Everything You Know About Economics Is Wrong: The US Won’t Turn Into The Weimar Republic

When you say the “government prints money,” the first image that pops into people’s heads is the Weimar Republic.

There’s something deeply unsettling about piles of money, that have taken countless hours of toil to acquire, being used for kindling.

But the act of printing money does not cause hyperinflation, let alone regular inflation.  Government printing money is how we get the money that’s in our wallets. It is the foundation of an efficient monetary system.

So just because the government prints money, doesn’t mean we are going to turn into the Weimar Republic. The Weimar Republic suffered from very specific circumstances that caused the spiraling hyperinflation.  These circumstances aren’t present in today’s Western economies.

To understand why the Weimar Republic is a special situation, you have to understand its context in history. The Weimar Republic had just emerged from the ravages of WWI. The country’s manufacturing and social infrastructure had been destroyed.

In any economic system, when supply becomes constrained, there’s an increased risk of inflation.

And Germany was definitely supply constrained.  German citizens were starving because the country’s infrastructure had not been rebuilt and an allied naval blockade kept food from being imported into Germany.  As Winston Churchill reported to Parliament in 1919:

…Germany is very near starvation. All the evidence I have received from officers sent by the War Office all over Germany show: firstly, the great privation which the German people are suffering; and, secondly, the danger of a collapse of the entire structure of German social and national life under the pressure of hunger and malnutrition.

The country could not produce anything until it was rebuilt. Even though the government was printing money, that money couldn’t buy anything because nothing was available. Therefore, the price of goods, like food, kept rising. Yes, the government printed too much money.  But correlation doesn’t mean causation. The main problem was the country had no resources to make bread.

In addition to the internal supply constraints that caused famine, the country had external draws on its supply of commodities.  The terms of the Versailles Treaty called for Germany to pay World War I reparations with gold, timber, industrial metals, and other valuable resources.  The country could not simply print Reichmarks to pay off France and England.  In practice, this was similar to Germany owing debt, denominated in hard currency, to other nations. The government had to obtain gold or commodities before it could make payments. But, again, much of the country’s infrastructure was destroyed.  The government had no real means to harvest commodities to pay the commodities it owed.  It was an endless, futile circle.

Finally, the Weimar government was basically non-functioning.  In 1919 and 1920, right-wing extremist groups prayed on the public’s desperation with racist, nationalistic, and economic propaganda.  These right-wing groups assassinated over 300 Weimar politicians to stoke fear in the opposition.  Communist parties staged revolts and coups attempts.  Private armies, staffed by discontented young soldiers tired of being unemployed, protected business and political interests because the government couldn’t do the job.

In an environment without a strong central government, the risk for inflation increases.  Government infrastructure is important in maintaining a stable currency because taxation is the main way to create demand for said currency.  Without the infrastructure to collect, enforce and levy taxes, a fiat currency has no underlying value.  And without receiving core public services like water and protection of property, citizens are less likely to pay their taxes voluntarily. Again, a death spiral for an economy.

So in reality, it wasn’t money printing that caused hyperinflation in the Weimar Republic.  Instead, very specific circumstances caused hyperinflation:

1. The country was supply-constrained. No matter how much money people had, they still could not buy the basic goods they needed for survival;
2. The country owed hard currency as reparations to foreign powers, hard currency that it had no means to obtain because it was supply-constrained and could not trade with other countries; and finally
3. The country had no functioning government that could enforce tax laws. Governments need to collect taxes, not to fund expenditures, but to give the currency value.  Without enforceable tax codes, a currency is only as good as someone else’s willingness to accept it for payment.

These circumstances were so specific that their consequences could be predicted. Economists are notorious for their inability to foretell disaster.  The predictions from most economists before the Great Recession in 2008 are comically tragic.  However, if an economist actually understands how money and inflation are created, a prediction is not fruitless.

In one of the great tragedies of world history, a whole book was written explaining the future collapse of Europe, long before the start of the second world war.  In 1919, John Mayard Keynes wrote The Economic Consequences of the Peace. Keynes was so outraged by the misguided negotiations at the Paris Peace Conference of 1919 he left in protest and immediately started writing the book.  Keynes picked apart the Treaty of Versailles, destroyed the reputations of the politicians that crafted the document, and offered specific alternatives to avoid the coming disaster.  It might be one of the most important economic documents ever written.

While his writing style was flowery, Keynes’ message was clear:

The Treaty includes no provisions for the economic rehabilitation of Europe – nothing to make the defeated Central Powers into good neighbors, nothing to stabilize the new states of Europe, nothing to reclaim Russia; nor does it promote in any way a compact of solidarity amongst the Allies themselves; no arrangement was reached at Paris for restoring the disordered finances of France and Italy, or to adjust the systems of the Old World and the New.

Keynes had a keen understanding that hampering Germany’s commodity-based economy would result in disaster. The Treaty was meant to destroy Germany so the country could no longer gather the resources to rebuild its economic and military power. All of Germany’s industrial supply was damaged and foreign trade was hindered. The country was supply-constrained.

The German economic system as it existed before the war depended on three main factors:

1. Overseas commerce as represented by her mercantile marine, her colonies, her foreign investments, her exports, and the overseas connections of her merchants;

2. The exploitation of her coal and iron and the industries built upon them;

3. Her transport and tariff system.

Of these the first, while not the least important, was certainly the most vulnerable. The Treaty aims at the systematic destruction of all three, but principally of the first two.

Keynes takes the Treaty to task for demanding payment in a matter of the Allies’ choosing.  Germany owed its reparations in hard currency, a currency it had little means of obtaining:

The Reparation Commission is empowered up to May 1, 1921, to demand payment up to $5,000,000,000 in such manner as they may fix, “whether in gold, commodities, ships, securities or otherwise.” This provision has the effect of intrusting to the Reparation Commission dictatorial powers over all German property of every description whatever.

And he also took the Treaty to task for demanding commodities from Germany that it needed to rebuild its economy.

The skilled exploitation of the great coalfields of the Ruhr, Upper Silesia, and the Saar, alone made possible the development of the steel, chemical, and electrical industries which established her as the first industrial nation of continental Europe. One-third of Germany’s population lives in towns of more than 20,000 inhabitants, an industrial concentration which is only possible on a foundation of coal and iron.

In striking, therefore, at her coal supply, the French politicians were not mistaking their target.

Keynes also understood the inability of the government to follow a budget and collect taxes would inevitably lead to uncontrollable inflation.  He links the high inflation experienced in France and Germany after the war to the inability of the governments to collect taxes.

The existing inflation and the maladjustment of international trade are aggravated, both in France and in Italy, by the unfortunate budgetary position of the Governments of these countries.

In France, the failure to impose taxation is notorious. Before the war, the aggregate French and British budgets, and also the average taxation per head, were about equal; but in France no substantial effort has been made to cover the increased expenditure. “Taxes increased in Great Britain during the war,” it has been estimated, “from 95 francs per head to 265 francs, whereas the increase in France was only from 90 to 103 francs.” The taxation voted in France for the financial year ending June 30, 1919, was less than half the estimated normal post-bellum expenditure.

In Germany, the total expenditure of the Empire, the Federal States, and the Communes in 1919–20 is estimated at 25 milliards of marks, of which not above 10 milliards are covered by previously existing taxation. This is without allowing anything for the payment of the indemnity. In Russia, Poland, Hungary, or Austria such a thing as a budget cannot be seriously considered to exist at all. … Thus the menace of inflationism described above is not merely a product of the war, of which peace begins the cure. It is a continuing phenomenon of which the end is not yet in sight.

“The Economic Consequences of The Peace” is a remarkable document, not only because it pointed out the Treaty’s mistakes, but it also recommended specific solutions.  Keynes specifically suggested the forgiveness of each countries war debts. He called the government debts “paper shackles” which held back the progress of restoring each country’s economy.  His suggestion highlights Keynes’ most famous contribution to economics: government-run deficits stimulate the private economy.

In the aftermath of WWI, Keynes believed the government’s best use of currency power was to rebuild and move forward rather than destroy and anchor in the past.

Unfortunately, the Western Powers did not heed his advice.  Keynes predicted the consequences of this misguided treaty would eventually come back to haunt Europe.

Men will not always die quietly. For starvation, which brings to some lethargy and a helpless despair, drives other temperaments to the nervous instability of hysteria and to a mad despair. And these in their distress may overturn the remnants of organization, and submerge civilization itself in their attempts to satisfy desperately the overwhelming needs of the individual. This is the danger against which all our resources and courage and idealism must now co-operate.

Catastrophes can still happen, and that modern society is not immune from the very greatest evils. If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp. Nothing can then delay for very long that final civil war between the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the late German war will fade into nothing, and which will destroy, whoever is victor, the civilization and the progress of our generation.

Reading “The Economic Consequences of the Peace” is haunting, not just because the predictions were so accurate, but the inevitable outcome could not be prevented.  Seeking justice through vengeance is a core human trait. But it never leads to peace.

Today, the lessons from “The Economic Consequences” still stand.  Our futures should not be tied to the “paper shackles” of a national debt that never has to be repaid.  Our futures should not be constrained by the misguided fears of hyperinflation.  Our futures should be guided by our desire to make every citizen’s lives better using the full capacities and resources of our country.

The United States and most Western economies do not suffer from any of the preludes to hyperinflation.  The United States is not, in any way, supply-constrained.  Industrial capacity utilization is barely at levels where it used to bottom out in the 1980s and 1990s even though the economy has been growing for 10 years.  In terms of access to energy, supply is plentiful as the US is now the largest oil producer in the world.

 

In addition, the United States has the most flexible monetary system in the world. The dollar is not tied to any hard commodities, is not pinned to other currencies, and has the benefit of being accepted the world over. The US government can literally pay for anything that it wishes to buy.

Finally, despite the best efforts of politicians, the US government still has the power to convince citizens to voluntarily pay their income taxes. Despite constant budget cuts, the IRS collects more money now than ever.  As long as citizens are required to pay taxes, demand for the US dollar will remain stable.  According to the Los Angeles Times:

The IRS is becoming something of a model of efficiency among Washington’s bureaucracies. It collects more taxes every year than ever before, at lower cost per dollar collected than anytime since 1980. It does fewer face-to-face audits, too; most of its enforcement is done by checking electronic data and sending out letters.

The IRS is the agency conservatives love to hate. Sen. Ted Cruz (R-Texas), who’s running for the GOP presidential nomination, gets some of his loudest cheers on the campaign trail when he says he has a simple approach to tax reform: “Abolish the IRS.” Aides say Cruz would replace the agency with a tax collection division in the Treasury Department. (Treasury already has a tax collection division. It’s called the IRS.)

Political attempts to strangle the taxing capabilities of the US government are one of the fastest ways to destabilize the economy.  High inflation and weak governments go hand in hand. Greece, Brazil, Argentina, Venezuela – all had or have weak governments that cannot efficiently levy and collect taxes, all are beset by corruption, and all cannot offer citizens the most basic of public services.

Now more than ever, Western governments need to understand their obligations…not in re-paying their debts but in spending for growth.  The canard of hyperinflation has prevented them from improving infrastructure and healthcare, increasing spending on education, and improving services.  Without such spending, we know from history that catastrophes can still happen, and that modern society is not immune from the very greatest evils.