DURING THE FIRST WORLD WAR - THE DARLEHNKASSENSCHEINE
The rentenmark was not the first or the last time what was effectively a pure fiat currency that could not be used internationally was introduced in Germany. Karl Helfferich has been given credit for developing the principle on which the rentenmark was based, but those who see the problem in terms of money printing and government deficits also blame him for the hyperinflation in the first place, seeing it as the culmination of a process that began in 1914 but was greatly exacerbated in 1916. Helfferich was, as we've seen, Minister of Finance in 1915 and then Vice Chancellor in 1916. The criticism made of him was that he financed the war through government debt rather than through taxation. This was particularly the case after Autumn 1916 when the 'Hindenburg plan' required a vastly increased expenditure on armaments.
Helfferich was, or purported to be, a strong believer in gold as the guarantor of the value of a currency and at the start of the war, when convertibility was suspended (people could no longer demand gold in exchange for paper notes) the principle was laid down that the Reichsbank could not issue paper money to a value of more than three times its holding in gold reserves, meaning that 'the only fetter restraining the Reichsbank from printing unlimited paper currency was the amount of gold, or gold-equivalent reserves held in its vaults.' (8) For this reason the German government launched a drive to collect as much gold as it possibly could, persuading the public, with great success, to give up its gold coinage in exchange for paper money. As a result, Germany emerged from the war with very substantial gold reserves which it rapidly lost in the circumstances of the reparations, occupation of the Ruhr and hyperinflation of the early 1920s.
(8) Stephen Gross: 'Confidence and gold: German war finance, 1914-1918, Central European History, June 2009, Vol 42, No 2, p.228. It should be said that this proportion of paper money to gold holdings had been established in 1875 (according to d'Abernon, 1876 according to Gross). Gross teaches in the Center for European and Mediterranean Studies and the Department of History at New York University with a specialist interest in the German economy throughout the twentieth century. He has a website - http://www.stephengross.org/.
Helfferich had published a book on money, singing the praises of gold, in 1903. In 1905, Georg Friedrich Knapp published his State Theory of Money, laying out the case for what was called 'Chartalism', which subsequently became Abba Lerner's 'Functional Finance' and is now making progress as 'Modern Money Theory.'
In his account of German finances during the war, Stephen Gross says:
'German economic commentators were roughly divided in their theories of money into two camps: bullionists and nominalists. The former believed that the value of paper money depended on its connection to the commodity of gold, whereas the latter were disciples of Georg Friedrich Knapp, who argued in 1905 "that money was not a commodity, but rather a purely functional instrument created by the state." In his speeches to the Reichstag, Helfferich was a bullionist, and with a few exceptions, many economists writing about war finance echoed his broad interpretation of money.' (p.240)
He quotes an economist of the time, Franz Eulenberg, as saying:
'With one blow ample quantities of cash have been created, indeed, cash that is sufficiently covered .... All of the gold flowing into the Reichsbank serves to increase the quantity of circulating money and to strengthen the coverage of printed notes. It is necessary that we unflinchingly adhere to the one-third coverage. Only then will our banknotes truly have their full worth: when this gold reserve forms the basis of them.'
The nominalists thought the gold ratio was absurd but nonetheless supported it as a means of getting the public used to using paper money. Gross takes the example of Werner Sombart, sociologist-economist and disciple of Max Weber, author of an influential study of the role of Jews in the development of capitalism:
'Writing a series of articles for the Berliner Tageblatt in August 1914, Sombart reassured readers that fear of an Assignat-like inflation (9) was a "misconception" and even in a military defeat "paper money would retain its full worth." Although Sombart forcefully argued that the public should accept Reichsbank notes because the state had ordained them a "legal means of payment," he reassured those "gold fetishists" that Germany's paper money still rested on a golden basis. "The foundation of our bank laws remain unchanged: each note must be covered by one third of hard currency and two-thirds through good bills with at least two signatures."'
(9) The 'assignat' was a paper currency introduced in the French Revolution which very rapidly lost its value.
A more sceptical view was expressed by Friedrich Bendixen:
'Friedrich Βendixen stands out as one of the few German critics who understood the arbitrary nature of the gold ratio. As a disciple of Knapp, Bendixen's stance toward the Reich's finances was complex. For while most other economists praised the Reichsbank for its actions in August, Bendixen remained unimpressed because he had suggested this move to a fiat system - proclaiming credit guarantees for private banks and eliminating gold convertibility - be taken in 1908. To the extent that the one-third gold ratio was predictable it could be a stabilizing element in the economy. Beyond this, though, he saw the ratio concept as more of a cult:
'"Today, one considers it as a law of nature, that for every golden twenty-mark piece, three paper twenty-mark pieces can be put into circulation. Naturally that is completely false. But for the public the proposition that gold metamorphises into three times its worth in paper works like a graceful wonder, and gold flows into the Reichsbank in an ever unbroken stream. So this absurdity generates a highly desirable result [that paper money is used and accepted by the public]."
'Ultimately he hoped that the Reichsbank would avoid falling victim to what he deemed to be a popular belief. Thus, while Bendixen aspired to a purely fiat system of paper currency, the transitional stage of a currency based on the symbol of gold instead of the abstract strength of the state had no place in his logic. Over-reliance on gold could be dangerous, and perhaps on account of this belief and his outspoken criticism of the Reichsbank, the Reich censored him, his book reaching publication only in 1919. The confidence of the people in Havenstein [President of the Reichsbank - PB] had to be spared.' (pp.241-2) (10)
(10) At the time I wrote this article and it was published I did not know that Helfferich had actually been a pupil of Knapp in Strasbourg, during the period when it was annexed to the German reich. See Jan Greitens: Karl Helfferich and Rudolf Hilferding on Georg Friedrich Knapp’s State Theory of Money: Monetary Theories during the Hyperinflation of 1923, Annual Conference of the European Society for the History of Economic Thought (ESHET), 2020, Sofia., ZBW - Leibniz Information Centre for Economics, Kiel, Hamburg, accessible on the web at http://hdl.handle.net/10419/216102. Greitens, pp.7-8, quotes Helfferich as saying (1922): “I [Helfferich] owe an infinite amount to his stimulations: they have been decisive for all my scientific work, even if the paths I have taken, with the difference of temperament and aptitudes, have separated me so much from those of Knapp that he described himself to me in one of his letters as ‘a chicken hatching a duck’.”
However, even at the beginning of the war, the two thirds rule was breached by the introduction of another, supplementary currency that was not tied to gold and could not be used internationally. This was the 'Darlehnkassenschein' - loan-bank bill - and it acquired particular importance with the Hindenburg programme of 1916 playing what Gross calls an 'infamous role in helping the Reich circumvent the gold ratio: printing more money while maintaining the illusion that this money was backed by gold.'
The Bank Laws of August 1914 'established Darlehnskassen, loan banks where people, firms, and municipalities could mortgage their illiquid securities and commodity assets as collateral for money in the form of Darlehnskassenscheine, loan bureau bills accepted as legal tender at all government agencies. Darlehnskassen helped Germany avoid a general moratorium, unique among the belligerent countries, and gave private enterprises and local governments a place to discount bills. Beyond this, the Reich encouraged loans secured from the Darlehnskassen to be invested in federal war bonds. People could then take these war bonds to the Darlehnskassen as collateral for yet further loans, creating the potential for a continuous cycle of money production. The key aspect of the Darlehnskassenscheine was that they did not have to be covered by gold held at the Reichsbank. Rather, when Darlehnskassenscheine were held by the Reichsbank, they acted as a gold surrogate that covered the issue of new Reichsbank notes.' (Gross, p.229)
Darlehnkassen had been established with success in the crises of 1848, 1866 and 1870. Although castigated by historians as one of the causes of inflation, they were almost universally welcomed by economists at the time apart, Gross says, from Bendixen. But Bendixen's main objection seems to have been just that it was an unnecessarily cumbersome way of going about the business of issuing money.
As a result of the Hindenburg plan 'The amount of currency in circulation in Germany rose 599 percent by 1918. Among Germany's main competitors Britain, France, and Russia, the money supply rose 91, 386, and 1,102 percent respectively.' However, although this accompanied a high rate of inflation it wasn't that much higher than in Britain: 'The gap between Germany and Great Britain appears less drastic when measuring inflation by the cost of living or wholesale price indices - which by 1918 in Germany had risen 105 and 204 percent respectively against 127 and 110 in Great Britain. Both of these indices reflect Germany's price controls.' (p.235)
Since the Reichsbank notes were still limited by law to three times the amount of gold 'the Reichsbank had either to increase its gold reserves, circumvent the one third limit by means of the Darlehnskassen or follow some combination of the two policies.' But the policy of appealing to the public for gold had been so successful in the early stages of the war that there was now very little left to be culled: 'virtually no gold remained in private circulation.' This had been a source of considerable pride: 'Helfferich argued that the German public could rest easy because the Rieichsbank had achieved the highest gold to paper ratio among central banks, whereas the British public should be nervous on account of their central bank's low gold reserves.' Now, however, he had to fall back on the Darlehnskassen.