THE CONSEQUENCES OF THE WORLD WAR I AND ITS INFLUENCE ON HYPERINFLATION IN GERMANY
Even though all three powers had the same financial burden, Germany was in the worst position because it was viewed as the loser of the war. The funding of World War I created the germ of inflation. Nonetheless, the point of no return for Germany toward hyper-inflation and currency devaluation in the later years was not yet reached. Only the political events of post World War I solidified the inflationary situation in Germany. In these hard times, the United States played a major role in the economic solutions to the problems of Europe, particularly those in Germany.
The German inflation of 1919 to 1924 was rooted in the war inflation beginning in 1914. Then, Germany raised much needed cash for the war without a well-planned financial strategy. The poor infrastructure of Germanys taxation system made the collection of funds even harder. Germany tried to limit the progressing inflation by way of a new taxation system. However, the rising inflation caused the mark to devaluate producing a stronger economy. The new German commercial strength was used to revise the peace treaty of Versailles. This was done with a close tie to the United States to make use of the last possibility for Germany to regain its previous status in Europe as a great power.
This paper aims to discuss the consequences of the World War on the overall economic situation in Europe. In particular, its influence on hyperinflation in Germany is assessed. The steps and policies taken by the Germany in order to overcome this post-war devastation are also discussed. Finally, some conclusive remarks are presented.
POST WORLD WAR I ECONOMIC SITUATION IN EUROPE WITH EMPHASIS ON GERMANY
The four-year war, whose primary protagonists were the European powers, destroyed the world economic and currency system.Compared to pre-war times, the European population declined by seven percent or twenty-two million people due to the effects and consequences of the war (lower birthrates). This number was as high as the natural increase between 1914 and 1920. Thus, the number of inhabitants did not vary much during the period. However, it has to be noticed that most of the casualties of war belonged to the most productive part of the work force, persons between twenty and forty years of age. In addition, the war disabled and the unemployable injured soldiers did not enter the statistics.
From a national economic point of view, the material losses of the war were more of a problem for the reconstruction efforts in Europe and the rejuvenation of the world economic system. In his estimate, Aldcroft calculated a capital loss of approximately 200 billion British pounds in pre-war prices. However, his evaluation did not include pure war costs as well as the decrease of capital value through missed maintenance or renewal.
After the end of hostilities, the countries and national economies of Europe were the main victims of the world-wide destruction. In particular, the material damage on the main battlefields of France, Southeastern and Eastern Europe was extensive. On the other hand, Great Britain, Germany and the new state of Austria had relatively little material destruction to show compared to the other countries. Still, in the case of the two main war losers, these limited losses were increased by high reparation demands as well as enormous territorial concessions. Particularly, the new division of the lost regions to other countries or the newly-founded nations often led to dismemberment of economic entities. These new units, split into separate components, had severe difficulties.
The war decisively shifted the position of Europe in the world economy. Until the year 1913, the major powers Great Britain, Germany, France, and the United States dominated the world economy. As modern industrial societies, these three European nations were responsible for three-fourths of Europes total industrial output. By themselves, the Americans were able to equal or surpass the Europeans in production. The supremacy of the three big European industrial societies was even stronger in their share of world trade. These nations bought seventy-five percent of all exports of foreign nations. Further, they transacted seventy-five percent of trade between Europe and the rest of the world, which likewise influenced the international capital markets.
The centers of finance were in Europe, whose large national economies maintained the world economy and supplied it with financial resources. This was possible due to three factors huge population density, high productivity as well as the import of raw materials. The center of the international capital market was London since Great Britain was the biggest trading nation in Europe.
The British economic system was based on the ideas of classical liberalism free trade and the enforcement of the gold standard. After the war, the British objective was to rebuild the international economic order, and therefore reestablish the dominating role of Great Britain. That this undertaking failed was mainly the direct result of the power shift in the world economic system to the disadvantage of Europe due to World War I.
Considering the new situation, a new objective was necessary rather than the return to pre-war conditions. The economic hegemony of Europe changed. This was due to the war-related overburdening of its national economic resources. As a result, Europe shifted into a dependence on foreign products and capital. The United States, a supplier of raw materials, food and capital to Europe, worked its way up from debtor to the European nations to creditor. Moreover, the United States jumped into third markets, where the Europeans were not able to deliver promised products because of the war at home. In these markets, the United States could beat out the European competition.
The center of world trade shifted away from Europe due to the commercial weakness of the former leaders of the world economy. This shift had many positive affects on the other members. However, it also had some negative consequences. Thus, it was in the interest of all participants to stabilize the European economy. To vitalize trade, the European industrial nations had to import raw materials from overseas and at the same time find buyers for their finished products in the raw material exporting countries. This mutual dependency required a balance of trade. Once, one side of this mutual demand fell out, the other side could not hold its trade level and vice versa. Furthermore, the developing economies could not place trade barriers against each other.
REORGANIZATION OF MONETARY SYSTEM
One of the most important tasks dealing with the economic problems of post-war Europe and for the world economy as a whole, was the reorganization of the money markets. Due to the war, the participating countries gave up the gold standard. Government interference in financial and currency policies to secure funding for the war replaced the gold standard. Therefore, to a large degree many currencies lost their stability and value by 1914.
The gold standard of the pre-war period was based on the convertibility of the various currencies against gold at guaranteed preset exchange rates. In addition, there were no restrictions placed upon the transfer of gold to other countries or currencies. In reality, since the nineteenth century coin and paper money, which were convertible at a preset rate against gold at any time, declined in usefulness. The emphasis of the domestic and international method of payment shifted towards bank deposits and credits. This way, gold functioned as an international clearing unit in which all currencies could be exchanged. In addition, gold was seen as the guarantor of international currency stability.
To maintain such a system, it was necessary to keep trade and currency balances among the nations at a relative equilibrium. The central and issuing banks had to regulate this system through their monetary policy in order to guarantee the automatic adjustment. The prevention of large inequalities could be provided by the monetary institutions independently.
The basic prerequisites for the equilibrium were stable internal conditions in the larger industrialized nations and peace. This was to keep extreme currency policies (inflation or deflation) in the background, as long as internal and trade conditions stood in harmony with each other. This ideal state of being was destroyed with the start of World War I and the shift into a war economy. The attempts after the war to adopt the gold standard failed since the pre-war conditions did not exist anymore.
The game plan of the central banks proposed to increase the leading interest rates and make credits more expensive in countries where gold reserves diminished. On the other hand, nations with a gold surplus had to free up their money supply. A strong pound sterling was necessary for the smooth functioning of the gold standard. The pounds strength was based on the economic strength of Great Britain. A rush out of the pound was not preferable since there was no alternative currency available but the British pound.
During the war years, higher government expenditures gradually disassembled the gold standard by diminishing gold backing through the central banks. The central banks tried to support the gold standard only through temporary measures. In the case of Germany, credit bank loans or bills were used as a gold substitute. Directly after the war, the artificial exchange rates could not be retained anymore once the United States returned to the gold standard on June 1919. Therefore, the overvalued European currencies lost in value against the dollar.
Shortly thereafter, the free floating of currencies caused the fiscal policies of the European nations to fall in disarray. Alternatively, this was expressed in rising and falling exchange rates and in the worst case in higher inflation and currency devaluation. Therefore, the free floating presented a main obstacle for an economic reconstruction of Europe. Inevitably, the problem of reconstructing the European commercial system had to be linked to the economic order in Germany. The reason was that pre-World War I Germany was one of the main pillars of the world economic system. Therefore, any business and social variations in Germany had to be considered in the rebuilding of the business sectors.
SITUATION IN GERMANY
The constitutional monarchy in Germany was removed at the end of the war and replaced by a parliamentary governmental system whose survival was questionable. In addition, a socialist revolution, not dissimilar to the Russian model, waited to take over the war-ravaged capitalist-based national economy. The insecure political situation in the Weimar Republic was weakened by the provisions of the Versailles Peace Treaty. During the entire Weimar period, the agreement was considered as the main cause for the poor economic conditions in Germany and internationally. The winners as well as losers strove for the revision of the agreement due to commercial reasons and power politics.
By the end of the war, the condition of the German economy was marked by a devastated and one-sided manufacturing apparatus based on war production. In addition, the absence of qualified workers, as well as a collapse in agricultural output, made it harder to supply food and consumer products to the population. Even during the war, a shortage of workers, food, and raw materials, due to an Allied blockade, pushed the government to interfere in the economy. As Holtfrerich comments
the war involved a blockade of German foreign trade which not only made it difficult to export but also impeded the imports of the foodstuffs and raw materials on which the German economy so largely depended. The blockade outlasted the war, it was not lifted until the Versailles Treaty was ratified in the summer of 1919
After the war, the intrusion was continued due to the prevailing supply crisis, which could only be slowly disassembled.
On the other hand, it has to be mentioned that the Weimar Republics territory, with some exceptions in the East, was not part of the theater of war therefore, Germany escaped major destruction. Moreover, Germany financed the war by an increase in debt which was funded mostly domestically. The biggest advantage was the end of the war expenditure as a whole, which constituted approximately fifty percent of the GNP.
The Peace Treaty provided for a roughly 13.5 percent territorial detachment of the pre-war areas, a loss of 10 percent of the total population of the Weimar Republic. Besides the not yet determined reparations payments, the material obligations and territorial losses led to a worsening situation in Germanys balance of payments. This was due to an increase in food and raw material imports and a lowering in exports. Moreover, Germany was not able to fall back on its foreign exchange revenues from its merchant fleet as well as its overseas investments. Therefore, before the actual reparation payments, the outside value of the mark fell and the much needed imports rose in cost.
Erzbergers financial reform created a central financial system, which granted the young Weimar nation additional stability. Due to the necessity to raise money for the republic, a modern taxation system was created, which asked all sections of the population to contribute equally in relation to their productive power. A prerequisite for such a project to function was the relative stability of the purchasing power of the German currency as well as an appropriate reparations regulation to make the monetary policy calculable again.
Of course, the drastic tax rates were the right attempt to stop inflation. However, particularly the wealthy and influential classes of society were interested in getting rid of their tax bills through ongoing inflation. At the beginning of the 1920s, the Allied reparations policy supported this circumstance further by playing into the hands of the adversaries of such a solid fiscal policy due to their excessive demands.
Only the reparations agreement, through the Dawes Plan of 1924, could assure the workability of Erzbergers finance reform. Therefore, it can be concluded that the financial reforms, which aimed to avoid a government bankruptcy, were a failure. On the other side, the fiscal infrastructure of Germany was still alive but not able to handle these new demands. However, even the reorganization of the taxation system and fiscal policy was not able to stop the drift towards higher inflation. As long as government expenditures were not limited and the limitless borrowing at the federal reserve was not brought to a halt, inflation kept on rising.
CONCLUSION
An expanding national debt, falling tax revenues, and still open payment obligations to compensate the Allies made a reform of the German financial and taxation apparatus necessary. The improvement was needed to supply the essential means without further indebtedness. The weak taxation system of the Weimar Republic, with its financial constitution from the Imperial era and its dominating tax sovereignty of the states had to be eliminated.
The financial reform of 1919 stem the war rooted currency devaluation, the measures were taken too late. Second, when the new financial and tax laws were put in place, their advantages could not be clearly explained to the affected people. Third, the currency consolidation after the great inflation could be completed from the already existing financial laws of Erzberger, with foreign help.
The United States followed a policy of stabilization and reconstruction of the war-impaired world economy. In this order, German post-war inflation played only a minor role. However, Germanys inflation was to have momentous consequences for the world as a whole. The Weimar Republic tried knowingly to avoid the reparation demands by way of inflation. Even with the available possibilities of a currency stabilization, the inflationary strategy was still practiced. The introduction of inflation as an instrument of foreign policy disguised the internal causes, namely the continuation of the war inflation. Further, this inflation transferred the problems of the Weimar Republic to the outside so that the internal stability of the young republic was supported by shifting the difficulties outward.
Apparently it was not possible to find a solution to the problem without the assistance of the economically most powerful participant, the United States. Therefore, Americas idea of introducing a panel of experts prevailed, which at least helped to find temporarily a resolution to the bungled issue. Moreover, the inclusion of the stabilized German currency into the gold currency standard created the basis for the decline of Great Britain as a leading economic and financial power. As a result, the possibility of Americans placing capital investments in Europe was enhanced.
Conclusively, German inflation during the first three years after World War I provided the function to secure social peace in the country and to push back the danger of a revolution. Only after hyper-inflation did the effects of currency devaluation threaten the social order and existence of the Weimar Republic. Inflation impeded the reconstruction efforts of the United States in Europe. As an important industrial nation, Germany, due to its weak currency, was only able to participate in the world economy on a restricted basis. Finally, inflation was used by Germany as a means to revise the Versailles Treaty by trying partly to escape its obligations.