After World War1 Germany experienced one of the history’s mostspeculator example

Question

After World War1 Germany experienced one of the history’s mostspeculator example of hyperinflation. The German government did notpay for the war by taxing people more heavily. Things got worse atthe end of the war. A huge amount for damages (reimbursement) wasdemanded from Germany. The sum to be paid was fixed at£6,600,000 in 1921. Germany’s currency losesconfidence of many foreigners because Germany was unableto pay for damages. German government has to face budget deficitbecause value of their currency decreased too much and they have topay more in exchange for other currencies.

Required:

Keeping in view the above scenario, how theGerman Government finances its budget deficit after World War1?

Explanation / Answer

The German debt was tied to an external value (pounds sterling)rather than German marks. Therefore, a relatively fixed debthad to be financed using German currency, which would be used toacquire British pounds and thereby pay off the debt.. Sincethe German government had not paid for the war by taxing itscitizens (i.e. a reallocation of assets from its people to thegovernment), it had to find the money to purchase the foreigncurrency from somewhere. With the gold and other hard assets(the Saar basin in southwestern Germany containing a largepercentage of the nation's coal deposits, and its locomotiveengines) seized as part of the war reparations, there was little"hard" value underlying the face value of the Germancurrency. Therefore, as was noted above, foreign demand forGerman notes decreased since they were viewed as lessvaluable. Since more marks were required to purchase Britishpounds, and there was only a fixed supply in the country, theGerman government financed its annual deficits by printingadditional currency. In short, it increased its moneysupply. The problem was, with no underlying value, demand for the marksdecreased further, heightening the inflationary spiral. Meanwhile within the country, Germans employed by or sellingproducts and services to the German government still needed to bepaid. They were similarly paid in additional newly-printedmarks. Simply increasing taxes would only have reallocatedthe (less valuable) marks to the German government - which wouldn'thave solved the problem of paying for the debt with everless-valuable currency. Therefore, they had to keep printingmore currency. Put another way, the German pie was shrinking, and simply cutting alarger slice to pay the foreign debt would shortly becomeinsufficient. By printing more notes and trying to stay aheadof the devaluation, the German government was attempting to createvalue by increasing the money supply. All they ended up doingwas evaporating the value of their currency. This was only fixed when the German government ceased honoring itswar debts, recalibrated the currency (after several attempts) andengaged in deficit spending to rebuild its military and industrygenerally (getting concrete products rather than pouring it out ofthe country). And a few other things a few years later.

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