yperin ations destroy economies. They also drastically change the way people think and, in turn, whom they vote for. Democracy may be the best form of government invented by mankind, but it ends up electing its share of idiots as well.
A great example of this is the German hyperin ation of the 1920s, when the Reichsbank, the central bank of Germany, had gone on a paper-money-issuing spree. By 15 November 1923, the day the in ation of cially ended, it had printed a whopping 92.8 quintillion (i.e., 92,800,000,000,000,000,000) paper marks (the German currency during those days). Five days later, on 20 November 1923, these marks were made convertible into a new currency at the rate of one trillion to one.1
The increase in money printing did not happen overnight; it had been happening since the First World War had started. By the time the war ended, in October 1918, the amount of paper money in the system was four times the money at the beginning of the war.
Despite this, prices had risen only by 139 per cent. But by the beginning of 1920, the situation had reversed. The money in circulation had grown 8.4 times since the start of the war, whereas the wholesale price index had risen nearly 12.4 times. It kept getting worse.
By November 1921, circulation had gone up eighteen times and prices thirty-four times. By the end of it all, in November 1923, the circulation of money had gone up 245 billion times. In turn, prices had skyrocketed 1,380 billion times since the beginning of the First World War.2
During the initial stages of in ation, the man on the street does not know that the government is printing money. He has con dence in the paper money he is using. He does not know his paper money will lose value soon and so does not rush to spend it.
Gradually, the news gets around that the government is printing money. At this point, there is some rush to spend money before it loses its value. This is when prices start to grow at the rate at which the money is being printed. In the nal stage of in ation, as the central bank continues to print money, backed by the government, people start to feel that this will continue inde nitely. They try to get rid of their paper money, as soon as it comes into their hands. This, in turn, causes prices to rise faster than the rate at which the money is being printed.3
Eventually, prices rise at such a fast rate that the central bank cannot print enough money to keep up. In Germany, thirty government-owned printing presses and 100 private
printing presses could not churn out money fast enough to keep up with the in ation. On 23 October 1923, a statement issued by the German central bank said it had been able to print only 120 quadrillion (i.e., 120 followed by 15 zeroes, or 120 x 1015) paper marks, when the demand had been a quintillion (one followed by 18 zeroes, 1018).4 Practically all money had become worthless. A wheelbarrow full of money was not good enough to buy a newspaper. Walter Levy, a well-respected German-born oil consultant working in New York, would later recall that his father had taken out an insurance policy in 1903. He had religiously paid the premiums on the twenty-year policy. When the policy had matured in 1923, the money he received was just enough to buy a loaf of bread.5 The wealth of the Germans was largely held in government bonds and it got completely wiped out due to hyperinflation.6
Things were so bad that farmers would not sell their produce for money. Businesses had to employ more people just to make calculations. Also, with prices increasing at the rate they were, the will to work began dying. The production of coal in the coal mining area of Ruhr fell from 928 kg per miner in 1913 to 585 kg per miner in 1922.7
The novelist Thomas Mann captured the spirit of the times beautifully when he wrote:
For instance, you might drop in at a tobacconist’s for a cigar. Alarmed by the price, you’d rush to a competitor, nd that his price was still higher, and race back to the rst shop, which may have doubled or tripled its price in the meantime. There was no help for it, you had to dig into your pocketbook for it and take out a huge bundle of millions, or even billions, depending on the date.8
Worthlessness was the principal product of hyperin ation. In The Ascent of Money, Niall Ferguson quotes Elias Canetti, a famous playwright, on his experience about living through the hyperinflation in Germany.
[It is] a witches’ sabbath of devaluation where men and the units of their money have strongest effects on each other. The one stands for the other, men feeling themselves as ‘bad’as their money; and this becomes worse and worse. Together they are all at its mercy and all feel equally worthless.
It need not be said that a generation of middle class people saw their savings fall to zero. Unionized unemployment rose to 30 per cent in 1923, from under 1 per cent in the previous year.9 People began to feel a sense of hatred and a loss of faith in the politicians of the day and in the German democratic system. This paved the way for the rise of Adolf Hitler.
Hitler’s Nazi Party (a short form for Nationalsozialistische Deutsche Arbeiterpartei or the National Socialist German Workers Party) had attempted a failed coup in 1923, but in the next elections in May 1924, the party won thirty-two seats. This was followed by another decent showing six months later in December 1924, when the party won twenty
seats. As Henry Hazlitt, an American journalist who worked for the New York Times and later Newsweek, wrote in What You Should Know About Inflation, ‘It was in the tremendous German inflation of 1923 that the seeds of Nazism were sown.’10
***
After the failed coup attempt in 1923, Hitler was imprisoned. During his con nement, he wrote his autobiography Mein Kampf (My Struggles). The book was released in two volumes in 1925 and 1926, and still remains in print all these years later. In this book, Hitler wrote about the two evils in the world: communism and Judaism, and stated that his aim was to eradicate both. Hitler divided the human race based on physical attributes.
He went on to state that the German Aryans, with their blue eyes and blonde hair (which Hitler himself had), were at the top of the hierarchy. At the bottom of the hierarchy were the Jews, Poles, Czechs and Russians. He further wrote that the Jews were conspiring to stop the master race of Germans from ruling this world.11
Hitler became the Chancellor of Germany on 30 January1933. He would stay the Chancellor of Germany till 30 April 1945, when he committed suicide along with his wife of two days and mistress of many years, Eva Braun. Many of Hitler’s actions during his twelve years at the helm of the German government had already been hinted at, or, in some cases, elaborated in Mein Kampf. He sent Jews to concentration camps throughout Europe and began a series of wars that came to be known as the Second World War. As the Second World War came to an end, the nancial system of the world was in a mess.
Instead of letting things drift as they had after the First World War, this time various countries decided to meet and develop a new financial system for the world.
***
Between 1 and 22 July 1944, a group of bankers, politicians and economists gathered at Mount Washington Hotel in Bretton Woods, New Hampshire, in the US. Their aim was to discuss and establish a post-war international nancial system. Around 730 delegates representing forty-four countries had come to the conference, which had to be extended beyond its original schedule.
There were two pivotal gures at the conference. One John Maynard Keynes. The other was Harry Dexter White, assistant treasury secretary of the US. Coincidentally, both Keynes and White died of a heart attack within a few years of the conference. White may have also been a spy for the Soviet Union, and might have passed on con dential information about the negotiations to the Russians.12
Between the two world wars, countries had tried to devalue their currencies and export their way out of trouble. This strategy only worked as long as a country was devaluing faster than other countries. This led to a situation where de ation, or falling prices, became an international phenomenon.
Against this background, it became very important to design an international monetary system in which currencies would have a xed value against each other. The classical gold standard that had been used before the First World War could have been such a system.
But for it to work, gold had to be adequately distributed among all the major countries of the world. The European countries which were involved in the Second World War were highly in debt to the US and had transferred large amounts of gold to the US.13
Countries such as Great Britain had suffered greatly upon returning to the classical gold standard after the First World War. The classical gold standard did not enjoy much support among the people who had gathered at the conference.
The idea was to come up with a system which allowed for stable exchange rates between the paper currencies of various countries and, at the same time, allowed these paper currencies to be converted into gold.
As Keynes put it, ‘We … have been trying to accomplish something very dif cult to accomplish … It has been our task to nd a common measure, a common standard, a common rule acceptable to each and not irksome to any.’14
The system that nally evolved out of the conference had the US dollar at the heart of it. The US agreed to convert paper dollars to gold and gold to paper dollars at the rate of
$35 per ounce of gold (the rate set by Roosevelt after he became president). So the dollar became as good as gold.
Only the central banks of countries were allowed to convert their dollars to gold. All other paper currencies were pegged to the dollar and would have par values against the dollar. In the case of Great Britain, the par value was set at the prevailing exchange rate of
$4.03 for £1. The par value of the Canadian dollar was set at 100 US cents or $1. These values could uctuate within a range of 1 per cent on either side. Members of the Bretton Woods nancial system had to ensure that in their respective territories, all transactions took place within these margins.15
This meant that if the dollar was overvalued with respect to the pound, the British government would have to be ready to sell dollars and bring its value within the permitted range. Conversely, if the dollar was undervalued with respect to the British pound, the British government would have to buy dollars to pump up its value and bring it within the permitted range.
The nancial system that evolved out of Bretton Woods made the dollar the lynchpin of the international monetary system. Never had the countries of the world formally come together to make one currency the leader of all others as they did at Bretton Woods.
With the Bretton Woods agreement in place, the US dollar would be the only international reserve currency. Unlike earlier, it was now the only currency that could be converted into gold. Countries would have to maintain their foreign exchange reserves in US dollars.
***
The Bretton Woods system was attempting to combine the best of the gold standard and the paper money systems which had prevailed during most of the time between the world wars. As Henry Hazlitt writes in The Inflation Crisis and How to Resolve It:
What they set up, under the leadership of Lord Keynes of England and Harry Dexter White of the United States, was a compromise designed to please the advocates of paper money, ‘ exibility’, and ‘national independence’, or ‘self- determination,’ of currencies, but at the same time to reassure conservatives that these currencies would retain a ‘link’ to gold. The supposed great merit of the new system was that the monetary role of gold – the ‘tyranny’ of gold – would be drastically reduced.16
The system was exible enough to allow a country to devalue its currency anytime up to 10 per cent. The International Monetary Fund (IMF) could not object to it. If a country wanted to devalue its currency by a further 10 per cent, the IMF had to agree or refuse within three days. If a country wanted to devalue even further, it had to consult the IMF, and if the IMF refused its request, the country could simply leave the system.17
Also, only one currency, that is, the dollar was convertible to gold. All other currencies were convertible into the dollar. This brought down the need for gold reserves. What it also did was give every country other than the US the freedom, or exibility, to print as much money as it wanted. It relieved every other country of strict monetary discipline.18
Under the gold standard, there had to be some link between the amount of paper money that a country could print and its gold reserves. But under Bretton Woods, the link was completely broken. The only country that had to ensure that it did not print too much paper money was the US. If it did, the central banks of the other countries would land up at its doors asking for the dollars they held to be converted into gold. And gold, unlike paper money, was not unlimited.
There was too much pressure on the US to keep the system going. If other currencies were also made convertible into gold, the pressure would have been a little less. But nearly three-fourths of the world’s monetary gold was held by the US. And no other country was really in a position to allow its paper money to be made convertible into gold.
***
The Bretton Woods Agreement made the US dollar the world’s currency. The role that was earlier played by gold was now to be played by the US dollar. But just being deemed the world’s currency was not enough. Enough dollars had to circulate outside the US for other countries to be able to carry out international trade (i.e., exports and imports) in US dollars, instead of gold or British pounds, as had been the case till then. This meant that the US would have to ensure that more dollars were leaving the US than coming back to it.
The greater the number of dollars it supplied, the more dollars other countries around the
world and overseas merchants would have. This, in turn, would lead to greater trade and economic growth.
But paradoxically, as the number of dollars outside the country grew, so did the chance of central banks of other countries presenting them to the US and asking for redemption in gold. Greater redemption would mean that the gold stock of the US would keep reducing.
The US would ultimately have to either stop redeeming dollars or devalue the dollar in terms of gold so that it would have to give lesser gold for every dollar redeemed.
Either way, it would lead to the system collapsing. If the dollar was devalued and a lesser amount of gold was given out for every dollar redeemed, countries which had accumulated dollars would feel cheated. And if the redemption of dollars for gold was stopped, countries which had ended up accumulating dollars would end up with paper money and no gold.
The irony of the Bretton Woods system was that the stronger it grew, the more unstable it became. This was rst pointed out by the Belgian economist Robert Trif n, and is thus called Trif n dilemma. Trif n was also of the opinion that if the US did not provide enough dollars, the world could see the kind of liquidity crunch that had caused the Great Depression.19
***
At that time, countries around the world did not have enough dollar reserves. Nearly half of the world’s trade was still conducted in British pounds.20 One way for the European and other countries to earn American dollars was to export goods to the US, while ensuring that their total imports from the US were lesser than their total exports to the US. This would help them accumulate dollar reserves.
At the end of the Second World War in 1945, the US was the greatest supplier of both manufactured and capital goods in the world. Britain, western Europe, and even Japan were heavily dependent on the US for equipment that would allow their industries to operate. It was the same case with consumer goods, which were needed to help their populations maintain a reasonable standard of living.21 There was also the attraction of American goods in general, and the world wanted them, whatever the cost. This meant importing Cadillac cars, Coca-Cola, nylons, and other products. These products were not really necessary for general welfare, but they cost dollars, which were precious at that point of time.22
To pay for these imports, European countries would have had to export goods to the US and other countries and get paid in dollars. But they were recovering from a war and the infrastructure that was required to manufacture goods for export was not in place.
In vanquished Germany, the directive was that nothing should be done to restore the German economy above the minimum level required to ensure that there was no disease or unrest, which might endanger the lives of the occupying forces. Soviet troops were
followed by industrial experts who ripped machinery, tools and even electrical and plumbing xtures out of German factories and loaded them on to trains to be transported to the Soviet Union. This started to happen even before the Reparations Committee met in Yalta, towards the end of June 1945. The Soviet Red Army was living off German land, because the Soviet Union was not in a particularly good shape after the war.23
Soon, the Soviets lost interest in dismantling and taking second-hand machinery and began taking away the current production of Germany. The Soviet Union badly needed assistance, and since it had refused to join the Bretton Woods system, there was no source of help available.24
It also did not help that Germany had been carved into two. The eastern region, which was the main agricultural region of the country and on which the western region depended for food, was handed over to the Soviets.
Eventually, the realization set in that an economic recovery in Europe was not possible without an economic recovery in Germany, the largest economy in Europe. Further, if Europe did not recover, there was no way that the Bretton Woods system would have worked. From July 1945, it was decided that coal production would be stimulated in Germany for delivery to Belgium, France and the Netherlands.25
Despite this, the production of coal and lignite in West Germany, which had the Ruhr region and was the second largest producer of coal in Europe after Britain, grew slowly and was at 133 million tonnes in 1947. It had produced 206 million tonnes in 1938, before the start of the Second World War. A slowdown in production had a direct impact on the production of steel, which fell from 280 million tonnes in 1938 to 178 million tonnes in 1947. This shrinkage of output meant that the whole economy of Europe was slowing down.26 And a slowdown would mean that they would have fewer goods to export and earn dollars against. This, in turn, would be seen as a failure of the Bretton Woods system.
Germany was not the only country facing problems. Half of the machines in Holland were of German make. But given the scarcity of spare parts in Germany, even if a small part was broken, an entire machine had to stay idle. This slowed down entire factories.27
Ultimately, a dollar shortage developed, because other countries imported far more from the US than they were able to export to it. The prevailing feeling was that the US was not able to supply enough dollars to the world market. The real trouble was that Britain, Europe and even Latin America wanted to buy more from the US than sell to it. In 1947, the US was supplying the outside world $1 billion worth of goods and services in excess of what it received in return, in a single month alone.28
This shortage of dollars was essentially a shortage of goods that could be exported to the US. Other than the reasons we have already seen, a major reason for the lack of goods to export was that most European currencies were overvalued in terms of the US dollar.
Henry Hazlitt explains this beautifully through an example in his 1947 book, Will Dollars Save the World?