Currency Wars_ The Making of the Next Global Crisis - James Rickards [32]
Finally, the hyperinflation showed that countries could, in effect, play with fire when it came to paper currencies, knowing that a simple resort to the gold standard or some other tangible asset such as land could restore order when conditions seemed opportune—exactly what Germany did. This is not to argue that German hyperinflation in 1922 was a carefully thought-out plan, only that hyperinflation can be used as a policy lever. Hyperinflation produces fairly predictable sets of winners and losers and prompts certain behaviors and therefore can be used politically to rearrange social and economic relations among debtors, creditors, labor and capital, while gold is kept available to clean up the wreckage if necessary.
Of course, the costs of hyperinflation were enormous. Trust in German government institutions evaporated and lives were literally destroyed. Yet the episode showed that a major country with natural resources, labor, hard assets and gold available to preserve wealth could emerge from hyperinflation relatively intact. From 1924 to 1929, immediately after the hyperinflation, German industrial production expanded at a faster rate than any other major economy, including the United States. Previously countries had gone off the gold standard in times of war, a notable example being England’s suspension of gold convertibility during and immediately after the Napoleonic Wars. Now Germany had broken the link to gold in a time of peace, albeit the hard peace of the Versailles Treaty. The Reichsbank had demonstrated that in a modern economy a paper currency, unlinked to gold, could be debased in pursuit of purely political goals and those goals could be achieved. This lesson was not lost on other major industrial nations.
At exactly the same time the Weimar hyperinflation was spiraling out of control, major industrial nations sent representatives to the Genoa Conference in Italy in the spring of 1922 to consider a return to the gold standard for the first time since before World War I. Prior to 1914, most major economies had a true gold standard in which paper notes existed in a fixed relationship to gold, so both paper and gold coins circulated side by side with one freely convertible into the other. However, these gold standards were mostly swept aside with the coming of World War I as the need to print currency to finance war expenditures became paramount. Now, in 1922, with the Versailles Treaty completed and war reparations established, although on an unsound footing, the world looked again to the anchor of a gold standard.
Yet important changes had taken place since the heyday of the classical gold standard. The United States had created a new central bank in 1913, the Federal Reserve System, with unprecedented powers to regulate interest rates and the supply of money. The interaction of gold stocks and Fed money was still an object of experimentation in the 1920s. Countries had also grown used to the convenience of issuing paper money as needed during the war years of 1914–1918, while citizens had likewise become accustomed to accepting paper money after gold coins had been withdrawn from circulation. The major powers came to the Genoa Conference with a view to reintroducing gold on a more flexible basis, more tightly controlled by the central banks themselves.
From the Genoa Conference there emerged the new gold exchange standard, which differed from the former classical gold standard in significant ways. Participating countries agreed that central bank reserves could be held not only in gold but in the currencies of other nations; the word “exchange” in “gold exchange standard” simply meant that certain foreign exchange balances would be treated like gold for reserve purposes.