by Alasdair Macleod, GoldMoney:

Germany suffered two currency collapses in the last century, in 1920-23 and1945-48. The architect of the recovery from the former, Hjalmar Schacht, chose to cooperate with the Nazi successors to the Weimar Republic, and failed. In that of the second, Ludwig Erhard remained true to his free market credentials and succeeded. While they were in different circumstances, comparisons between the two events might give some guidance to politicians faced with similar destructions of their state currencies, which is a growing possibility.

Introduction

Let us assume the next credit crisis is on its way. Given enhanced levels of government debt, it is likely to be more serious than the last one in 2008. Let us also note that it is happening despite the supposed stimulus of low and negative interest rates, when we would expect them to be at their maximum in the credit cycle, and that some $17 trillion of bonds are negative yielding, an unnatural distortion of markets. Let us further assume that McKinsey in their annual banking survey of 2019 are correct when they effectively say that 60% of the world’s banks are consuming their capital before a credit crisis. Add to this a developing recession in Germany that will almost certainly lead to both Deutsche Bank and Commerzbank having to be rescued by the German government. And note the IMF recently warned that $19 trillion in corporate debt is a systemic timebomb, and that collateralised loan obligations and direct exposure to junk held by the US commercial banks is approximately equal to the sum of their equity.

Then we can say with some confidence that a major credit crisis is developing, and that it will almost certainly be far greater than Lehman. We can also say that the money-printing by central banks to rescue both the banking system and government finances will be on a far greater scale, likely to destabilise the purchasing power of government currencies. If that happens, interest rates will then be forced higher as prices for everything begin to rise uncontrollably, irrespective of central bank interest rate policies. And where they depend on budget deficits being covered by additional issues of government stock, Government finances will be in crisis. It will threaten the ending of unbacked currencies based only on the faith and credit of governments whose spending is spiralling out of control.

The factors determining the pace of currency decline

The end of currencies might not be immediate. The lessons from the past tell us that the public can be slow to recognise what is happening to their money and savings. Currency collapses have happened in individual currencies before, but next time it appears it will be a common fate faced by all major currencies. In the past, there have been other sounder currencies available in the foreign exchanges, but with a declining dollar at the centre of it all, the alternatives to a cadre of collapsing currencies are extremely limited. The consequences for populations accustomed to welfare payments and services are bound to be drastic.

It is the interplay between foreign exchanges and domestic valuations that sets the pace for a currency’s decline. The Argentinian peso is a contemporary example of a currency that is still accepted in the foreign exchanges but is discarded as overvalued by its users. The proof is found in the black-market rate at over 70 to the US dollar compared with the foreign exchanges rate of 59.

Unlike the Argentinians who already value their pesos less than foreigners, in the major currencies the delusion of the masses about their frailty is almost absolute, and the learning process about the consequences of creating money out of nothing has yet to begin. The time taken for ordinary people and the foreign exchanges to learn the hard truths about accelerated currency debasement can vary enormously.

But fiat currencies die. Other than today’s currencies that have yet to do so they always have, and any student of money and the exchanges should be able to detect signs of their demise as well. The death of a currency is painful for all those involved. It is a national bankruptcy, but even though it is difficult to see how, nations and their peoples do survive the destruction of their currencies.

Germany experienced it twice in the last century. The first time paved the way for a dictatorship ten years later. The second had a more enduring legacy, making Germany one of the two most economically powerful nations in recent years, at least until the bureaucrats and planners won, folding the deutsche mark into the new euro. For politicians seeking to navigate their way through what is lining up to be the greatest credit crisis since the 1930s, the lessons from the German experience are salutary. In Britain, a new government will be formed by Christmas, and in its early years, it will probably face a global credit and banking crisis, threatening the future of sterling.

Assuming Boris Johnson wins and continues as Prime Minister, we know from his writings that he understands free markets, the importance of price discovery, the evils of excessive government intervention and regulation, and crony capitalism. He is in a minority in these views, though there are powerful figures around him who share them. This was similar to the position of two German nationals, who handled their currency collapses with different outcomes.

If a widespread currency collapse takes sterling with it, the political class will be unable to stop it. Then, will Boris be a Hjalmar Schacht, or a Ludwig Erhardt, both of which saw a collapse of the mark at different times and managed the subsequent recovery. It is an interesting thought.

Germany’s Weimar government

During the Weimar inflation, a weak government went from believing in Knapp’s pre-war Chartalist state theory of money under the previous sovereign regime, which allowed it to print at will, to learning the hard way of its fundamental errors too late to stop it. The whole Western world in this century has embarked on this journey, so Germany’s experience offers some salutary guidance. Just as interesting is how President trump would respond.

Before Hitler came to power in 1933, the post-war Weimar government had continued in office long after the people suffered the great inflation which ended in 1923. The ten years that followed showed that a system of government can survive a monetary catastrophe. Following the inflation, the Weimar government found itself still balancing the demands of the workers with those of industrial cartels, the Marxists and the Capitalists. And when Britain went off the gold standard in 1931 (along with the whole sterling area) the fall in sterling made German export prices suddenly too high in comparison by an estimated 20%. In 1930, Chancellor Brüning had already responded to the developing depression in America by tightening credit and reversing salary increases, so sterling’s devaluation was an extra blow. Combined with Brüning’s deliberate deflationary policies, this led to mass unemployment and the advancement of the Nazi party, which finally took control of the German economy in January 1933 when Hitler was appointed Chancellor.

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