For some folks in the US (including myself) there is a major concern with the size and scope of the US deficit (now over $20T and approaching 100% of GDP). The latest round of “stimulus” put us another $2Trillion in debt, further pushing the day of reckoning up. At some point, the US is going to find that it can’t get people to buy their debt. When that happens – look out!
A lot of folks are not that worried, because the cost of borrowing for the US is incredibly low In one of their recent podcasts, Stacking Benjamins talked about how the cost of borrowing for the US government is incredibly low (0.68% for the latest round of bonds recently) – so why not borrow at this incredible rate? The concern I have is that, no matter what the rate is, we are still borrowing a crapload of money, and that will need to be paid! It may be 10 years, 20 years, 30 years from now, but we are going to have to pay it off – or put out new bonds. What happens when the rate on those bonds is 4%? 6%? 8%? Each of those rates have been paid at some point by the US government.
The FIRE community is all about generating cash flow and using debt strategically. This isn’t strategic. So what is a person to do when their government is addicted to debt, and you can see the train wreck coming? Over the next several weeks, I’m going to go through some periods of history where countries had this happen, and what were the areas where someone could have at least done some items in advance to mitigate it. Maybe we can do some of these now to prepare.
The issues with Germany’s 1923 financial collapse starts at the beginning of World War I. While Britain had large financial resources, and France imposed their first income tax to pay for the war, Germany “decided to fund the war entirely by borrowing.” The idea was to pay for the war from the spoils of war, gained from France, Russia, etc. At the start of the war, the mark (German currency) was valued at 4.2 marks to the dollar, but as the war progressed without success, it dropped down to 7.9 marks per dollar.
As we all know, German eventually lost the war, with one of the reasons being the economic collapse of the country. By 1919, the mark was valued at around 48 to the dollar. For the next several years, the mark slowly drifted down, as Germany tried to come out of the war, eventually landing around 90 marks to the dollar by 1921. Germany’s industry hadn’t been damaged during the war (unlike France) but the reparations decision in 1921 ordered Germany to pay their reparations in gold or foreign currency (not cheaper marks). While there were arguments about this, eventually Germany had to comply, which led to more and more devaluations of the German mark. By 1922, the mark was valued at 320 to the dollar.
Germany tried to work out a better reparations method (including working with J.P. Morgan Jr) but it failed, and hyper-inflation was kicked off, with the mark falling to 7,400 to the dollar by the end of 1922. When Germany couldn’t pay reparations, Belgium and France occupied the Ruhr Valley industrial area. In trying to work this out, Germany printed more and more notes, further devaluing the currency. “A loaf of bread in Berlin that cost around 160 Marks at the end of 1922 cost 200,000,000,000 Marks by late 1923. By November 1923, the US dollar was worth 4,210,500,000,000 German marks.”
In late 1923, Germany issued a new currency, backed by bonds indexed to the market price of gold – based on the same price of marks-to-gold as it was pre-war. The central bank was no longer allowed to discount government treasury bills. The new marks were allowed to be exchanged with the old marks (at a rate of 1-trillion paper marks to one new Reichmark). By 1924, one dollar was the equivalent of 4.2 of the new marks (i.e. back to pre-war levels)
So what were the lessons we can learn from this experience?
• The link to a real asset, gold, was broken at the beginning of the war, unleashing inflation. Since the US got off the gold standard, inflation has eaten up 80% of its buying power, as of 1971. There are numerous tradeoffs that the gold standard has created, so that is a topic for another time
• When you lose a war, the victors can be very punitive (see Versailles 1919).
• Political Fragility and infighting can prevent a positive solution to the problem (anyone see that as an issue in the US today?)
• Hyperinflation destroys savings and fixed return assets (bonds). Since a large number of people save this way, hyperinflation can lead to riots and societal collapse
• All these issues can easily lead to the creation of a dictatorship or rule-by-decree. People will do anything to lessen the pain
• The items that maintained (somewhat) their value were good quality company stocks and real assets (gold, real estate, etc.) For those concerned about hyperinflation, invest wisely, start growing some of your own food, and be prepared for society to go through some rough spots.
My plan is to look at other historical issues in the past to get some guidance for long-term planning in the US
Mr. 39 Months