The Death of Paper Money

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by Ambrose Evans-Pritchard: With
the US Trapped in Depression, This Really Is Starting to Feel Like



As they prepare
for holiday reading in Tuscany, City bankers are buying up rare
copies of an obscure book on the mechanics of Weimar inflation published
in 1974.

Ebay is offering
a well-thumbed volume of Dying
of Money: Lessons of the Great German and American Inflations

at a starting bid of $699 (shipping free.. thanks a lot).

The crucial
passage comes in Chapter 17 entitled "Velocity". Each
big inflation – whether the early 1920s in Germany, or the
Korean and Vietnam wars in the US – starts with a passive expansion
of the quantity money. This sits inert for a surprisingly long time.
Asset prices may go up, but latent price inflation is disguised.
The effect is much like lighter fuel on a camp fire before the match
is struck.

willingness to hold money can change suddenly for a "psychological
and spontaneous reason", causing a spike in the velocity of
money. It can occur at lightning speed, over a few weeks. The shift
invariably catches economists by surprise. They wait too long to
drain the excess money.

took an almost right-angle turn upward in the summer of 1922,"
said Mr O Parsson. Reichsbank officials were baffled. They could
not fathom why the German people had started to behave differently
almost two years after the bank had already boosted the money supply.
He contends that public patience snapped abruptly once people lost
trust and began to "smell a government rat".

Some might
smile at the Bank of England "surprise" at the recent
the jump in Brtiish inflation. Across the Atlantic, Fed critics
say the rise in the US monetary base from $871bn to $2,024bn in
just two years is an incendiary pyre that will ignite as soon as
US money velocity returns to normal.

Morgan Stanley
expects bond carnage as this catches up with the Fed, predicting
that yields on US Treasuries will rocket to 5.5pc. This has not
happened so far. 10-year yields have fallen below 3pc, and M2 velocity
has remained at historic lows of 1.72.

As a signed-up
member of the deflation camp, I think the Bank and the Fed are right
to keep their nerve and delay the withdrawal of stimulus –
though that case is easier to make in the US where core inflation
has dropped to the lowest since the mid 1960s. But fact that O Parsson’s
book is suddenly in demand in elite banking circles is itself a
sign of the sort of behavioral change that can become self-fulfilling.

As it happens,
another book from the 1970s entitled When
Money Dies: the Nightmare of The Weimar Hyper-Inflation
just been reprinted. Written by former Tory MEP Adam Fergusson –
endorsed by Warren Buffett as a must-read – it is a vivid account
drawn from the diaries of those who lived through the turmoil in
Germany, Austria, and Hungary as the empires were broken up.

Near civil
war between town and country was a pervasive feature of this break-down
in social order. Large mobs of half-starved and vindictive townsmen
descended on villages to seize food from farmers accused of hoarding.
The diary of one young woman described the scene at her cousin’s

"In the
cart I saw three slaughtered pigs. The cowshed was drenched in blood.
One cow had been slaughtered where it stood and the meat torn from
its bones. The monsters had slit the udder of the finest milch cow,
so that she had to be put out of her misery immediately. In the
granary, a rag soaked with petrol was still smouldering to show
what these beasts had intended," she wrote.

Grand pianos
became a currency of sorts as pauperized members of the civil service
elites traded the symbols of their old status for a sack of potatoes
and a side of bacon. There is a harrowing moment when each middle-class
family first starts to undertand that its gilt-edged securities
and War Loan will never recover. Irreversible ruin lies ahead. Elderly
couples gassed themselves in their apartments.

with dollars, pounds, Swiss francs, or Czech crowns lived in opulence.
They were hated. "Times made us cynical. Everybody saw an enemy
in everybody else," said Erna von Pustau, daughter of a Hamburg
fish merchant.

the rest of the article

27, 2010

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