Jahrbuch für das deutsche Reich, Statistik des deutschen Reichs, Wirtschaft und Statistik, Monatliche Nachweise über den auswärtigen Handel Deutschlands, Zahlen zur Geldentwertung in Deutschland 1914 bis 1923, and Germany’s Economy, Currency and Finance. Sparing use has been made of forms of statistics already available in these sources and, where tables are given in the text, they are, in nearly all cases, the result of computations from the original data.
• 4The cessation of war found Germany in a financial position not markedly inferior to that of most of the other countries involved in the struggle. The far-reaching alterations in the Reichsbankgesetz in 1914 had permitted the suspension of specie payments, had removed the tax on excess Reichsbank note issues, had permitted the Reichsbank to use discounted Treasury bills in lieu of commercial bills as the non-cash cover for Reichsbank notes, and had made Reichskassenscheine and Darlehns-kassenscheine available to meet the “cash” reserve requirements. (The distinction between cash and non-cash cover was abolished in 1921.) This war legislation paved the way for all the coming currency difficulties but it did not differ very greatly from that adopted at the same time in practically all the countries then engaged in hostilities, nor did inflation in Germany, up to the time of the Armistice, much surpass that of some of the principal Entente Allies. The total circulation (including coin other than Reichsbank reserves) in the middle of 1914 is estimated to have been approximately six billions of marks; at the end of 1918 it was something more than five times as much, 32,936,700,000 marks. The total monetary circulation in Great Britain was about £180,000,000 when war broke out while four and a half years later the total of outstanding notes was more than double that sum and stood at approximately £394,000,000. Bank deposits, which in England are a more important index of inflation, had grown in about the same proportion. The total circulation in France (excluding reserves of the Bank of France) in mid-1914 was something over 8,000,000,000 francs (6.5 billion francs in gold and silver, less 4 billion Bank of France reserves, plus 5.8 billion in notes of the Bank of France) while at the end of 1918 the note circulation of the Bank of France amouted to over 30,000,000,000 francs or not quite four times the total pre-war volume of currency. By this date all the gold formerly in circulation had of course disappeared.
• 5The cessation of war found Germany in a financial position not markedly inferior to that of most of the other countries involved in the struggle. The far-reaching alterations in the Reichsbankgesetz in 1914 had permitted the suspension of specie payments, had removed the tax on excess Reichsbank note issues, had permitted the Reichsbank to use discounted Treasury bills in lieu of commercial bills as the non-cash cover for Reichsbank notes, and had made Reichskassenscheine and Darlehns-kassenscheine available to meet the “cash” reserve requirements. (The distinction between cash and non-cash cover was abolished in 1921.) This war legislation paved the way for all the coming currency difficulties but it did not differ very greatly from that adopted at the same time in practically all the countries then engaged in hostilities, nor did inflation in Germany, up to the time of the Armistice, much surpass that of some of the principal Entente Allies. The total circulation (including coin other than Reichsbank reserves) in the middle of 1914 is estimated to have been approximately six billions of marks; at the end of 1918 it was something more than five times as much, 32,936,700,000 marks. The total monetary circulation in Great Britain was about £180,000,000 when war broke out while four and a half years later the total of outstanding notes was more than double that sum and stood at approximately £394,000,000. Bank deposits, which in England are a more important index of inflation, had grown in about the same proportion. The total circulation in France (excluding reserves of the Bank of France) in mid-1914 was something over 8,000,000,000 francs (6.5 billion francs in gold and silver, less 4 billion Bank of France reserves, plus 5.8 billion in notes of the Bank of France) while at the end of 1918 the note circulation of the Bank of France amouted to over 30,000,000,000 francs or not quite four times the total pre-war volume of currency. By this date all the gold formerly in circulation had of course disappeared.
• 6The cessation of war found Germany in a financial position not markedly inferior to that of most of the other countries involved in the struggle. The far-reaching alterations in the Reichsbankgesetz in 1914 had permitted the suspension of specie payments, had removed the tax on excess Reichsbank note issues, had permitted the Reichsbank to use discounted Treasury bills in lieu of commercial bills as the non-cash cover for Reichsbank notes, and had made Reichskassenscheine and Darlehns-kassenscheine available to meet the “cash” reserve requirements. (The distinction between cash and non-cash cover was abolished in 1921.) This war legislation paved the way for all the coming currency difficulties but it did not differ very greatly from that adopted at the same time in practically all the countries then engaged in hostilities, nor did inflation in Germany, up to the time of the Armistice, much surpass that of some of the principal Entente Allies. The total circulation (including coin other than Reichsbank reserves) in the middle of 1914 is estimated to have been approximately six billions of marks; at the end of 1918 it was something more than five times as much, 32,936,700,000 marks. The total monetary circulation in Great Britain was about £180,000,000 when war broke out while four and a half years later the total of outstanding notes was more than double that sum and stood at approximately £394,000,000. Bank deposits, which in England are a more important index of inflation, had grown in about the same proportion. The total circulation in France (excluding reserves of the Bank of France) in mid-1914 was something over 8,000,000,000 francs (6.5 billion francs in gold and silver, less 4 billion Bank of France reserves, plus 5.8 billion in notes of the Bank of France) while at the end of 1918 the note circulation of the Bank of France amouted to over 30,000,000,000 francs or not quite four times the total pre-war volume of currency. By this date all the gold formerly in circulation had of course disappeared.
• 7The cessation of war found Germany in a financial position not markedly inferior to that of most of the other countries involved in the struggle. The far-reaching alterations in the Reichsbankgesetz in 1914 had permitted the suspension of specie payments, had removed the tax on excess Reichsbank note issues, had permitted the Reichsbank to use discounted Treasury bills in lieu of commercial bills as the non-cash cover for Reichsbank notes, and had made Reichskassenscheine and Darlehns-kassenscheine available to meet the “cash” reserve requirements. (The distinction between cash and non-cash cover was abolished in 1921.) This war legislation paved the way for all the coming currency difficulties but it did not differ very greatly from that adopted at the same time in practically all the countries then engaged in hostilities, nor did inflation in Germany, up to the time of the Armistice, much surpass that of some of the principal Entente Allies. The total circulation (including coin other than Reichsbank reserves) in the middle of 1914 is estimated to have been approximately six billions of marks; at the end of 1918 it was something more than five times as much, 32,936,700,000 marks. The total monetary circulation in Great Britain was about £180,000,000 when war broke out while four and a half years later the total of outstanding notes was more than double that sum and stood at approximately £394,000,000. Bank deposits, which in England are a more important index of inflation, had grown in about the same proportion. The total circulation in France (excluding reserves of the Bank of France) in mid-1914 was something over 8,000,000,000 francs (6.5 billion francs in gold and silver, less 4 billion Bank of France reserves, plus 5.8 billion in notes of the Bank of France) while at the end of 1918 the note circulation of the Bank of France amouted to over 30,000,000,000 francs or not quite four times the total pre-war volume of currency. By this date all the gold formerly in circulation had of course disappeared.
• 8The cessation of war found Germany in a financial position not markedly inferior to that of most of the other countries involved in the struggle. The far-reaching alterations in the Reichsbankgesetz in 1914 had permitted the suspension of specie payments, had removed the tax on excess Reichsbank note issues, had permitted the Reichsbank to use discounted Treasury bills in lieu of commercial bills as the non-cash cover for Reichsbank notes, and had made Reichskassenscheine and Darlehns-kassenscheine available to meet the “cash” reserve requirements. (The distinction between cash and non-cash cover was abolished in 1921.) This war legislation paved the way for all the coming currency difficulties but it did not differ very greatly from that adopted at the same time in practically all the countries then engaged in hostilities, nor did inflation in Germany, up to the time of the Armistice, much surpass that of some of the principal Entente Allies. The total circulation (including coin other than Reichsbank reserves) in the middle of 1914 is estimated to have been approximately six billions of marks; at the end of 1918 it was something more than five times as much, 32,936,700,000 marks. The total monetary circulation in Great Britain was about £180,000,000 when war broke out while four and a half years later the total of outstanding notes was more than double that sum and stood at approximately £394,000,000. Bank deposits, which in England are a more important index of inflation, had grown in about the same proportion. The total circulation in France (excluding reserves of the Bank of France) in mid-1914 was something over 8,000,000,000 francs (6.5 billion francs in gold and silver, less 4 billion Bank of France reserves, plus 5.8 billion in notes of the Bank of France) while at the end of 1918 the note circulation of the Bank of France amouted to over 30,000,000,000 francs or not quite four times the total pre-war volume of currency. By this date all the gold formerly in circulation had of course disappeared.
• 9The cessation of war found Germany in a financial position not markedly inferior to that of most of the other countries involved in the struggle. The far-reaching alterations in the Reichsbankgesetz in 1914 had permitted the suspension of specie payments, had removed the tax on excess Reichsbank note issues, had permitted the Reichsbank to use discounted Treasury bills in lieu of commercial bills as the non-cash cover for Reichsbank notes, and had made Reichskassenscheine and Darlehns-kassenscheine available to meet the “cash” reserve requirements. (The distinction between cash and non-cash cover was abolished in 1921.) This war legislation paved the way for all the coming currency difficulties but it did not differ very greatly from that adopted at the same time in practically all the countries then engaged in hostilities, nor did inflation in Germany, up to the time of the Armistice, much surpass that of some of the principal Entente Allies. The total circulation (including coin other than Reichsbank reserves) in the middle of 1914 is estimated to have been approximately six billions of marks; at the end of 1918 it was something more than five times as much, 32,936,700,000 marks. The total monetary circulation in Great Britain was about £180,000,000 when war broke out while four and a half years later the total of outstanding notes was more than double that sum and stood at approximately £394,000,000. Bank deposits, which in England are a more important index of inflation, had grown in about the same proportion. The total circulation in France (excluding reserves of the Bank of France) in mid-1914 was something over 8,000,000,000 francs (6.5 billion francs in gold and silver, less 4 billion Bank of France reserves, plus 5.8 billion in notes of the Bank of France) while at the end of 1918 the note circulation of the Bank of France amouted to over 30,000,000,000 francs or not quite four times the total pre-war volume of currency. By this date all the gold formerly in circulation had of course disappeared.
• 10The cessation of war found Germany in a financial position not markedly inferior to that of most of the other countries involved in the struggle. The far-reaching alterations in the Reichsbankgesetz in 1914 had permitted the suspension of specie payments, had removed the tax on excess Reichsbank note issues, had permitted the Reichsbank to use discounted Treasury bills in lieu of commercial bills as the non-cash cover for Reichsbank notes, and had made Reichskassenscheine and Darlehns-kassenscheine available to meet the “cash” reserve requirements. (The distinction between cash and non-cash cover was abolished in 1921.) This war legislation paved the way for all the coming currency difficulties but it did not differ very greatly from that adopted at the same time in practically all the countries then engaged in hostilities, nor did inflation in Germany, up to the time of the Armistice, much surpass that of some of the principal Entente Allies. The total circulation (including coin other than Reichsbank reserves) in the middle of 1914 is estimated to have been approximately six billions of marks; at the end of 1918 it was something more than five times as much, 32,936,700,000 marks. The total monetary circulation in Great Britain was about £180,000,000 when war broke out while four and a half years later the total of outstanding notes was more than double that sum and stood at approximately £394,000,000. Bank deposits, which in England are a more important index of inflation, had grown in about the same proportion. The total circulation in France (excluding reserves of the Bank of France) in mid-1914 was something over 8,000,000,000 francs (6.5 billion francs in gold and silver, less 4 billion Bank of France reserves, plus 5.8 billion in notes of the Bank of France) while at the end of 1918 the note circulation of the Bank of France amouted to over 30,000,000,000 francs or not quite four times the total pre-war volume of currency. By this date all the gold formerly in circulation had of course disappeared.
• 11Wholesale prices in Germany, Great Britain and France at the end of 1918 were respectively 2.45, 2.30 and 3.53 times their pre-war height. In the United States they were just about twice their 1913 level.
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• 13The occupation, by French and Belgian troops, took place in the early days of January 1923. The British government of the day adopted an attitude of passive disapproval and Italy, while assenting to the measures taken, refused to participate actively in the occupation.
• 14The exchange value of French currency, for instance, was brought very low when it became apparent that the French fise could not count on any large receipts from Germany.
• 15When the administration proposed a capital levy to meet the burdens imposed, the industrialists countered with the offer of a loan of one billion gold marks. But, as negotiations proceeded, the industrialists demanded a remission of future taxes and the turning over to them of the state railroads. The government properly refused and resorted to a forced loan which, however, yielded only 50 million gold marks.
• 16The provisions for redemption in “rentenbank certificates” and the mortgage cover provided had, as all students of monetary phenomena will recognize, but a psychological value. The success of the rentenmark was due entirely to the rigid limitations on issue.
• 17cf. Foreign Banking Systems, H. P. Willis and B. H. Beckhart, editors, Chap, VIII, “The Banking System of Germany,” Paul Quittner, Henry Holt and Company, New York, 1929, p. 632, where it is declared that it would be useless to try to connect the development of the German currency system from 1919 to 1923 with any theories of money.
• 18In the matter of mark exchange rates, for instance, sizable differences developed, in the later stages of inflation, between the Berlin and other markets. These were due to the obstruction of arbitrage transactions. At the time that this occurred, however, the Berlin rate was alone of much significance. The Berlin rates have therefore been used throughout. In the matter of prices the alternative sources are the indices of the Berliner Tageblatt, the Frankfurter Zeitung, and the Industrie- und Handelszeitung.
• 19The latter compilation was published in English, as well as in German, for use by the Committees of Experts of the Reparations Commission.
• 20Treasury notes, a fiduciary currency. These were, however, issued rather sparingly. The maximum issue was 356 million marks. Reichskassenscheine had been legal as cash cover in pre-war days but their issue had been closely restricted and few had been available. These Treasury notes are to be carefully distinguished from Treasury bills, a short-term security not used as money.
• 21A form of currency issued by officially established Loan Bureaus against the pledge of securities (or commodities) by borrowers other than the government and the larger banks and business concerns. During the war these notes formed an important share of the circulating medium but thereafter remained comparatively stable in absolute figures (7 to 14 billion marks) and were of constantly declining relative importance. They played but a slight ròle from 1921 onward.
• 22Germany’s Economic and Financial Situation, Statistisches Reichsamt, Zentralverlag G.m.b.H., Berlin, 1923, p. 28.
• 23Zahlen zur Geldentwertung in Deutschland 1914 bis 1923, Statistisches Reichsamt, Verlag von Reimar Hobbing, Berlin, 1925, p. 46.
• 24Committee on Currency and Foreign Exchanges After the War (Cunliffe Committee) First Interim Report, H. M. Stationery Office, London, 1924, p. 5.
• 25Total bank deposits, exclusive of those of small private banks, were £716 million on June 30, 1914, and £1361 million on June 30, 1919. European Currency and Finance, United States Senate Commission of Gold and Silver Inquiry, Serial 9, Vol. I, Government Printing Office, Washington, 1925, pp. 277, 278.
• 26ibid., Vol. I, pp. 308, 470.
• 27ibid., Vol. I, pp. 534. 477, 455.
• 28Of this amount approximately 97 billion marks had been obtained through long-term loans.
• 29The climax in the reparations conflict came with the invasion of the Ruhr, an action which had no support from some of the creditor Powers. Much as the invasion is to be regretted or condemned, however foolish it may have been as a method of collecting payment, and however evil its immediate results, it was the thunderclap that cleared the air. It showed the obdurate creditors how little could be obtained by a policy of force and, on the other hand, it brought such distress to Germany as to convince even the stoutest opponent of the policy of fulfilment (and they were many and powerful) that it was better to accept a moderated burden of payments which, in spite of strong convictions to the contrary, it might be possible for the country to carry, than to continue in an attitude of stubborn intransigence.
• 30When force had led to disaster, the repercussions of which affected the creditors as well as the debtors, the way was at last open to men of conciliatory spirit, and a solution of the problem, or at any rate a working compromise, could be reached. The invasion was a tragic but triumphant vindication of the policy of moderation, and it led to sympathetic, even if selfish, efforts on the part of the creditor Powers to rehabilitate the economy and finances of the Reich. Once order had been restored progress was possible.
• 31Inflation was therefore combated but half-heartedly at best. Though several of the administrations of the years 1920 to 1923 made valiant attempts to arrest its progress they could not summon the sustained powers necessary to success. All of their efforts came to naught, largely through the apathy or active opposition of powerful business groups who were disposed neither to aid their government in imposing regular taxation nor to cooperate with it in carrying out its obligations under the Treaty of Versailles. Whatever might have been possible to a government backed by a people determined to have no further traffic with inflation, the will to establish a stable standard was lacking until the drama had run its course. It may well be doubted whether a stable standard could in any case have been set up while immense reparations debts were plaguing the situation. But this must remain an open question. So long as wealth and income were being merely transferred by the decline in the value of the monetary unit and not, as a sum, diminished, so long as scapegoats could be found to assume the burdens and yield of their substance to those who knew how to profit from the situation, projects of reform were treated cavalierly. It was only when enterprisers, instead of surely profiting from inflation as they long did, were suddenly plunged into a sea of uncertainties, only when business activity passed from the stage of exhilaration to panic, only when resistance to a further assumption of losses on the part of the public at large became general, that influential opinion veered to a conviction of the necessity of restoring a stable standard. The pass to which matters had then come is shown in Table III.
• 32The successful introduction of the rentenmark in November 1923, a currency without gold backing and, indeed, nothing more than a new tenor of inconvertible paper, with the monetary stabilization thus effected, has been hailed as a miracle. It was certainly a remarkable achievement and bears strong witness to the steadfastness of the German character. The time was ripe but extremely unpropitious. The people had lost all confidence in their currency and in the possibility of its reform. Foreign troops were in possession of their chief industrial districts and the coercive measures adopted by the occupying powers had paralyzed the industrial life of the country. The masses of the urban population were living from hand to mouth, nay, had nothing in their hands but worthless bits of paper which the farmers would no longer accept in exchange for grain. Food riots were general. Political dissolution was in imminent prospect and armed revolt had already raised its head. Affairs were indeed so black that it is clear, in retrospect, that they actually facilitated the reform by imbuing the people with the resolution of despair. The conduct of currency matters was given to Dr. Hjalmar Schacht who possessed the temperament necessary to the situation. His powers were presently enlarged by his election to the Presidency of the Reichsbank. The former President Havenstein had died on the very day that conversion of the old currency into the new was under-taken, a demise which cannot be thought of as other than opportune.