The Question Now Is Whether or Not Sense Can Prevail

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On November 26, 1934, the Secretary General of the League of Nations, Joseph Avenol of France, delivered to the Romanian delegation a "note" to be considered under the "procedure in force in the matter of the protection of minorities." The end of World War I had led to confusion, to put it mildly, as borders were changed all throughout Europe and elsewhere. The cause of the petition was that of Dr. Meer (Mayer) Wilderman. The unfortunate industrialist had built and owned factories in Germany starting in 1912. But because he was born in Bessarabia, then part of Russia, at the outbreak of war the capital assets were seized under the accusation that Wilderman was an "enemy alien" in Germany.

The Wilderman case became something of a regional fixation, with good reason, which is why the League of Nations became involved two decades later. Like something out of the best Hollywood fiction, there was enormous intrigue and dirty tricks, the kind of underhanded tactics and immorality that seems only appropriate from a clichéd movie villain. Secretary General Avenol's note to the Romanian (Roumanian) government spells it all out in 501 pages of 30 annexes. Dr. Wilderman had to fight years not just to reclaim his factories, but prove that they were rightfully his and further that they were even worth reclaiming (the LoN note is in French, the following quote is Google Translate).

"During the following months (H1 1917) the group Stinnes, who managed to guard against any indiscreet investigation de Wilderman, prepared at will the implementation of the plan was to give the D.W.W. appearance of a company bad situation. But their process does not go without revolt some people who made it a duty to prevent Wilderman."

The subsequent owners of the capital enterprises, Wilderman charged, had forged financial documents and statements to reduce the value of the assets almost to nothing. But the wildest parts were in questioning Wilderman's own birth. The defendants in the case claimed to have uncovered evidence that Wilderman had never been born in Bessarabia at all, and even that no Wilderman ever was (again Google Translate).

The administrative home parents and grandparents of Dr. Wilderman, all its side and aunts uncles father is proven way of absolute. Not only for the time of the birth of Wilderman, but several dozens of years covering the entire nineteenth century. Not a single Bessarabian.

As much as there was of this kind of drama, the case received its attention mostly because of the defendants themselves. The man ultimately accused of taking Wilderman's property was none other than Hugo Stinnes. That name has been lost to history largely because his family proved yet again the nature of income "inequality" in a free system; his vast industrial empire did not long survive him.

In the 1910's and early 1920's, however, Stinnes was the Warren Buffet of that age, popular and admired far beyond Germany's borders. He had come to the position where he could take Wilderman's factories in 1914 by building up his own enterprises in mining and shipping and then using them as collateral. Known as the Baron of Ruhr, the German government sought his advice as he became more politically active. With his activism came more opportunity for growth, and not just in the manner of appropriation due to war "necessity."

At the time of his death, Stinnes' empire had amassed something like 4,500 companies. In 1922, Time Magazine dubbed him "Germany's new Kaiser." Regular Germans simply called him Inflationskönig - the King of Inflation.

He was the living embodiment, fairly or not, of the zero sum game of inflation; in this case hyperinflation. The vast majority of Germans were wiped out by the monetary monster of 1922 and 1923. Some, however, did extremely well. Stinnes was, as his nickname openly declares, at the top of that list. The basis for his wealth was hard assets that in the time of existential currency crisis made them nearly invaluable. But he used that position to leverage and borrow much, much more. He could take over bankrupt competitors while storing his own profits in Swiss gold, all with understanding full well where it was all going - total monetary default.

Those that benefit from currency collapse are the borrowers, usually the state. Those that pay for it are those who behaved most responsibly: the savers, the thrifty majority who were wiped out not from holding worthless cash but having invested their positive assets in places like "risk free" government bonds and bank shares. They came to realize far too late that it was all equally paper and equally destroyed by the introduction and revaluation of the rentenmark in October 1923.

The stories from that era are unbelievable to our modern senses; they just don't compute even though there have been more recent hyperinflationary episodes. Zimbabwe, or now perhaps Venezuela, is not Germany, a country that in the early 1920's was technologically advanced and the third largest economy in the world. As German newspaper Spiegel recalled in August 2009:

"Take for example the family that sold its house to emigrate to America. On arrival at the port of Hamburg, they found that the money wasn't enough to pay for their crossing -- in fact, it didn't even pay for their tickets back home. Then there was the man who drank two cups of coffee at 5,000 marks each, only to be presented with a bill for 14,000. When he asked why this was he was told he should have ordered the coffees at the same time because the price had gone up in between. And then there's the story about the couple that took a few hundred million marks to the theater box office hoping to see a show, but discovered it wasn't nearly enough. Tickets were now a billion marks each."

How it could ever spiral so far out of control is still not much cleared up almost a century later. And that is the most relevant lesson to be taken from the catastrophe. Like any engineered system, a building or an airplane, it takes not one glitch or mistake but a highly improbable series of them to bring about total systemic failure. To crash a jet, for example, requires overcoming a great many redundancies and self-corrections which is why they have become so rare. But that modernity comes with a price - arrogance.

The primary failsafe of money has always been gold, but all the great powers, save America, abandoned the gold standard at the outset of WWI. The Germans, as the British, French, and Russians, knew that to pay for the war meant robbing from future generations in the form of debt, but also that that wouldn't quite be enough. They would also have to steal from the war generation itself, as if the human sacrifice weren't sufficient, in the form of monetizing the debt. Even though the volume of currency had surged from 13 billion marks in circulation in 1913 to more than 60 billion by war's end, Germany wasn't in any worse shape, monetarily, than the other major powers. Consumer prices had risen roughly 140%, but the mark had been devalued no more than the pound, and was actually stronger than the franc.

Conventional explanations at this point assert war reparations and eventually the French takeover of the Ruhr as the heightened monetary tensions that tipped the scale, but like the Great Inflation in the US and elsewhere in the middle 1960's there needs to be more attention paid to the governing philosophies of the time. Just as Samuelson and Solow argued for inflation as an economic tool in the early 1960's in the US (the "exploitable" Phillips Curve), the same idea in a different format was prevalent in Weimar Germany. As the Spiegel article notes, economist and historian Carl-Ludwig Holtfrerich claimed at the time that the, "lubricant of inflation" would "breathe new life into the private sector."

In other words, German monetary officials, particularly Reichsbank head Rudolf von Havenstein and Minister of Finance Karl Helfferich, denied that Germany had an inflation problem at all - right up until the end. Minister Helfferich declared that Germany had better gold coverage after the war than before it, despite that more than quadrupling of currency volume. One economics professor, Julius Wolf, wrote in 1922 that, "in proportion to the need, less money circulates in Germany now than before the war." As much as the easy-to-see Versailles excuse played a part, there can be no doubt that beyond 1921 the German people themselves began to recognize that authorities had no idea what they were doing; worse, they came to see that even though policymakers were inept and incompetent, officials themselves would never admit as much and thus nothing would prevent Germany from its fate. That awakening meant an increase in danger that French occupation could never have unleashed on its own.

It has been the dirty little secret of this brand of economics since it was first postulated under different conventions in the 19th century. There have been various schemes and frameworks devised, but at their center is this idea that inflation can be controlled as an economic tool - an no one or any amount of history seems able to convince them otherwise. Nowhere has this point been better summarized than in Paul Krugman's attempted critique of the Bank of Japan in the late 1990's. Paraphrasing, he said that the central bank must promise to credibly be irresponsible to overcome entrenched deflationary expectations (this was the true nature of "forward guidance"). It is a low probability result from the very start, that in a technically complex system central control can devise just the "right" amount to stay between continued failure on the one side and going too far on the other. It is natural, however, for any process that continues on the side of failure to eventually and suddenly attempt going too far without thinking it possible.

The specific incidence of hyperinflation, as financial deflation, is human emotion. There is no mathematical model that will predict the moment that Germans suddenly decide that their currency will be worthless, and thus begin determined actions to hold as little as economically possible. Likewise, there is no regression formula that will devise the exact point at which foreign holders of Weimar bonds will be happy to do so one day and then divest entirely of them the very next. It is a slippery slope made more slippery by authorities and their philosophical, operational, and/or political blindness.

It is from that perspective that we must evaluate central banks today. I am not in any way suggesting that hyperinflation throughout the world is a looming danger. Instead, what I believe has occurred is that central banks by their insistent and repeated actions have stripped away and eroded those safeguards and redundancies that make an "accident" that much more realistic. I take that view not just from my own analysis but from the actions of central banks themselves especially in 2016; they know they are losing credibility, but they also know that they are already testing beyond limits ever believed possible. If you were told in 2006 that somewhere between $12 and $15 trillion in debt around the world would be trading and even regularly issued at negative rates you would have thought the person totally mad.

The proper view of markets, especially funding markets, in July 2016 is one of so little faith in "stimulus" that the time value of money far into the future has been stomped down to almost nothing. The lesson of the monetary events of August and January was that central banks had no idea what they were doing. First the People's Bank of China was run over by the "dollar", following only by months the Swiss National Bank's unfortunate but similar experience. Just a few months later, the Bank of Japan lost total control over the yen.

The scary part was that the real economy, the global economy seemed to have turned with it all. While the Fed was declaring "full employment" in the US and its hard expectation for all the great economic benefits that would supposedly come with it, instead people turned to view recession the more realistic economic scenario. In late 2014, such dire circumstances were declared impossible; by 2016, people had begun wondering instead just how bad it might actually get.

Sensing that they were in danger of losing all credibility, the ECB, Bank of Japan, and People's Bank of China all reacted in significant fashion. The Federal Reserve also responded, but in its own bumbling way that has become the hallmark of the Yellen FOMC; like a duck hit over the head, as Abraham Lincoln once declared of General Rosecrans after losing at Chickamauga, Chairman Yellen this year sounds only progressively lost and stunned. It cannot be quantified just how much this year of "full employment" has been left to ridicule.

It is an entirely different world than the one envisioned in 2009, in no small part because that vision didn't even last two years. Even though the central bank re-responses in 2012 were given the benefit of the doubt, the dark clouds have been gathering ever since. Commodity prices, interest rates, yield and money curves all have been moving contrary to "stimulus" since that rupture in the summer of 2011. There was a lot of faith that, like QE3 in the US, monetary policy would get it right this time.

That, however, was the real danger of last year economically and monetarily-speaking. It proved that they didn't and then raised the far more dangerous possibility that they never can. And so central bankers are stuck; caught between the boundaries of having proved their own impotence with what they have already done, a considerable amount by their own words, against a global monetary problem they won't even admit. On the other side is the incomprehensible void, the dark abyss where emotion and eroding confidence might at some point conspire to the worst of the worst cases.

There is, fortunately, more than one dimension to all of this. Having witnessed a conspicuous abundance of many Inflationskönig particularly in the financial sector these past few years, the rest of the populace has begun to stir. The left and the right have split in their responses, as you would expect, with one going to Occupy Wall Street and all its splintered descendants focused on inequality but really what they see as the failure of capitalism and freedom; the other into the Tea Party and an indomitable mood for or emphasis on the restoration of capitalism and freedom in the place of cronyism but really financialism.

Both see statements like that from Ben Bernanke in 2015 telling us that savers must be punished (my word, not his) so that they can in the future benefit from the real recovery that will normalize interest rates. Interest rates have only moved further in the other direction, making him out to be even more of a liar in far more popular perception. It is intuitive, even if people don't know the story of Hugo Stinnes; inflation is winners and losers, and more often than not, despite all the monolithic academics and dense mathematics of econometrics, those who win are the irresponsible and irresponsibly connected while those who lose are the everyday people forced by diktat and fiat to pay for it all. This recovery has been one, long, immense bill ushered onto not just the further burden of Americans but the whole global economy by those who are still hard at work intentionally trying to lengthen the ledger and run up further the cost - all for our own good.

In reality, we aren't even talking about inflation, or at least as it is understood in orthodox terms. That is the point of Economics (capital "E"), it seems, to distill what should never be distilled. These are grand, global monetary imbalances where imposing the classification of inflation or deflation actually leads to huge understatement of the risks and more so the ongoing negatives. There is the growing worry throughout the world, Brexit being the latest prime example, that all of us could be the next Mayer Wilderman - even more so than we already have been in this non-recovery recovery.

The light at the end of this tunnel is in the growing body of evidence that we are not yet Japan. The lost decades of the Japanese economy are both parts monetary criminality ("stimulus" after "stimulus" after "stimulus" with nothing ever being stimulated) but also political status quo to further entrench bad economics. Just this week, the Republican National Committee unveiled its commitment to restoring some type of Glass-Steagall. I have no idea how committed they really are, or exactly through what mechanism it might work, and I don't really care. More important to me is the symbolism of even saying that they will do it and that banking (really money) is no longer a sacred political cow; recognizing just how far that is from TBTF.

Wall Street isn't really the problem, of course, it is what has happened to banking throughout the eurodollar age that has bastardized and distorted markets and finance. Glass-Steagall itself arose out of one of the few things that economists of the New Deal got right - that money and finance need not be intertwined, and, in fact, the public far better served if they weren't (TBTF arises purely from the combination). It is reborn populism because faith and credibility have systemically shrunk to much closer to the individual - with very good reason.

It is difficult to see how there could be any other outcome. The erosion of central bank credibility mirrors the erosion in eurodollar function, as people realize through constant ineptitude that the whole system of faith and deference from before 2007 was all predicated on a lie. Alan Greenspan was a genius because he did nothing except (wrongfully) take credit for all that (seemingly) went right. With everything now going wrong, Janet Yellen (rightfully) gets blamed because the Fed has been mobilized sufficiently to prove that Greenspan's legend (for the real economy, anyway) was all a bluff.

The real danger of 2016 and immediately beyond, then, is this race; those that are catching up to the real problem and trying to find a real solution not of inflation or deflation but of stable money will need time to find and then implement it (this is where the lost opportunity of 2008 is so tragic). Against them are those who would impede intellectual growth (as what did happen in 2008). But as confidence in the old order falls and the strong populist desire to look elsewhere begins to take its place, into that messy void is still the potentially disruptive force of bad economics. Where do all these curves meet? In other words, what is the point at which shrinking faith, desperate central banks, and growing economic despair all conspire to push us into the darker reaches?

Unfortunately, we are likely much closer to the edge than anyone would readily admit. After nearly a decade of stagnation and attrition, the forces of stability are already worn thin. That is the essence of the populist revolt, a response to years and years of getting nowhere. What has changed in the past few, especially under this "rising dollar" or dollar shortage, is that the populists have been proven right; following further down the mainstream path has led nowhere but to more uncertainty and greater anguish. Time is now the biggest cost.

The question right now is whether or not sense can prevail before the agents of the unworkable status quo really do go too far. It truly doesn't matter that the ECB or Bank of Japan are domiciled where they are, the wholesale system is all interconnected and linked. And as both those central banks seem hell-bent on only further testing the boundaries of faith and really sanity, it is a global issue. Germany didn't need to fall into the catastrophe of hyperinflation, even years after the war there were possible countertrends that would have avoided the ultimate collapse. Unfortunately for history, populism didn't arise sufficiently until after it was over; and by then it was much darker and bitter at its core, having lost the opportunity to avoid all of it. We should endeavor not to make the same mistake.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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