Mark Gleich Mark

I haven't written much about the economy or financial markets in a while. But it's been interesting to watch the stock market march higher with the attendant hype about "new all time highs" for the Dow. Of course, outside of niche market commentators, there's no mention that those new highs are nominal. Take a look at this chart via Barry Ritholtz that shows how the Dow has performed against gold in recent years. Jude Wanniski would have been proud -- and I'm sure he'd be reminding us right now that the Dow would have to rise several thousand more points to reach a "real" all-time high after accounting for inflation. This is one reason why, despite the stock market's rise in recent months, the economy still ranks as a major concern in public opinion polls. Give me a large truckload of million-dollar bills to distribute randomly for a few years, and I guarantee you the stock market will rise. I also guarantee that everything we need to live will get more expensive, and everything we merely want will get cheaper.

At this point, it's clear we've entered a period in which policymakers have decided that it's never a good time for a stock market decline or a recession. Natural ebbs in the business cycle used to be times of cleansing and adjustment. Now, with a Federal Reserve chairman whose scholarly interest is the Great Depression, soft spots are considered "deflation" and are to be avoided at all costs. I've posted before about the use of liquidity as a tool of the nanny state, and it's never been more true than right now. After the Fed's brief dalliance with sanity (draining liquidity) earlier this year -- during which the Nasdaq fell about 15% and some overseas markets plunged 25% or more -- the liquidity jets are blasting away again at full strength.

It's hard to predict how long this can continue (and risky to bet against it, of course). Monetary policy is the art of the possible, and much depends on our overseas creditors. But I think it's important to understand the dynamic at work, so one can either protect himself or recognize events as significant when they occur. I just finished reading a fantastic book called When Money Dies by Adam Fergusson. For those interested in what can happen when fiscal and monetary policy go awry, this is a must-read. Sadly, it's out of print and extremely rare; I've seen it listed by internet booksellers from $500 to over $1,000. As an alternative, you might try a library search using this wonderful service.

The book is an account of the inflation that ravaged Europe in the 1920's, particularly in Germany. Let's be clear: anyone who thinks we're living in Weimar-redux is either shrill or uninformed. Despite our current fiscal and monetary mess, the dollar is still the world's de facto reserve currency (although certainly not to the degree it has been in the past) and the U.S. still makes things the rest of the world buys. Germany enjoyed neither of these advantages eighty years ago, and that's important. But the basic dynamic of inflation doesn't change, and certain parallels are worth noting if only to understand the potential dangers of the path we've clearly started down.

I'd always thought Germany's runaway inflation in the early 1920's resulted from the harsh reparation terms imposed after World War I. Instead, Fergusson shows that inflation was a calculated path chosen by Germany's central bank to boost the country's exports and thus its domestic employment. After the war, the main fear in Germany was unemployment and the potential appeal of Communism. To the extent it made Germany's goods more competitive in foreign markets, inflation was desirable and politically expedient. Fergusson notes that prominent industrialists like Hugo Stinnes (on this Time magazine cover in 1923) openly supported inflation as deliberate policy. Stinnes ran Germany's equivalent of a Dow Jones-listed industrial giant, and thus benefited from inflation just as our own similar companies (and their stocks) are doing right now.

Moreover, Rudolph Havenstein, head of Germany's Reichsbank (the equivalent of our Federal Reserve) was open about his actions. From Fergusson (p.165-166):

Dr. Havenstein plunged on. Day and night 30 paper mills, 150 printing firms and 2,000 printing presses toiled away adding perpetually to the blizzard of banknotes under which the country's economy had already disappeared. Havenstein spoke of the efficiency -- the Leistungsfahigkeit -- of his printing system.

A central banker boasting about the ability of his printing press. Sound familiar? (If not, read the section on "Curing Deflation" halfway through this speech.)

As Germany went down this road, a cruel dichotomy developed. At the same time a pensioner needed a stack of paper money to buy a cup of coffee, the stock market and the economy soared because of the massive liquidity. Fergusson quotes from the letters of a private citizen:

Speculation on the stock exchange has spread to all ranks of the population and shares rise like air balloons to limitless heights. My banker congratulates me on every new rise, but he does not dispel the secret uneasiness which my growing wealth arouses in me...it already amounts to millions.

The folly was easier to grasp, perhaps, if one was a foreigner. Again, from Fergusson (p.81):

The Times on April 18, 1922, printed a bitter report from 'a man of business' recently in the country:

The greatest fraudulent conspiracy in the history of the world is now being enacted in Germany with the full concurrence and active support of its 60 or 70 millions of people. Germany is teeming with wealth. She is humming like a beehive. The comfort and prosperity of her people absolutely astound me. Poverty is practically non-existent. And yet this is the country that is determined she will not pay her debts...They are a nation of actors...If it wasn't for the fact that the German is guiltless of humor, one might imagine the whole nation was bent on perpetrating an elaborately laborious practical joke.

Of course prosperity existed for some, and was to be seen on the surface. Those eating well in restaurants were those who could afford to eat well in restaurants. As money saved diminished like a lump of ice on a summer's day, there was in any case every incentive to eat it, drink it or be merry with it.

Inflation "worked." It was the fuel that created the veneer of thriving consumerism. And it worked most of all for the banks that sprouted on every corner, the 20 year-old stock trader, and those who had the savvy and means to protect themselves through hard assets.

There were consequences, of course. From Fergusson (p.229):

No people could be expected to remain unconcerned while huge profits and riotous luxury were ostentatiously being enjoyed by the few. Corruption bred corruption, and the Civil Service caught the infection even in the war years.

As the old virtues of thrift, honesty and hard work lost their appeal, everybody was out to get rich quickly, especially as speculation in currency or shares could palpably yield far greater rewards than labour. While the anonymous, mindless Republic in the shape of the Reichsbank was prepared to be the dupe of the borrowers, no industrialist, businessman or merchant would have wished to let the opportunities for enrichment slip by while others were making hay. For the less astute, it was incentive enough, and arguably morally defensible, to play the markets and take every advantage of the unworkable fiscal system merely to maintain one's financial and social position.

As that position slid away, patriotism, social obligations and morals slid away with it. The ethic cracked. Willingness to break the rules reflected the common attitude. Not to be able to hold on to what one had, or what one had saved, little as it worried those who had nothing, was a very real basis of the human despair from which jealousy, fear and outrage were not far removed. The air of corruption in business, politics, and the public service, then, was general.

Remember, this was Germany -- a society that had always been staid, ordered, and steeped in respect for the law. Something to think about in light of what we've seen in corporate America and Lagos-on-the-Potomac during recent years.

Just as the dynamic of inflation never changes, the "spin" from central bankers comes from the same script. Fergusson describes how most Germans tragically bought the spin until it was too late (p.18):

Most of them clung to the mark, the currency they knew and believed in, long after the eleventh hour had come round for the umpteenth time. Most had no choice; but all were encouraged or bemused by the Reichsbank's creed of "Mark gleich Mark" -- paper or gold, a mark is a mark is a mark. If prices went up, people demanded not a stable purchasing power for the marks they had, but more marks to buy what they needed. More marks were printed, and more, and more.

Confidence, of course, must be maintained. A bit of perspective for whenever we hear a more contemporary "creed" from a Treasury Secretary that "the U.S. favors a strong dollar."

So some cautionary parallels to keep in mind, particularly in light of what Germany's inflation-related moral breakdown facilitated in the 1930's (I'll leave it to others to debate whether state-sanctioned torture and an invasion based on a false pretense indicate we've already gone off the rails in our own unique way). If anyone's feeling patriotic and has an extra $500 or so laying around, I have a holiday stocking-stuffer idea for our Fed chairman.