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The Reichsbank: Germany’s Central Bank Lays Foundation of Monetary Disaster

On January 18, 1871, the German Empire was established after a seven-year conflict to unite the German confederacies. Prussia, a northern German state on the Baltic Sea would be the nation to unite Germany under a central ruler, Kaiser Wilhelm I. The central bank of Prussia, the “Reichsbank,” would assume control on January 1, 1876. While the gold standard was adopted after the reunification wars in 1871, the Reichsbank would adopt a “gold” mark as the universal German currency.

One kilogram (2.2 pounds) of gold would equal 2,790 marks, with one mark exchanging for 358 milligrams. Every nation, however, had different exchange rates for their “gold” money. The pound sterling, for instance, had an exchange rate of 7.32 grams. The “gold” dollar had an exchange rate of 1.50 grams, meaning four gold marks exchanged for one US dollar.

However, like every central bank, they would not stay honest and would destroy the nation’s economy. Gold confiscation, inflation, and interest rate manipulation would all be introduced in pre—and post–World War I Germany.

Gold Confiscation

While governments permitted a “gold standard” and personal use of gold, when the state needed to inflate to finance either its war or welfare policies, they would not hesitate to confiscate gold. Executive Order 6102, signed on May 1, 1933, ordered all US citizens to hand in their gold, whether it be coins, bullion, or certificates. Gold would be stored in vaults and America would go half off the gold standard; foreigners would not yet be prevented from exchanging the dollar into gold.

Because of this, President Roosevelt would have no problem inflating the currency as the citizens no longer had control on monetary policy. The Reichsbank of pre–World War I Germany also had the same benefits of confiscation, with tension brewing between the European powers, the state would need more money to fight the war. Gerald Feldman in his book The Great Disorder states:

The Reichsbank viewed the dependency of coinage with increasing disapproval. As international tensions mounted in the prewar years, the Reichsbank also considered the excessive circulation of coinage dangerous, because it could act as an extreme brake on the Reichsbank ability to satisfy government liquidity requirements in the event of war.

The Reichsbankers knew a war was coming, so they took action in decreasing the amount of gold coins in circulation, and to print more fiat paper notes in order to finance the upcoming war. President Rudolf Havenstein of the Reichsbank demanded on June 18, 1914, that all banks hand over all gold to the Reichsbank vaults, this was ten days before Archduke Franz Ferdinand would be assassinated in Sarajevo.

As always, the central bank printed more paper fiat notes then there was actual redeemable gold in the banking system. So, on July 31, 1914, the Reichsbank closed its doors to prevent bank runs until finally August 4, 1914, when the convertibility of the mark to gold was banned. Ludwig von Mises in his book Human Action (p. 472) states:

The inflationists are fighting the gold standard precisely because they consider these limits (bank runs, and no easy money) a serious obstacle to their plans. The governments were eager to destroy it, because they were committed to the fallacies that credit expansion is an appropriate means of lowering interest rates.

With gold no longer a problem, as gold premiums, deals, and exports of gold were made illegal, the Reichsbank was now free to expand money to finance the war.

Expansion of Easy Money in Germany

As mentioned before, the central banks were notorious for printing more paper notes than there was gold. The number of high-denomination bills (fifty, hundred, thousand) increased from 1,951,000 in 1908 to 2,574,000 in 1913. Low-denomination bills (fives and tens) saw increased from 62 million to 148 million.

By 1914, there were 2.1 billion marks in circulation, and by the end of the war in 1918, there were 22.2 billion marks in circulation. Inflation will always lead to higher prices; printing paper notes will devalue the currency and businesses will need to keep up with such changes. However, governments can initiate price controls on certain goods that will keep the price artificially low, the German government did this during World War One.

Prices of food were kept extremely low but there were also massive shortages in all types of goods, in 1918 the German Board of Public Health stated that: “763,00 German had died of disease and starvation from a blockade.”

Was it a blockade? Or was it bad economic policy that occurred before and during the war? Not only did price controls keep the price of produce low, but the German stock market was also closed until December 1917 which severely hindered the price system. Conscription from rural Germany and the movement of farm hands to armament factories were also a reason for shortages, either way the farmers were cutting their production due to lack of price incentives. Frederick Taylor’s The Downfall of Money speaks on this:

It was clear that Germany was turning into two countries: an urban Germany, dependent on food imported from abroad or the countryside; and a rural Germany, which was self-sufficient and reluctant to release what it grew or reared unless the price was right. This division will continue well into the unhappy peace.

Not only did the central bankers and politicians ruin the economy of Germany, but they also successfully divided the people against each other.

Conclusion

The mistakes of both the central bankers and commissars of the German government would follow the German people into the uneasy peace during the Weimar Republic, and as we know now it was only going to get worse. The idea of easy money, price controls, and the glorification of war would persist in both the newly formed Weimar Republic and Nazi Germany. The decades of government intervention have led the German people at that point to be as Thomas Mann put it: “Cold hearted and reliant on politics and destiny and forgetting on how to rely on themselves as individuals.”

But many people in Europe and abroad have not learned the lessons of government control. The bankers and politicians, however, have learned. But they did not learn basic economics. They learned how much they can get away with.