Wasn't it nice when Eurotrash meant an annoying group at the bar and not Sovereign Debt? Anyway, despite what you might have read in the paper or seen on the news, the recently announced rescue package isn’t a rescue at all. It’s like sending someone who can’t swim into a riptide to rescue a drowning swimmer. Or to use another analogy, Europe is like 2 drunks staggering down the street leaning on one another. They think they are sober and fine until one stops walking. Then they both fall over. Lending money from one broke country to another broke country doesn’t make the first one less broke. It just props it up for a while. See our note from yesterday for more on this issue.
Since the solution to the problem is easy, clear, and everyone seems to actually know what it is, why won’t it happen? Simply put, just like the US fears a second Great Depression, Germany fears a second Great Inflation. They are worried that monetizing the debt via the European Central Bank (ECB) will cause rampant inflation. Secondarily, the German leaders have a political problem. They can be seen by their citizens (who have actually done a good job of saving and not over-extending themselves) as bailing out the lazy early-pension-taking partiers in southern Europe, or they can wait for Greece and Italy to default (“voluntary reduction”, sorry) and then backstop their own banks. The amount of money at stake is about the same (for the Germans). But it is much more politically palatable to give German money to German banks than to give it to Greece so that German banks don’t take losses on Greek bonds. Simple right?
So what are the Germans afraid of? Art Cashin is the best writer on Wall Street. His daily notes are a must read. So instead of doing his history a disservice, I have quoted it in its entirety below. Enjoy.
An Encore Presentation
By Art Cashin
Originally, on this day (-2) in 1922, the German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to "jump start" a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental "more is better" theory they simply created more and more money.
But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then, suddenly prices began to explode unbelievably (but, perversely, not business activity). So, on this day government officials decided to bring figures in line with market realities. They devalued the mark. The new value would be 2 billion marks to a dollar. At the start of World War I the exchange rate had been a mere 4.2 marks to the dollar. In simple terms you needed 4.2 marks in order to get one dollar. Now it was 2 billion marks to get one dollar. And thirteen months from this date (late November 1923) you would need 4.2 trillion marks to get one dollar. In ten years the amount of money had increased a trillion fold.
Numbers like billions and trillions tend to numb the mind. They are too large to grasp in any "real" sense. Thirty years ago an older member of the NYSE (there were some then) gave me a graphic and memorable (at least for me) example. "Young man," he said, "would you like a million dollars?" "I sure would, sir!" I replied anxiously. "Then just put aside $500 every week for the next 40 years." I have never forgotten that a million dollars is enough to pay you $500 per week for 40 years (and that's without benefit of interest). To get a billion dollars you would have to set aside $500,000 dollars per week for 40 years. And a…..trillion that would require $500 million every week for 40 years. Even with these examples, the enormity is difficult to grasp.
Let's take a different tack. To understand the incomprehensible scope of the German inflation maybe it's best to start with something basic….like a loaf of bread. (To keep things simple we'll substitute dollars and cents in place of marks and pfennigs. You'll get the picture.) In the middle of 1914, just before the war, a one pound loaf of bread cost 13 cents. Two years later it was 19 cents. Two years more and it sold for 22 cents. By 1919 it was 26 cents. Now the fun begins.
In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid month it was $100 billion. Then it all collapsed.
Let's go back to "marks". In 1913, the total currency of Germany was a grand total of 6 billion marks. In November of 1923 that loaf of bread we just talked about cost 428 billion marks. A kilo of fresh butter cost 6000 billion marks (as you will note that kilo of butter cost 1000 times more than the entire money supply of the nation just 10 years earlier).
How Could This All Happen?
In 1913 Germany had a solid, prosperous, advanced culture and population. Like much of Europe it was a monarchy (under the Kaiser). Then, following the assassination of the Archduke Franz Ferdinand in Sarajevo in 1914, the world moved toward war. Each side was convinced the other would not dare go to war. So, in a global game of chicken they stumbled into the Great War.
The German General Staff thought the war would be short and sweet and that they could finance the costs with the post war reparations that they, as victors, would exact. The war was long. The flower of their manhood was killed or injured. They lost and, thus, it was they who had to pay reparations rather than receive them.
Things did not go badly instantly. Yes, the deficit soared but much of it was borne by foreign and domestic bond buyers. As had been noted by scholars….."The foreign and domestic public willingly purchased new debt issues when it believed that the government could run future surpluses to offset contemporaneous deficits." In layman's English that means foreign bond buyers said – "Hey this is a great nation and this is probably just a speed bump in the economy." (Can you imagine such a thing happening again?)
When things began to disintegrate, no one dared to take away the punchbowl. They feared shutting off the monetary heroin would lead to riots, civil war, and, worst of all communism. So, realizing that what they were doing was destructive, they kept doing it out of fear that stopping would be even more destructive.
Currencies, Culture and Chaos
If it is difficult to grasp the enormity of the numbers in this tale of hyper-inflation, it is far more difficult to grasp how it destroyed a culture, a nation and, almost, the world.
People's savings were suddenly worthless. Pensions were meaningless. If you had a 400 mark monthly pension, you went from comfortable to penniless in a matter of months. People demanded to be paid daily so they would not have their wages devalued by a few days passing. Ultimately, they demanded their pay twice daily just to cover changes in trolley fare. People heated their homes by burning money instead of coal. (It was more plentiful and cheaper to get.)
The middle class was destroyed. It was an age of renters, not of home ownership, so thousands became homeless.
But the cultural collapse may have had other more pernicious effects.
Some sociologists note that it was still an era of arranged marriages. Families scrimped and saved for years to build a dowry so that their daughter might marry well. Suddenly, the dowry was worthless – wiped out. And with it was gone all hope of marriage. Girls who had stayed prim and proper awaiting some future Prince Charming now had no hope at all. Social morality began to collapse. The roar of the roaring twenties began to rumble.
All hope and belief in systems, governmental or otherwise, collapsed. With its culture and its economy disintegrating, Germany saw a guy named Hitler begin a ten year effort to come to power by trading on the chaos and street rioting. And then came World War II.
That soul-wrenching and disastrous experience with inflation is seared into the German psyche. It is why the populace is reluctant to endorse the bailout. It is also why all the German proposals have each country taking care of its own banks. (It gives them more control.) The French plans tend to socialize the bailout. There's more disagreement in these plans than the headlines would indicate.
To celebrate have a Jagermeister or two at the Pre Fuhrer Lounge and try to explain that for over half a century America's trauma has been depression-era unemployment while Germany's trauma has been runaway inflation. But drink fast, prices change radically after happy hour.