When Gary Becker put forward his idea of human capital in 1964, it was to address the effects of knowledge and training on individual economic performance. This idea can and should be extended to gauge the productive capacities of society in general.

It amazes me just how heavy a load of regulation a country can inflict on its economy so long as it doesn't mess with money.

Cultural patterns of behavior that become ingrained over time, such as norms of punctuality, honesty, sobriety, or what others might call social capital, are just another way of speaking about human capital. When Max Weber described the attributes of character that marked the modern bourgeois, he was, in fact, emphasizing patterns of belief that facilitated the operation of markets by enabling individuals to effectively negotiate their social landscape—to engage in commerce and production over the long run.

All of society is composed of such levels of meaningful coordination articulated around ideas and concepts. It is a terrible thing to see what happens when that kind of capital breaks down. And that is the story told in an important new book by Fredrick Taylor, The Downfall of Money: Germany’s Hyperinflation and the Destruction of the Middle Class. Today, Germany has a well-established reputation for eschewing monetary inflation. In fact, since the great downturn of the last decade, that trait is perhaps its best-known attribute (after beer and soccer). Because so much of the European Union’s monetary policy is influenced by the Germans, it has become a source of constant complaint from other members. Yet, it’s hard to argue with success.

It amazes me just how heavy a load of regulation and intervention a country can inflict on its economy so long as it learns one crucial lesson: don’t mess with money. That bespeaks powerful human capital. But it wasn’t always this way, and the price paid for learning the lesson was enormously steep. Taylor doesn’t quite put his story in these terms, but that is exactly what he describes in this blow-by-blow account of the onslaught of hyperinflation and its impact on German society during the interwar years. This should be required reading for central bankers and treasury secretaries the world over.

Before the First World War, Germany had experienced remarkable economic success. In large measure, this was owing to the stability of its legal order and, perhaps most importantly, strict enforcement of Germans’ contractual obligations. (A nice summary of the history of capitalism in Germany is given by Joyce Appleby in her 2010 book The Relentless Revolution.) It was this moral and legal foundation that facilitated the formation of some very large industrial firms that were able to reap the rewards of scale made possible by new technologies. As Taylor’s narrative makes clear, so strong was this foundation that it actually survived the initial blows of war and political revolution.

What it couldn’t survive was the downfall of money.

The Critical Role of Price Stability

One can think of the store of concepts available to a people as their repertoire of possible responses to challenges. Individuals “download” these patterned understandings as they develop their personalities from childhood over the course of lived experience in families and communities. Human capital is the individualized form of human culture, and personality is its expression.

Stability in the enforcement of contracts and the protection of property are essential for maintaining a durable and free society.

That repertoire includes more than just concepts associated with cooperative and voluntary interaction. It also contains notions of caution, fear, and fight. If civil order begins to break down, the ideas associated with the best in human behavior, the ones that promote longer-term perspectives on self-interest, give way to more immediate conceptions of survival and subsistence, however disagreeable they may be.

That’s why, in a society based largely around markets, certain navigable markers are essential to preserving the ability to make plans and move forward in time. Various institutions, formal and informal alike, are necessary to ensure that most of those plans will more or less work out acceptably. Stability in the enforcement of contracts and the protection of property are essential for maintaining a durable and free society.

A general stability of prices is another critical landmark. Prices normally vary, of course, but they do so within a range and over a span of time that allows for the possibility of rationally adjusting one’s expectations and patterns of consumption and production. And what is the single most important factor relating to prices? It is the one factor that touches everything in a market economy: currency.

The Deutsche Mark remained fairly stable even through much of the turmoil of the Great War. Whatever one thinks about the causes of that conflict, it is clear that the political and institutional ramifications of war initiated the processes that would eventually undo the currency. There are previous examples—the currency issue following the American War of Independence was a major, if not primary, concern that eventually prompted James Madison to move for constitutional reform.

But that was a cake walk compared to the 1920s. As the economies of Europe, in 1914 and thereafter, left the gold standard to embrace finance by inflation, the first effects seemed mild. And the Germans, in the patriotic spirit of the day, appeared to accept the change, because they were accustomed, as part of their repertoire of concepts, to the enforcement of rules. They accepted the Kaiser’s pledge to uphold the integrity of the Deutsche Mark. As Taylor writes:

The last bit about the Reich’s trustworthiness, the bit about how the Kaiser and his Reichsbank would never do anything that endangered the soundness of the currency and the welfare of ordinary Germans, must have done the trick. Unfortunately, it was precisely this part of the argument that was—let us not mince words—a lie.

What followed was a tragedy on a grand scale.

Inflation in the Post-War Period

There were many things about the Versailles Treaty to be regretted, but it isn’t hard to see why France insisted on harsh terms. Most of the physical destruction of the war had taken place in France, at the hands of the Kaiser’s army. That Germany would have a difficult time making payments on reparations was obvious. Still, did the Weimar Republic need to continue the inflationary policy of the war years to continue to make those payments?

That is an interesting speculative question. It “might, theoretically, have worked,” our author writes, but for the fact that the government faced enormous internal political pressures. It needed not only to satisfy the victors, but to cover its inherited debts to its own people—to veterans, pensioners, and all the other various creditors. It had to provide for its own casualties: 525,000 widows, 1.3 million orphans, 1.5 million disabled veterans. And it had to do all this while maintaining the basic functions of government in the face of violent protests and insurgencies by communist labor organizers on the left, and proto-fascist agitators on the right.

Whatever an ideal solution might have been, we hardly expect governments to be able to perform well in times of peace and plenty let alone amid such crises. Under these conditions, it is little wonder that inflation beckoned. The strongly anti-German financier J.P. Morgan basically acknowledged that the “Allies must make up their minds as to whether they wanted a weak Germany who could not pay or a strong Germany who could pay.” Taylor, after reviewing all of this, strangely and almost off-handedly comments that “Germany was deliberately making herself incapable of paying.”

Germany had actually been reduced for a time to a barter economy with “near-medieval suffering of wide swathes of her population.

In what way does he mean “Germany”? As a government? As a people riven with factions? Unfortunately, he doesn’t say. Fortunately, his evidence speaks for itself.

For a long while after the formation of the Weimar Republic, inflation against the dollar held in the double digits. To meet the first reparations payment deadline at the end of August 1921, the Republic had to scramble to cobble together a variety of revenue sources and financial instruments. To make matters worse, 1 billion of the total owed (50 billion marks) had to be made in a currency still convertible to gold: the U.S. dollar. Add to this the fact that the key industrial area of Upper Silesia was slated for transfer to Poland as part of the peace settlement, and the currency was doomed.

International bankers’ willingness to invest in Germany (and surprisingly, significant interest still remained in the immediate aftermath of the war) evaporated in the last quarter of 1921. With Silesia gone, and France threatening to take away the other great industrial and coal mining region of the Ruhr, whatever had remained of international demand for marks disappeared. German domestic attitudes and actions wholly aside, the international community itself had clearly registered disbelief that the country could make good on its obligations—even as it demanded that Germany try.

And of course, trying to meet the deadline—which entailed selling huge additional quantities of marks on foreign exchange markets—made matters worse. Here one will find Taylor’s timeline at the back of the book particularly helpful. With mark-to-dollar ratios listed down the right-hand column, the reader can follow the month by month collapse. By October 1921, the currency was worth 150.2 marks to the dollar. By the following year, it was over 10 times that number. And a year later (1923) we are in the realms of hyperinflation: 25,260,000,000 marks to a dollar.

Not that the full costs can be captured by financial figures. For this, you need the vital statistics, which Taylor provides. The worst damage visited on those who had already been severely hurt by the war itself, often locked into fixed pensions with no access to foreign currencies. Many Germans, because of the infirmities of disease, malnutrition, or an inability to adjust quickly to changing circumstances, were inexorably pushed down to subsistence levels.

Taylor reviews many details, including the ascending incidence of rickets—a bone-deforming, growth-stunting disease to which malnourished children are prone. In 1921, it afflicted 59 percent of children over the age of two.

The Starving Billionaires

The author does balance this grim picture with a discussion of the more financially nimble in the cities who seemed, for a time, to be able to mimic America’s “Roaring Twenties,” but the ephemeral nature of such “successes” is underlined by the title of a later chapter: “The Starving Billionaires.”

What happens to a population faced with such uncertainty? It is of course fashionable today to imagine a peculiarly evil Germany, at its core homicidally anti-Semitic. It would certainly be easier if evil came so conveniently packaged in a single culture. Here, the Goldhagen thesis comes to mind. But it takes a hardier sort of historian to face realities as they actually were. Taylor’s history is replete with the complexities of what can happen when otherwise ordinary people are confronted with extraordinarily bad circumstances.

One particularly arresting story is that of Maximilian Bern, a man of literary education exemplary of Germany’s formerly middle-class Bildungsbürgertum. In 1923, writes Taylor,

[he] withdrew all his savings—100,000 marks, formerly sufficient to support a modestly comfortable retirement—and purchased all it would buy by that time: a subway ticket. The old gentleman took a last ride around the city, then went back to his apartment and locked himself in.

If you are like me, you probably assumed the next sentence would conclude with suicide. No. “There he died of hunger.” I had to linger over that sentence to fully grasp the reality: starvation in a society that had recently been among the most technologically and commercially advanced of any on earth.

As Taylor’s account sunk in, so too did the nature of the evil that was shortly to follow. As he noted, Germany had actually been reduced for a time to a barter economy with “near-medieval suffering of wide swathes of her population.” In such an atmosphere, time horizons shrink. One thinks in terms of the next meal—not tomorrow, not next week, and certainly not over one’s future in a broader sense. The clarity of longer-term reasoning is exchanged for expediency. As the average person looks for order, enemies are “seen” wherever those who offer easy answers point them out. There is a reversion to the more immediate and narrower reference markers in a people’s repertoire of possible responses.

Here’s hoping the rest of us don’t have to learn this lesson the hard way.

Inflation was eventually halted by the introduction of the new “Rentenmark” in November 1923, but the damage was done. All those who had bought war debt, all the creditors to the government, were wiped out. Unfortunately, the ones blamed were not the ministers in the Kaiser’s authoritarian government who originally approved the loosening of the currency from its gold moorings in 1914, but the democratic government of Weimar. Everywhere, left and right, people looked for leadership and blamed the Republic for its impotency. The economy was able to stabilize and even recover somewhat under the new currency, but the next crisis—the global Great Depression—kicked out the remaining props. Far worse than the economic cost was the loss of faith among individual Germans that they could plan for and meet the future with hope.

And the rest we know well enough.

With defeat in 1945 and a stability born of occupation, an exhausted Germany could begin to take stock of what had happened. Germans came to hold to the absolute necessity of a stable currency:

[Their] awareness of their own history, including the price they paid for the hyperinflation—financial aversion therapy of the most drastic sort—as well as the benefits of financial discipline, which transformed the country after the Second World War, makes it obvious to most Germans that a similar course of action must be pursued by their troubled Eurozone friends if they are to lift themselves out of the mire.

Human capital purchased dearly. Concludes Taylor: “The problem for the world may be that Germany’s instinct is correct.” Here’s hoping the rest of us don’t have to learn it the hard way.

Republished from the Library of Law and Liberty.