Creating Wealth With Inflation – Lessons from Weimar Germany

Hans Schoff wrote:

There’s a lot of talk about inflation, deflation, trillion dollar deficits, unfunded liabilities, quantitative easing, stimulus packages, high unemployment… what does it all mean and how does it relate to creating wealth?

First of all, it’s important to review some history to help put it all into some context.  As Mark Twain once said,

“History doesn’t repeat itself, but it does rhyme.”

To that point, the US today finds itself with the same kinds of problems governments of the past were stuck with: governments like the Weimar Republic of Germany almost a century ago.  With high unemployment, insurmountable debt, a fiat currency (currency not backed by anything with inherent or intrinsic value like gold or silver), rising prices and other causes for concern, the US appears to be heading down a similar path to the one taken by the Germans.  The types of issues just mentioned cause lots of change which can create an environment for total destitution for some who are uneducated and uninformed and an incredible opportunity for creating wealth for those who are educated and who are informed.

So first, a quick history lesson on the Weimar Republic of Germany:

July 24, 1914 – The depreciation of Germany’s currency, the Reichsmark, began when the Reichsbank (Germany’s central bank) suspended gold convertibility on the Reichsmark, meaning you could no longer trade in your Reichsmarks for actual gold.  From that point forward there was no limitation to the amount of money the Reichsbank could then create (money backed by nothing, basically just printed out of thin air and placed into the system thereby reducing the value of the existing currency, ie, inflation).

Within 2 weeks of the gold-convertibility suspension, circulation of the Reichsmark increased by 2 milliard marks (two billion marks).  In comparison, when inflation finally stopped on Nov 15, 1923 when they quit printing  money and went to the Rentenmark, a new currency actually backed by something substantial and real, the amount of Reichsmarks in circulation had increased to 92.8 trillion.  That’s a lot of Reichsmarks and huge inflation – hyper-inflation in fact where it would require as much as an entire wheelbarrow full of cash just to buy a loaf of bread (you didn’t worry about someone stealing the cash, you worried about someone stealing your wheelbarrow!  The cash was basically worthless).

Why did Germany turn to inflating their currency?  After world war one, many countries went through a contraction period, demobilizing their militaries and decreasing their expenditures, and contracting their money supply which caused a period of deflation and high unemployment in the U.S. between 1920 and 1921 with similar events taking place in Great Britain and France (withdrawal symptoms after getting off the inflation drug in order to recover).  But Germany, however, stuck with footing the bill for having just lost the war, in addition to the massive unemployment and massive loss of confidence, decided to go the opposite direction with their newly formed Weimar government.

So while the rest of the world was contracting and cutting back, Germany’s Weimar government began spending lots of money on unemployment, extravagant government expenditures and public works projects, spending and printing their way to (temporary) good times, all the while windening the gap between their revenues and expenses.  In the short term this caused the economy to begin to recover, the stock market began to go up, economic growth rates began to go up, more people began to go to work, and this tremendous influx into the economy created a lot of “initial false prosperity”.   On the main street level, people were starting to believe that times were getting better, the German public believed they were prospering.  But then the “smart” money – the big industrialists and wealthy class, began to realize what the government was doing, realized that the government was inflating.  They started putting their money outside the country, converting it into other currencies so that it would gain in value against the German Reichsmarks.

Today in the U.S., we have recently experienced the same kinds of events albeit for different reasons, today being somewhere in the middle of these events. Like Weimar Germany we too have suspended gold-convertibility of our currency, the US dollar, back in 1933 so that the Roosevelt administration could begin to inflate it.  Sure enough, shortly after 1933, the CPI rate began to go up and went up throughout the war (inflation is how most governments usually pay for war).  Then in 1944, another key event took place as we went onto the Breton Woods System, where the US dollar was partially backed by gold, but the U.S. still had the ability to increase its money supply, and therefore still had inflation.

“If you go back through the lessons of history, throughout all of history, increases in the quantity of money always provokes a diminution of the purchase power of money” – Jim Puplava

After August 1971, the U.S. completely suspended the convertibility of the US dollar into gold.  US citizens could only convert dollars into gold prior to 1933 but when we went on the Brenton Woods System, foreign governments could still exchange their US dollars for gold until it was later suspended in 1971 when President Nixon took the dollar off gold completely.  Since 1971, the U.S. has run non-stop deficits nearly every year that have continued to get bigger, contract some, then get even bigger.  The U.S. government and spending programs have continued to grow way beyond their means, resulting in the “con-job” they did to the American public in 1984 of raising the social security base and doubling the social security tax so that the excess revenues that came in to the government could be used in the general fund, giving the government a different set of books, issuing more and more IOU’s for the social security trust fund, and enabling the government to continue to spend into the future and pile up huge debts.  Today our trade deficits are not only growing year after year, but this decade they are beginning to go parabolic.

What resulted in Weimar Germany due to their prolific spending?  In 1914 government expenditures were 9.6 billion Reichsmarks and tax revenue was only 8.1 billion Reichsmarks (the government was spending 1.5 billion more than it was taking in).  By 1918 towards the end of the war, the German government was spending almost 46 billion but only taking in 31 billion in tax revenues.  Basically by the end, tax revenues were only covering 1/6th of the government’s expenditures with the remaining deficit having to be covered by printing money, worsening the hyper-inflation cycle.

So just as the “smart” money and wealthy class began taking action in Germany to maximize the opportunity they saw for creating wealth in the midst of inflation, you see the same trend happening today in the U.S.: Warren Buffett has close to $20 billion worth of Berkshire Hathaway’s money allocated in foreign currency which he says is going to stay like that for some time. Bill Gates and George Soros both also going into foreign currency and hard assets.  In Germany, that action paid off huge as big industrialists, the merchant firms doing international business and the wealthy began to hoard foreign currency and over just a few years were able to make an absolute fortune.

In addition, between 1915 and 1922 the Reichsbank lowered the federal funds rate equivalent to a low fixed rate of 5% (just as the US has lowered and kept the federal funds rate fixed at an unprecedented 1% today), even though the Wiemar Republic was hyper-inflating its currency (which only increased the velocity of money, worsening the rate of inflation).  But on top of keeping the discount rate low, they further encouraged businesses to take out loans at these very low rates and then take the money and invest it in other currencies or enterprises where they made far larger returns on the money they were borrowing (very similar again to the carry trade of today).  So you had this carry trade going on in Germany between wealthy individuals and businesses who could borrow at incredibly low rates while the annual rate of inflation was running at hundreds of a percent, able to instantly make returns of 200% and above – who wouldn’t borrow money in that kind of environment?

Again you have the beginnings of that going on today with hedge funds and banks making a positive spread between the rate they can borrow at and what they can earn on other money.  And just as the Germans came up with additional means of borrowing when there was a need for more money, we too came up with new forms of credit like interest only loans, negative amortization loans, the use of derivatives, etc.  What happened in Germany is the upper classes and wealthy lost faith in the system, understood what was going on and began to take advantage of the situation to profit from it, creating wealth.

Today you’re seeing the same thing happening in the U.S.  As the costs of goods and services rise showing evidence of inflation, the upper and wealthy classes are making a killing today investing in gold and investing in silver and other hard assets, commodities, real estate, stocks, and other foreign currencies.  Yet on the other end, the average guy on the street is having to spend more, rely more on credit cards and is going deeper into debt to try and keep up with increasing prices because their wages are not keeping up with the rise of inflation.  With the actual un-manipulated rate of inflation today somewhere between 6 and 7%, this signals inflationary times.

How Velocity of Money Accelerates the Impact of Inflation

August 24, 1914 – the Reichsbank made the decision to inflate  their currency (or print additional currency) in order to finance the war, as many governments do.  This began depreciating the currency (as described previously), but depreciation of a currency begins very slowly.  It gradually increases over time and then when you get towards the end or “terminal stages,” it gathers momentum as a result of one key thing: money velocity increasing.

Velocity of money is the turnover of money in the economy.  As you start printing more money the depreciation of a currency begins, more money goes into circulation, but not all of it gets turned over very rapidly.  Some of it goes into foreign hands, like when Germany had to buy imported goods for war materials.  Also, some people may decide to hold onto the excess currency like they did during the war, hoarding cash which also kept the money velocity low (in the beginning stages).  So even though the supply of money was increasing in the economy and along with it the cost of goods and services, Germans were savers, saving the marks that they got which kept this increasingly large quantity of money moving slow, therefore building up the inevitable effects of inflation but delaying the impact.

Inflation in the beginning is like a drug, sort of a good feeling in the economy to start with because there are more jobs, more goods, house values are increasing, the stock market rises, etc.  It isn’t until the money velocity accelerates that you begin to feel that something is wrong.  And that’s when everybody begins running faster and faster just to keep up.

During the last months of the great inflation (at its worst), there was a direct correlation between the quantity of money in circulation, it’s exchange value with the US dollar (which was the main currency still backed by gold at the time), and a direct relationship between wholesale prices and inflation.  In other words, if the money supply increased 10% in a week, the price of goods would increase 10% in a week and the value of the currency would drop by 10% in a week.  Eventually the people began catching on to what was going on in the country and they started getting rid of the currency, pulling it out from under their mattresses to buy something with it, to somehow dump it back into the system, realizing it’s increasing worthlessness, which further increased money velocity.

By 1921 and 1922 money velocity really started to pick up and by 1923, money velocity just went through the roof – the end or terminal stage of the great inflation.

Using Inflation for Creating Wealth

Inflation doesn’t impact all goods and services across the board equally.  Over time, history has shown that inflation is felt most with energy and food, because that becomes a necessity.  Manufactured goods do not keep up in terms of the rise of inflation because the average middle class or working person’s wages does not keep up with inflation and with more of their money needed for essentials like energy for heating the home, for cooking, fuel and having enough food to eat, these are critical things people must have in order to survive.

On the other hand, what these inflations do is divide the upper middle class and upper classes from the middle class and lower class.  If you have discretionary or disposable income you can profit immensely from these great inflations as many people did.  Whether you’re speculating in real estate, or like the German industrialists did, speculating in foreign currencies which was appreciating against the german Reichsmark enabling them to buy up property and businesses in Germany for next to nothing.

So its important to remember that inflations start out slowly – governments will not openly come out and tell you they are debasing the currency.  They will give other reasons why inflation is going up but they will not point the finger at themselves – government officials never do that, just as no one inside the current administration wants to acknowledge that these huge trade and budget deficits are our problem today.  Instead everyone wants to blame China as the cause for the depreciation of our dollar.

Again, the same thing happened in Weimar Germany with government officials and those within the finance community blaming foreigners and their trade partners for the Reichsmark depreciating.  German writers and politicians at the time had said that “paper inflation was not the cause or consequence of the external depreciation of the Reichsmark.  The depreciation of the Mark was held completely independent of the condition of paper circulation between 1921 and 1923″ – even though circulation went up 23 times (the amount of currency within 2 years increased 23-fold)!  Prices of imported goods back then – denominated in US dollars – went up 344 times.  The official view from within the government of the Weimar Republic – the chancellor, the head of finance, the head of the Reichsbank – was to blame it on the excessive burdens thrust on the German people with war reparations, the violent policy adopted by France (when France invaded and took over an entire industrial section of Germany), and they also blamed it on increases on the price of imported goods.

Conversely, the outside view held by those outside of Germany was that the depreciation of the Reichsmark was due to the government’s huge budget deficits, which required continually printing paper money.  Today you see the same kinds of thing happening again here in the U.S.: denial from the government itself while foreigners reprimand the U.S. for its huge trade and/or deficit imbalances.  Isn’t it funny how history rhymes?  (Another signal of what is yet to come…)

Many parallels and similarities can be drawn between what happened in Weimar Germany almost a century ago and the path the U.S. is currently taking.  Having already experienced many of the same events and reactions by government today as the German government made back then shows that we definitely need to be prepared for inflation and possibly hyper-inflation.  Yes, there are many differences between our economy and the world economy today versus the way economies operated back then.  But the fundamentals remain the same, just as we saw a few years back with the housing crash and stock market crashes which none of the so-called experts saw coming with their highly advanced and specialized software programs – you can’t outsmart the market, you can only prolong the inevitable.

I believe a familiar quote goes like this: “Those who fail to learn from history are doomed to repeat it.”

I’d suggest that those who DO learn from history, have the ability to PROFIT from it.

So, taking into consideration what has happened before in Weimar Germany and many other fiat-currency-based governments since, what can one do to position oneself for creating wealth from what follows?

I have three suggestions.

1. First of all, I’d highly suggest that you take the opportunity today to make as much money as you possibly can while the opportunity exists, perhaps an internet home based business or a residual income business and to invest that excess money wisely in liquid hard assets that will retain their value (nearly all currencies today around the globe are fiat and NOT backed by gold or silver or other real tangible asset) in inflationary times – gold investing, silver investing for example.  The other reason for increasing your income and net worth is to increase your ability to be able to borrow when market conditions are right and opportunities are a plenty.  If inflation rates ever get as high as they did in Germany, you’ll definitely be wanting to acquire assets that put cash in your pocket with debt that will be inflated away by the inflation itself shortly after borrowing it (like property investing).  This brings up the next suggestion:
2. Secondly, continue to increase your financial education and financial IQ by investing into your education through books and courses to help you learn about economic history, inflation/deflation and the monetary system, market fundamentals and cycles, etc.  A great place to start is with Rich Dad’s Guide to Investing in Gold & Silver.  Another great book is Rich Dad’s Conspiracy of the Rich.  A third is The Creature from Jekyll Island which explains the U.S. monetary system and the mystery behind the Federal Reserve…  Check out the right-sidebar for additional recommendations on this topic, including the great book on the Weimar Republic collapse, The The Economics of Inflation.
3. Thirdly, with your built up liquid hard asset position and your new found and newly acquired financial knowledge, you’ll be ready to act when the money velocity really picks up, intensifying the inflationary or hyper-inflationary effects on the economy. When this happens you’ll be able to then convert your liquid assets into other assets whose prices are rock bottom (in terms of gold or silver) like real estate, gas and oil projects, businesses, etc.  Imagine being able to purchase a house for example with 50 ounces of gold (the equivalent of $75,000 in today’s market which was half that only a year or so ago) – that’s the power of what inflation can have on creating wealth.  This may also be a smart time to get into good debt to purchase as much real estate as the bank will let you buy knowing that the debt of the asset could be paid down significantly with the new money the government pumps into the system…

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Originally posted 2011-02-16 07:55:07.

Original post can be found here: “Creating Wealth With Inflation – Lessons from Weimar Germany