Inflation, Taxation and Revaluation: Germany 1920-30

However grim the global financial crisis of 2008-9, it was not quite so spectacular as events in Germany in the early 1920s. One US dollar was worth 4.2 Reichsmarks (RM) when the Great War began in 1914. By November 1923, it was worth RM 4,200,000,000,000. Professor David Southern, another of our members, took us on a sometimes spine-chilling tour of “Inflation, Taxation and Revaluation: Germany 1920-30”, for the second talk of the evening. By comparison with that period, David regarded Zimbabwe in recent years as a model of monetary stability. He traced the seeds of the later turmoil in the establishment in 1891-3 of the Prussian Income and Property Tax laws and the central tax appeals court. Fundamental to the new taxes was the principle that commercial accounts were followed for tax purposes, which led inevitably to profits being recognised only if realised at the accounting date whereas any anticipated risks had to be recognised at the same time.

Thus, when the Great War began Germany had a relatively weak taxation base, and when it was cut off from international capital markets, it had to rely to a far larger extent than Britain or France on the monetising of government securities by the central bank, now familiar to us as quantitative easing. Under the post-war Weimar Republic, taxing powers were shifted heavily from the states to the Reich government which soon had to cope with the phenomenon of massive inflation. Economists such as Schumpeter held that rather than causing inflation, an increase in the money supply allowed it to continue; others, such as the President of the Reichsbank, Rudolf Havenstein, took the view that inflation was caused by shortage of credit, and the way to overcome inflation was to print more money. Inevitably the latter view ended in tears, and it was just as well that Havenstein, an unsackable civil servant, died in 1923. By now things were so bad that it was said that even the largest pre-war mortgage could be redeemed for the price of a litre of milk.

Accounting systems responded by using replacement cost instead of historic cost. The legal system responded by invoking the principle of abuse of law, later more familiar in a EU context, and held that in some circumstances creditors could require pre-inflation debts to be honoured at their “old” values. The Reich government eventually passed a law requiring debtors to add a “revaluation contribution” of 25% of the historic exchange value of the debt. The courts were soon swamped by revaluation cases. Ironically, one the most vocal judicial critics of the wide discretion exercised by the courts in applying the “abuse of law” rule, Wilhelm Hedermann, who viewed it as a step on the road to tyranny, later rose to high office under the Nazis. Their accession to power in 1933 was helped by conservative politicians supported by disappointed victims of the erosion of assets which the state was powerless to remedy.

David ended by quoting Schumpeter’s claim that “He who knows how to listen to [the] message [of fiscal history] discerns the thunder of world history”-an apt thought on which to end a fascinating talk and send us to our usual supper at a nearby restaurant in reflective mood.

David Williams

September 2010