Inflation and German sensibilities

This perhaps encapsulates Germany’s fears, born out of experience, and it would be wrong to dismiss her statement, as many commentators have, as mere rhetoric. The whole concept of the European Coal and Steel Community, the original forerunner of the European Union, was to tie Germany and her neighbours together in a trade and political union to prevent future wars between them.

The EU has delivered peace and prosperity for Germany. It is reasonable to conclude, as Merkel does, that the destruction of the euro will reverse the political process. Post-war European politics has been largely based on these two premises. But there is a deeper point to Merkel’s statement, which has been forgotten in our modern world of fiat currencies: in history the greatest threats to peace and social stability have usually been associated with currency debasement. And here, Germany’s unhappy experience has become rooted in its people’s psyche.

Germany’s spending in the build-up and early years of the First World War was financed purely by monetary inflation, and even by 1917, 85% of the cost was paid for by new paper money. This came about as a result of the economic advice at the time, principally from Georg Knapp, who believed that money is a government product and should be free of other constraints. For the Kaiser, it was like having a modern Keynesian economist advising a government today that it has a right to finance itself through monetary inflation. It was therefore hardly surprising that an ambitious Kaiser, having been shown how to finance the expansion of Germany by attacking its neighbours, actually did so.

The social consequences of printing money are entirely supported by economic theory of the Austrian School of economists and the lessons of history. It boils down to a simple fact: any electorate can be patriotically roused for war, so long as it doesn’t have to pay for it. And that is the lie behind monetary inflation. If you print money to finance a war instead of raising taxes, for a time, no one notices the cost.

Germany has been through this lesson twice in the last century, so her people instinctively understand the chaos that results. It is the rest of Europe, with the exception perhaps of Austria, which has forgotten it. So let us state it loud and clear: sound money is the best guarantee of peace, while fiat money is a precondition for chaos.

So Angela Merkel is right, but the pressure from other euroland and G20 states will be difficult to resist. They have placed their trust in an expanded bailout fund to be supported partly by the EU’s Asian trading partners, which if it gets off the ground will do so at the expense of the dollar. The trouble will come if the European Central Bank is also expected to fund it, which so far is assumed by many but not discussed. Any major injection of ECB money into the fund will be extremely controversial in Germany, and therefore should not be taken as read.