Funny money.

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Venezuela Could Learn From Weimar Hyperinflation

Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to the Bloomberg View. Follow him on Twitter at @smihm.
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With inflation at an annual average of 98.3 percent for 2015, and predictions that it could reach 720 percent this year, Venezuela may be about to join the ranks of countries that have experienced out-of-control price increases that cripple the economy.

If hyperinflation -- defined as price increases of 50 percent or more a month -- sets in, there will be inevitable comparisons to other such episodes. The most famous of these is the one that hit Germany in the early 1920s, with its images of ordinary people paying for necessities with wheelbarrows full of money.

But perhaps the most interesting aspect of historical episodes of hyperinflation is how they end. And Germany offers an example that Venezuela might credibly emulate to regain control of its currency.

Venezuela

After World War I, the Treaty of Versailles required Germany to pay reparations to the victors, to be delivered in gold, as well as commodities such as steel and timber. When Germany defaulted on its payments, French and Belgian troops occupied the Ruhr, the nation's industrial heartland, in January 1923.

German workers refused to cooperate with the occupiers and went on strike, encouraged in part by government officials. The industries of the Ruhr largely shut down and tax revenue collapsed. As it ran short of money, the German government resorted to the printing press to pay its bills and support the growing legions of unemployed workers in the Ruhr.  Inflation, already raging out of control, metastasized into hyperinflation.

The spectacular collapse of the German mark had few parallels. In 1918, a single mark purchased a loaf of bread. By September 1923, the cost was 200 billion marks. Germany flirted with total collapse, providing an opening for Adolf Hitler's failed Beer Hall Putsch. Hitler ended up in prison, but hyperinflation continued to rage.

The chancellor, Gustav Stresemann, was a capable administrator who sought to defuse the conflict over reparations. He also moved to end hyperinflation, appointing an ambitious banker named Hjalmar Schacht to the new cabinet-level post of "currency commissioner." The position came with appropriately sweeping powers that gave Schacht considerable sway over cabinet decisions affecting the currency.

At first glance, Schacht seemed to be in a no-win situation. He could not reasonably return Germany to a conventional gold standard because there wasn't enough gold in the country, and what little there was remained locked up in the vaults of the Reichsbank.

Most governments facing this situation would take the easy road out and issue new, high-denominations currencies. Germany already had gone down that road, minting notes with ever-higher denominations -- the highest was an eye-popping 100 trillion mark bill -- but these measures did little to arrest the hyperinflation. If anything, they likely contributed to the growing sense that the government had lost control.

Another option was to call in the old notes and exchange them for new ones of a lower denomination currency but with a new name.  But this tactic rarely works, either. The public must believe that something fundamental has changed, and that the currency is backed by some kind of asset, or at the very least, a commitment on the part of the government to avoid using the printing press.

And that is where Schacht came up with a brilliant innovation. He refined and deployed a clever plan crafted by Finance Minister Hans Luther.  It called for the creation of a new national bank -- the Rentenbank -- that would issue a currency known as the "Rentenmark" (meaning "Debt Security Mark") to supplant the worthless marks issued by the Reichsbank. There was to be a new currency, yes. But it would be backed by real assets -- just not gold.

The Rentenbank relied on a mix of coercion and persuasion to pull off this monetary miracle. Using a valuation system called the Wehrbeitagswert (a tax system used to pay for the military), the government forced Germany's economic elite to mortgage four percent of the nation's industrial and agricultural properties. The Rentenbank securitized these mortgages, turning them into the so-called Rentenbriefe, bonds that paid 5 percent interest.

The Rentenmarks could be redeemed for Rentenbriefe at the rate of 500 to 1. Significantly, the principal and interest payments of the Rentenbriefe were indexed to gold, even if there was no gold immediately on hand. The new currency, then, was backed by something tangible -- real property -- and ultimately pegged to gold.  Moreover, the actual number of Rentenmarks that the Rentenbank could issue was limited by the value of the underlying property. 

Schacht, operating out of a broom closet in the Finance Ministry, kept an eye on the money markets as he readied the Rentenmark for circulation. He waited until the foreign exchange rate had fallen to a magical number: 4.2 trillion Reichsmarks to the dollar. As Liaquat Ahamed has observed, this was a symbolic moment to arrest the slide: prior to World War I, 4.2 Reichsmarks had been worth a single dollar.

Schacht then offered to exchange a trillion Reichsmarks for a single Rentenmark. The German people accepted the new currency. The public grasped that the new currency was in fact backed by something, even if that something was extremely difficult to grasp. And hyperinflation, after a few wobbly weeks, effectively ended. Schacht had triumphed, even if the fragile stability he engineered ultimately unraveled with catastrophic consequences in the 1930s. (Schacht later served as Hitler's economy minister from 1934 to 1937. After the war, he was tried and acquitted by the Nuremberg Tribunal.)

Nonetheless, Venezuela might be a very good candidate for adopting some of Germany's actions in 1923. As Germany's example suggests, Venezuela need only create a currency that is backed, however mysteriously, by a tangible asset that's guaranteed to hold at least some of its value.

By some estimates, Venezuela has the largest oil reserves in the world. Even though oil prices are scraping the bottom of the barrel, the crude is worth something, both now and in the future. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Stephen Mihm at smihm1@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net