A Trip Down Ugly Memory Lane

06/28/2012 6:30 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Hitler came to power thanks to austerity and tight credit, rather than hyperinflation as the ignorant now claim, writes MoneyShow.com senior editor Igor Greenwald.

This morning on CNBC, the frequently factual Jim Cramer attempted to pass on one of the most popular and widespread historical fallacies in circulation.

He was explaining how Germany can watch the slow-motion European collapse without resorting to such common-sense remedies as Eurobonds or pan-European deposit insurance. And that’s when Cramer mentioned the hyperinflation of the Weimar Republic between the world wars and the German belief that this started the train of events culminating in Nazism.

The trouble is, it wasn’t so much a train of events that brought Hitler to power as a train wreck of a policy—policy that bears an uncanny resemblance to those advocated by German conservatives, Ron Paul fans, and establishment Republicans obsessed with fiscal restraint until the moment a Republican president takes office.

The Weimar hyperinflation began in June 1921, just as Germany was making the first payment on punitive World War I reparations. The reparations sucked gold and hard currency out of the country and led to an abrupt decline of the mark as Germany incurred a huge current-account deficit.

The German government ramped up the printing of marks in an attempt to reconcile the irreconcilable—efforts to satisfy Allied victors’ demands while keeping the economy running. In just over two years, one US dollar was worth a trillion marks and Germans was reduced to barter for survival.

Then, as abruptly as hyperinflation set in, it was ended by the introduction of a new currency, coupled with a credible commitment to limit its printing.

The German economy took off, aided by American loans, and by 1927 had recovered a veneer of its former prosperity. Unemployment was 8.8%, down from 13.5% three years earlier. The economy was growing at a 10% annual rate. Industrial production boomed in what a visiting US economist called “one of the most spectacular recoveries in the world’s entire economic history."

That would soon be undone by equally spectacular policy errors. In early 1927, the Reichsbank—Germany’s central bank—grew worried that a stock-market bubble had formed, encouraging overconsumption and renewed current-account deficits. Additionally, the bull market in stocks was undermining Germany’s arguments for continued forbearance by Allies in the endless talks over reparations.

So in May 1927, the Reichsbank forced German banks to drastically reduce lending for buyers of equities. The assumption was that this would free up more credit for the “real economy.”

Instead, the stock market promptly tanked, dropping 11% in a day on the news, and so did investment in the real economy, which fell 15% in 1928 as manufacturers pared inventories. (For more on this sorry episode, see this excellent ten-year-old paper by a German economist and historian.)

In fact, there probably was no German stock-market bubble—merely a robust and fundamentally warranted recovery from post-war lows. But the Reichsbank was just as sure about the dangers of “easy money” as Steve Forbes is today when he bays for the head of Ben Bernanke. And it was just as wrong.

The Reichsbank’s errors were soon repeated by the US Federal Reserve, which sought to prick what it viewed as unwarranted speculation with interest-rate hikes in 1928 and 1929, but ended up precipitating the Wall Street Crash and the ensuing Great Depression.

The crash of 1929, in turn, caused US lenders to call their German loans, further starving Germany of credit.

It was against this background that Heinrich Bruning became chancellor in 1930. An economist and World War II veteran, he belonged to the same moderate-right tendency of German politics that has given us Chancellor Angela Merkel today.

Bruning’s policies, implemented by presidential decree over the German parliament’s objections, were remarkably similar to Merkel’s prescriptions for Greece, Spain, and Italy: higher taxes, reduced spending, and lower wages. Bruning advocated tighter credit as well, and the German economy under his leadership circled the deflationary drain that much faster. By 1933, unemployment had reached 26%, bringing Adolf Hitler to power.

The people who remember German history as Hyperinflation—>Hitler conveniently omit a nine-year interregnum, the first third of which was marked by a healthy expansion and then by six years of unforced policy errors. Precisely of the sort Germany is now inflicting on its neighbors, and with which gold-standard enthusiasts would strangle the US economy as well.

The difference is that hyperinflation was at least a recent memory in 1927. Now, after several outbreaks elsewhere, it’s widely understood to be a pretty rare and usually short-lived phenomenon, cured much more easily than a depression.

But the modern-day Heinrich Brunings are still fighting it, sabotaging economic prospects in the process. Those hurt most by their policies throughout Europe and in the US are falling for radical demagogues outside the old political mainstream.

This is a recipe for calamity, not prosperity. Fortunately, the lessons of 1927 to 1933 are there for all to see, and they have nothing to do with hyperinflation.

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