The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.
You can access the entire sequence of blogs in this series through the – Euro book Category.
I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).
Part III – Options for Europe[THE FOLLOWING ]
Chapter X – OMF[PRIOR MATERIAL HERE – SHORT SECTION ON FEARS OF HYPERINFLATION IF CENTRAL BANKS USE OVERT MONETARY FINANCING] [NEW MATERIAL TODAY]
The Hyperinflation Myth
We opened this Chapter noting the German ‘Angst vor der Inflation’. Mark Blyth (2013: 103) terms it the ‘German Ideology’, a “collective historical neuralgia over the inflation of the 1920, which inveitably leads German policy makers to the conclusion that ‘throwing money around’ is never a good idea”. The perversity of the current ideological trap that the Germans are imposing on the rest of Europe is that it is informed by a very selective and misunderstood period of history – the Weimar years. They are obsessed with that historical epoch and have largely ingrained into the cultural fabric an ill-constructed version of what actually happened during those years of hyperinflation. The modern Germans, so self-assured, have also forgotten that in the 1930s, the gross and indecent acts of the Nazis aside, their economy prospered on the back of strong fiscal interventions. They also have forgotten the period after World War II when their economy was repaired via a massive fiscal injection, in part, via the Marshall Plan.
The hyperinflationists also have a new pariah to stoke the fires of their paranoia – Zimbabwe is the new Weimar Republic. The financial press is awash with articles claiming that Zimbabwe is the modern day demonstration of the proposition that government deficits and OMF generate hyperinflation. When one understands what really went on in Zimbabwe the only reasonable conclusion is that it is an African country, which has laboured under a dysfunctional government. There is nothing in the Zimbabwean experience that militates against the use of fiscal deficits accompanied by OMF.
Any hint of OMF sends the hyperinflationists into a hyperventilating state of apoplexy. It is a pity that their appreciation of history and causality doesn’t match the intensity of their hysteria. The Weimar Republic of the 1920s and Zimbabwe in the modern era are distinct cases of hyperinflation. Let us briefly explore each instance in order to understand what really caused the hyperinflation.
The economic problems in the Weimar Republic began long before the hyperinflation in 1922. Inflation rose throughout Europe with the onset of World War I as import prices increased as exchange rates depreciated as investors sought safer currencies, such as the US dollar. So at the end of the War, Germany, like many of the warring nations, were dealing with elevated inflation rates (see Feldman, 1997).
The Treaty of Versailles, signed in June 1919 was particularly harsh to Germany, not only in terms of its reputation, but also in terms of the reparations and loss of territory that were required as part of the peace settlement. While the loss of repute and position in Europe was probably justified given the aggression Germany showed to Belgium and France after the Austria-Hungary declared war on Serbia to reclaim disputed territory in the Balkans, the scale of the reparations and the loss of territory is reasonably considered to be an unwise response by the victors. The harshness of the reparations may have given France some consolation after it has been forced to pay massive compensation to Germany under the terms of the 1871 Treaty of Frankfurt, but it also directly contributed to Germany’s martial behaviour, which led to World War II.
The reparations had to be made in gold Marks, which involved regular cash payments and equivalent in-kind deliveries of “coal, timber, chemical dyes and pharmacuetical drugs” (Marks, 1978: 233). There were other items involved, such as transfer of state-owned Saar coal mines and the return of some art treasures and materials, machinery and equipment to replace the stolen booty as the Germans retreated towards the end of the War (Marks, 1978). Between 1919 and 1922, the German mark depreciated significantly and this placed further strain on its export revenue and pushed the inflation rate up further. The reparation payments schedule squeezed the German government’ capacity to pay and eventually they were unable to meet the terms. They had been lagging behind on payments throughout 1921 and 1922 and then was declared in default on agreed timber deliveries, an act that was interpreted by the Allies to be a show of “German governmental bad faith” (Marks, 1978: 240). Then in early 1923, Germany defaulted on agree coal deliveries and the Belgian and French armies responded by occupying the industrial area of the Ruhr – Germany’s mining and manufacturing heartland. They were supporting Belgian, French and Italian engineers who were intent on extracting the coal themselves (Bergmann, 1927). The Germans, in turn, engaged in a campaign of strikes and production ground to a halt. To encourage the local resistance among workers, the Germans kept paying the their wages in local currency despite limited production being possible and the inflation rate escalated and export income fell sharply (Bergmann, 1927). The German workers of the 1920s were more worried about unemployment than inflation (Smith, 1981).
While the political struggles between the French and Germans, in particular, were considered to be “an extension of World War I”, the economics of the situation was simply that the supply capacity of the German economy fell sharply below the spending capacity, and inflation is the obvious relief valve. Many commentators claim that the German central bank funded the continued spending (for example, the wage payments to the Rhur workers) and this caused the hyperinflation. But if the supply capacity of the economy had not been curtailed, there would not have been the same issue with rising prices. The final crunch came when the export trade stalled and the only way the German Government could keep paying their obligations was to keep spending. The high inflation morphed, not unexpectedly into hyperinflation.
The causality is clear – excessive spending growth in the face of a declining output capacity. Clearly, the growth in spending had to be radically constrained for Germany to have avoided the hyperinflation and that was politically possible, particularly as the national government was fragile and under attack from the Communists (Smith, 1981). It was a very abnormal situation and not related in any way to the case where a currency-issuing government spends to fill the gap left by the saving plans of the non-government sector so as to keep employment and output levels high. Mark Blyth (2013: 104-5) concludes that “Today, this specter of hyperinflation is invoked by German and ECB policy makers whenever they want to either curtail criticism of austerity measures or go on the offensive against stimulus proposals. Yet, it seems an odd argument to make when the classic case of hyperinflation haunting the policy memory of Europe’s most powerful country was singularly not caused by a deliberate monetary stimulus attempting to arrest an economic slump.”
The collapse of the supply potential of the economy also is relevant for understanding the Zimbabwean hyperinflation episode. Imagine an agrarian-based economy is growing steadily and farm output is sufficient to supply the demands of both the export and domestic markets. Then a dictator comes along and starts taking land off the original farmers (who were productive) and gives it to those who do not understand how to farm or have no real interest in farming. The result would be that the overall capacity of the economy to produce goods and services would contract. The current spending levels in this economy would now be excessive in relation to the dramatically reduced supply potential and inflation would result. In this case, initially food prices would rise quickly.
This example is almost exactly what happened in Zimbabwe in the recent decades. The white racist regime that ruled prior to 1980 and which had broken away from the colonial arrangements with Britain, created such an unfair sharing of land between the whites and blacks that a backlash was always going to occur once the minority rule ended. From the inception of Colonial rule in the 1890s, the minority white population had conspired in various ways to keep “the black farmers poor” (Guardian, 2000). By 1970 the white population constituted around 5 per cent of the population (Jakobsen, 2012) but owned more than 70 per cent of “the most fertile lands” (The Guardian, 2000). After the civil war of the 1970s and the recognition of independence in 1980s, President Mugabe’s government more or less oversaw relatively improved growth with stable enough inflation outcomes. The economy underwent a severe drought in 1992-93 which pushed the inflation rate up but it soon came back to usual levels (World Bank, 1995). After independence in 1980 and up to 2000, economic gowth was variable but usually positive except for the harsh drought in 1992-93. There were no signs of the disaster that followed.
During the 1980s and 1990s, land reform was a central topic in Zimbabwe and the “need for land reform in Zimbabwe … [was] … generally acknowledged, even by representatives of the commercial farming sector” (Human Rights Watch, 2002: 2). The problem was that while many governments eager to assist the restructuring of the Zimbabwean economy in the early years of independence provided funds, “conditions were put on the way that the money handed over could be used” (p.3). In particular the British, which had brokered the transition to majority rule, was “protective of white farming interests in Zimbabwe” (p.3) and the World Bank imposed a ‘Economic Structural Adjustment Plan’, which had “damaging social consequences, in particular by increasing poverty” (p.4). The debate became bogged down as to whether the support should be provided “on the basis … of historical obligation rather than development assistance” (p.4). None of these interactions were solving the basic problem whereby the “(c)Colonial policies of expropriation … [had] … established ownership patterns in which white farmers in Zimbabwe possess large, fertile farms while black rural dwellers barely subsist” (p.4).
The problems came to a head in 2000 when President Mugabe introduced the ‘fast track’ land reforms to speed up the process of equality and breakthrough the resistance from international donors (such as the World Bank and the IMF). The reaction to the stark inequality in land holdings and wealth in general was understandable but its operationalisation was not very sensible in terms of maintaining an economy that could continue to grow and produce at reasonably high levels of output and employment. The revolutionary fighters that gained Zimbabwe’s freedom were allowed to take over productive, white-owned commercial farms, sometimes violently and, in many cases, also expel the local farm workers (Human Rights Watch, 2002). No compensation was provided. These farms had hitherto fed the population and were the largest employers in the economy. From an economic perspective, the farm take over and collapse of food production was catastrophic.
In December 2001, the United Nations Food and Agriculture Organization (FAO) reported that “the already tight food supply situation has deteriorated as a result of reduced cereal production and general economic decline. Serious food difficulties are reported in the south, east and extreme north where production was reduced by dry weather or excessive rains. A recent vulnerability assessment indicated that 705 000 people in rural areas are at risk of food shortages. In addition, 250 000 people in urban areas are experiencing food difficulties due to a sharp increase in food prices, while some 30 000 farm workers have lost their jobs and are left without means of subsistence.” A major drought in the 2000/01 growing season combined with the farm takeovers to produce a decline in total agricultural output by 12.9 per cent in 2001 (AfDB/OECD, 2003). Real GDP fell by 9.3 per cent in 2002, 16.8 per cent in 2003, 6.1 per cent in 2004 and 5.6 per cent in 2005 (IMF, 2014). By 2005, the unemployment had risen to 80 per cent and many of those who had managed to remain employed were forced to scratch around for a part-time, low-wage existence.
The land reforms represented the first big contraction in potential output (supply). A rapid contraction in total spending (demand) was required but impossible to implement politically given that around 45 per cent of the food output capacity was destroyed. The situation then compounded as other other infrastructure was trashed and the constraints flowed through the supply-chain. For example, the National Railways of Zimbabwe (NRZ) had decayed to the point the capacity to transport its mining export output has fallen substantially (Mbohwa, 2008).
Manufacturing output also fell by 29 per cent in 2005, 18 per cent in 2006 and 28 per cent in 2007. In 2007, only 18.9 per cent of Zimbabwe’s industrial capacity was being used. This reflected a range of things including raw material shortages. But overall, the manufacturers blamed the central bank for stalling their access to foreign exchange which was needed to buy imported raw materials (Confederation of Zimbabwe Industries, 2009). The Reserve Bank of Zimbabwe was using foreign reserves to fund the purchase of imported food to ease the food crisis. The causality chain was clear. The land reforms undermined the domestic food supply, which introduced a reliance on imported food. This, in turn, squeezed importers of raw materials who could not get access to foreign exchange. So not only was the agricultural capacity been destroyed, what manufacturing capacity the economy had was being barely being utilised. Further, significant volumes of imported goods and services were also prevented from flowing in because many importers abandoned goods at the border when they were hit by exorbitant import duties.
Given these circumstances, the hyperinflation was inevitable but that experience is not remotely like a situation where a currency-issuing government uses OMF associated with permanent fiscal deficits, which are scaled closely to the spending gap left by the overall saving of the non-government sector and thus just sufficient to maintain full employment. In other words, there can be no threat of hyperinflation, if the total growth spending in the economy matches the capacity of the economy to produce real output.
Conversely, when a nation so comprehensively mismanages the supply side of its economy, as in the case of Zimbabwe, the only way it can avoid inflation is to severely contract real spending to match the new lower capacity. Had the government of Zimbabwe adopted that strategy, more people would have died from starvation than was the case. In the situation that Zimbabwe found itself in, even a surge in private sector investment would have triggered a severe worsening of the inflation situation until the growth in supply capacity caught up with the spending growth.[THAT COMPLETES THE DRAFT OF THIS CHAPTER AND THE BOOK. I AM NOW EDITING THE DRAFT AND HOPE TO HAVE A FINAL MANUSCRIPT TO THE PUBLISHER IN TWO WEEKS – RELIEF. NORMAL BLOG TRANSMISSION WILL RESUME TOMORROW]
This list will be progressively compiled.
AfDB/OECD (2003) African Economic Outlook 2003/2004, African Development Bank and Organisation for Economic Co-operation and Development Organsiation, Paris. http://www.oecd.org/countries/zimbabwe/2497679.pdf
Bergmann, C. (1927) The History of Reparations, Boston, Houghton Mifflin.
Confederation of Zimbabwe Industries (2009) Manufacturing Sector Survey 2009, http://www.czi.co.zw/images/Documents/Surveys/2009.pdf
Feldman, G. (1997) The Great Disorder: Politics, Economics and Society 1914–1924, Oxford, Oxford University Press.
Food and Agriculture Organisation (2001) ‘Food Supply Situation Tightening in Southern Africa’, Africa Report No. 3, United Nations, December 2001. http://www.fao.org/docrep/005/y2916e/y2916e09.htm
Human Rights Watch (2002) Fast Track Land Reform in Zimbabwe, March 2002. http://www.hrw.org/reports/2002/zimbabwe/ZimLand0302.pdf
IMF (2014) World Economic Outlook, April 2014 database.
Jakobsen, T.G. (2012) ‘The Fall of Rhodesia’, Popular Social Science, October 19, 2012. http://www.popularsocialscience.com/2012/10/19/the-fall-of-rhodesia/
Marks, S. (1978) ‘The Myths of Reparations’, Central European History, 11(3), 231–255.
Mbohwa, C. (2008) ‘Operating a Railway System within a Challenging Environment: Economic History and Experiences of Zimbabwe’s National Railways’, Journal of Transport and Supply Chain Management, 2(1), November, 25-40.
Smith, A. pseudonym of Goodman, G.J.W. (1981) Paper Money, New York, G.K Hall.
The Guardian (2000) ‘Land redistribution is not robbery, but a necessity’, The Guardian, April 19, 2000. http://www.theguardian.com/world/2000/apr/19/zimbabwe
World Bank (1995) ‘Zimbabwe Achieving Shared Growth’, Country Economic Memorandum Volume 1: Overview, Report No. 13540-ZIM, April 21, 1995. http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/1995/04/21/000009265_3961019095856/Rendered/PDF/multi0page.pdf
(c) Copyright 2014 Bill Mitchell. All Rights Reserved.