Inflation is everywhere, and always, a monetary phenomenon

In our last two letters, we have dived into a history of the Great German inflation of the early 1920s, and taken some lessons for investors today, in reviewing by Jens O. Parsson’s Dying of Money: Lessons of the Great German and American Inflations.

You can read parts one and two on the website.

Today, we turn to the US in the 1970s.

Some commentators have pointed out the many parallels between the policies and environment of the 1960s and today.

So it’s an incredibly valuable period to get our heads around, for some clues on what might come our way next. From Dying of Money:

… the American dollar lost only about 70 percent of its value from 1939 to 1973. Prices were not quite 3.5 times as high at the end of that time as at the beginning. In thirty-four years, that was a smaller loss than the Reichsmark suffered in a single year after the inflation steamroller began to roll, or in just two or three average days as the inflation approached its final crash.

Why?

Well, American debt was only 1/4th larger than its economy (debt to GDP) after WWII, while Germany’s was ½ larger after WWI (this could equally be written as 125% vs 150% debt-to-GDP ratios).

So not a major difference there.

But, Parsson writes, “Where Germany’s performance was dismally worse was in its inflation of its money supply by 25 times, compared with the American monetary inflation of only 3.5 times.”

So it’s hardly a surprise that American prices only doubled in the post war years, compared to Germany’s 17x increase. (Both, interestingly, are around 2/3rds of the increase in money supply, showing that prices tended to rise in proportion to the growth in money supply – the amount of currency in circulation.)

Given where we are today, with money supply growth breaking all kinds of records, it’s not a surprise that people who see monetary policy as the key driver of inflation are very concerned indeed.

Source: Koyfin

You can see the dramatic increase in money supply during the Covid-19 pandemic – very similar to the jolts higher after the two world wars in Germany and the US.

Given the similarities between the central bank and government responses to the two world wars and the Covid pandemic, it really is worthwhile us paying attention to what drove those policies, and what effects they had.

One effect, for example, was both very deliberate, and a positive from the perspective of governments.

In 1950, US war debt was still 90% of GDP, down from 125%.

For Germany after WW1, five years on its war debt and reparations had shrunk from four times GDP to just a sixth (400% to 17% debt to GDP).

From a government’s perspective, reducing the debt burden was the goal. The reparations added massively to Germany’s and pushed them to print money much faster. Germany ended up paying off the reparations in an increasingly worthless currency, so that was nice, I guess.

But inflation extracts a price of its own.

Moderation turned out to be the safer path to debt reduction, even though it took longer.

Could it be suggested that American authorities in the central bank and the White House knew this and acted appropriately?

Not according to Parsson:

President Truman’s administration displayed little understanding of what was happening or of its own good management. In his June 1946 veto message pleading for stronger price controls for another year, President Truman was able to say unabashedly, “For the last five years we have proved that inflation can be prevented [by controls].”

This of course was wholly wrong.

At that point, the big inflation to come had already been built. Nothing that the government did after the war was responsible for the price inflation of the next two years, and nothing that the government could have done could permanently prevent it from happening.

By November of 1947, after a year’s severe inflation, President Truman was back again with a panicky plea to a joint session of Congress for the whole array of new price controls, rent controls, credit controls, and rationing. Reviewing the disheartening course of the inflation since the preceding year, he asked querulously, “Where will it end?”

Thanks to balanced budgets and the continued quiescence of the money supply, the inflation was in fact already within a few months of ending. Congress had become Republican in the previous autumn’s elections and gave the president substantially none of his controls.

The inflation nevertheless ended within a few months in early 1948, right on schedule.

The Federal Reserve System, which like the Reichsbank in Germany was the guardian of the money supply, seems to have been as uncomprehending as the Truman administration was. In 1947, it too was calling for new powers and controls. The remarkable stability of the money supply throughout these years occurred without the conscious volition of the Federal Reserve.

In other words, it was pure luck.

The lesson from this great inflation, to Parsson, seems to be that policies, price controls, rationing, and all manner of clever tricks are like flies to the inflationary elephant.

The only thing that matters is the money supply, and by following the money supply, you could have followed the inflation in the US much more closely.

We have seen that prices rise in proportion to money supply – around 2/3rds.

They also operate on a delay, of 1-3 years. So that’s worth thinking about today.

To those who say that we haven’t had (headline CPI) inflation yet from the Covid stimulus… I’d say it’s probably too soon to tell.

An interesting observation followed this passage, which resonates with what I’m seeing today.

In those days, the monetary policy of the Federal Reserve was dominated by its duty to control interest rates on government obligations. If interest rates tended to rise, the Federal Reserve issued money to stop their rising, but not otherwise.

Well, now the Fed is already issuing heaps of dollars in order to stop interest rates rising.

They continue to rise though.

I wrote about the Fed’s dilemma a while ago (here).

If it keeps printing more money, it will push inflation expectations higher.

If the markets start predicting higher inflation based on Fed money printing, then they will sell bonds, pushing interest rates higher – which means death for the equity market, and probably property too.

The only way to stop that happening is to pull the plug on the money printer.

But that too would crash the stock, bond, and housing markets, so dependent are they now on the flow of liquidity from the central bank.

The Fed is in a trap of its own making now, as it was in the US, and as it was in Germany.

To finish, I’d like to offer this quote.

Since those dim beginnings in the forests of the Stone Age, governments have been perpetually rediscovering first the splendors and later the woes of inflation. Each new government discoverer of the splendors seems to believe that no one has ever beheld such splendors before. Each new discoverer of the woes professes not to understand any connection with the earlier splendors. In the thousands of years of inflation’s history, there has been nothing really new about inflation, and there still is not.

All told, it’s an absolutely brilliant read. Well written, thrilling, informative and insightful.

I recommend it wholeheartedly, and would say that a solid understanding of these two past inflations will stand investors in very good stead in the tumultuous years which may lie ahead.

Very best wishes,

Kit Winder
Editor, UK Uncensored

PS If you’re worried about the devaluation of your currency, then you need to read this.

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