The German economy between the wars

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1. The German economy between the wars Lecture 5: The German Great Depression Dr. Cristiano Ristuccia [email protected]

2. Bibliography for Lectures 5 and 6 THE DEPRESSION Aguado, I. G., ‘The Creditanstalt crisis of 1931 and the failure of the Austro-German custom union project’, The Historical Journal, V. 44, No. 1, March 2001, pp .199-221. Borchart, K., ‘Constraints and room for manoeuvre in the great depression of the early thirties: towards a revision of the received historical picture’, in Borchart, K., Perspectives on Modern German Economic History and Policy, CUP 1991, ch. 9, pp. 143-160 and pp. 238-258 [Univ. Lib. 220.c.99.174, South Wing, Floor 6] also in Fischer, W. (ed.), The economic development of Germany since 1870. Volume II, Cheltenham UK and Lyme US: Edward Elgar 1997, pp. 53 - 91 [Univ. Lib. 220:01.b.23.15, South Wing Floor 6]; Cohn, R.L., `Fiscal Policy in Germany During the Great Depression', in Explorations in Economic History, V. 29, No. 3, July 1992, pp. 318 - 342; James, H., The German Slump, Oxford 1986 [Univ. Lib. 1993.8.5609]; Holtfrerich, C.-L., ‘Economic policy options and the end of the Weimar Republic’, in Ian Kershaw (ed.), Weimar: why did German democracy fail?, London: Weidenfeld & Nicolson 1990, pp. 58 - 91 and pp. 200 - 201, also in Fischer, W. (ed.), The economic development of Germany since 1870. Volume II, Cheltenham UK and Lyme US: Edward Elgar 1997, pp. 92 - 127 [Univ. Lib. 220:01.b.23.15, South Wing Floor 6]; Schneider, M., ‘The development of State work-creation policy in Germany, 1930-1933’, in Stachura, P. D. (ed.), Unemployment and the Great Depression in Weimar Germany, Basingstoke: Macmillan, 1986, [Univ. Lib. 229.c.98.864, South Wing, Floor 6]; Temin, P., ‘The German crisis of 1931: evidence and tradition’, Cliometrica (2008) Vol. 2 pp. 5–17; Voth, H.-J., ‘Did high wages or high interest rates bring down the Weimar Republic? A cointegration model of investment in Germany, 1925 - 1930’, in Journal of Economic History, V. 55, No. 4, December 1995, pp. 801 - 821.

3. THE NAZI ECONOMIC RECOVERY Abelshauser, W., ‘Germany: guns, butter, and economic miracles’, in M. Harrison (ed.), The economics of World War II. Six great powers in international comparison, Cambridge: Cambridge University Press, 1998, pp. 122 - 176, [Univ. Lib. 539:1.c.550.189 North Front, Floor 4]; Buchheim C., Scherner J.,  'The Role of Private Property in the Nazi Economy: The Case of Industry', Journal of Economic History, Vol. 66, No. 2 June 2006,  pp. 390 - 416, Carr, W., Arms, Autarky and Aggression, London, 1972, [Univ. Lib. 9570.d.146]; Ellam, M. et al., `Quarterly National Income Accounts for Inter-war Germany 1925-38', DAE Working Paper, 1992; Kitson, M., `The Move to Autarky: The Political Economy of Nazi Trade Policy', Department of Applied Economics working Paper, 1992; Hentschell, V., ‘German Economic and Social Policy, 1815-1939’, in P. Mathias and S. Pollard (eds.), The Cambridge Economic History of Europe, Volume VIII, Chapter XI, pp. 773-806, 1989; Overy, R. J., The Nazi economic recovery, 1932-1938 (2nd edn.), Cambridge: Cambridge University Press, 1996, [Univ. Lib. 9005.c.1268]; Overy, R. J., War and economy in the Third Reich, Oxford: Clarendon Press, 1994, [Univ. Lib. 1997.9.2186 or 220.c.99.2034 South Wing, Floor 6]; Ritschl, A. O., ‘Nazi economic imperialism and the exploitation of the small: evidence from Germany’s secret foreign exchange balances, 1938 – 1940’, Economic History Review, V. 54, No. 2, May 2001, pp. 324 – 345; Ritschl, A. O., ‘Spurious growth in German output data 1913-1938’, in European Review of Economic History, V. 8, No. 2, August 2004, pp. 201 – 223; Temin, P., Lessons from the Great Depression. The Lionel Robbins lectures for 1989, MIT Press, Cambridge, Massachusetts and London, 1989, Chapter 3 [Univ. Lib. 220.d.98.218 South Wing, Floor 6]; Tooze, J. A., The wages of destruction. The making and breaking of the Nazi economy, London: Penguin 2006, pp. 1 – 199.

4. Economic and political chronology of the German Great Depression

8. Germany can not follow on the path of devaluation because it would revaluate its massive gold-denominated foreign debt. US oppose such a move because they want Germany to continue to service their long-term debt; 8 December 1931 Brüning issues a fourth Presidential emergency decree with a further round of deflationary measures (mandatory cuts in wages, salaries, prices, and interest rates; increases in taxation; and cuts in government spending); Winter 1931/32 unemployment reaches 6,000,000; May 1932 Gregor Strasser (National Socialist) made his famous speech to the Reichstag demanding deficit spending on work-creation programmes; June 1932 Von Papen’s Government announces programme to stimulate the economy; July 1932 New General elections the NSDAP (Nazis) get 37.4 of the vote. 1932 Government of Franz von Papen ;General Kurt von Shleicher: July 1932 Lausanne Conference (reparations payments suspended indefinitely). After this moment fulfilment is meaningless – German governments are not bound to deflationary policies by international treaties anymore. Nor they have any interest in the alignment with the US. Indeed from this moment they have nothing to gain from US backing. Indeed cancellation of the debt towards the US accumulated by Germany after 1924 becomes a top priority as service and repayment would require a substantial compression of German living standards.

9. 7 November 1932 The head of the army General Kurt von Scleicher authorises the Umbau Plan for the creation of a standing army of 21 divisions in open breach of the Versailles Treaty; November 1932 new elections (fall in the Nazi vote but rise in the communist vote). Together the extremes have more than 50% of the vote. This prevents the formation of any government committed to the continuation of the Constitutional order; December 1932 General Kurt von Shleicher becomes Chancellor; December 1932 Britain makes the last payment on her debt to the US (and protests against it) France, Belgium, and others simply default on it; 30 January 1933 Adolf Hitler becomes German Chancellor (prime Minister); March 1933 new elections confirm the National Socialists in power (but fail to give them an outright majority in the Reichstag (indeed they remain at around a third of the vote); 23 March 1933 Enabling Law June 1st 1933 new work-creation programme.

10. The German Great Depression in international comparison (Sources: H. James, The German Slump, 1985, p. 6)

12. Big question: could recovery have been achieved through expansionary policies before January 1933? Decomposes into: 1. Was there an alternative policy? (Or as Borchardt put it the question of technical availability); 2. Was Hitler’s recipe viable to be applied by the Weimar’s governments? (Or as Borchardt put the question of political availability); 3. A question that is not for us here to answer (although it remains in the background): Would more pro-active economic policies by the Weimar governments have saved Germany (and the world) from Nazism? The “Big question” here is: could it have been done before January 1933? Could the German governments that presided over the period of the Great Depression have implemented measures that could have avoided and/or reversed the tragic slump into unemployment experienced up to the rise of the Nazis? This question can be disassembled in the following component parts:? Was there an alternative policy? (Or as Borchardt put it, ‘the question of technical availability’);? Could Hitler’s recipe have been applied by the Weimar governments? (Or as Borchardt put it, ‘the question of political availability’);?   A question that is not for us here to answer (although it remains in the background): Would more pro-active economic policies by the Weimar governments have saved Germany from the scourge of Nazism? Here it is worth returning to Borchardt’s thesis. He clearly posited the historiographical problems associated with the use of ex-post insight. Until the beginning of 1931 no one thought the Great Depression to be a “Great Depression” an unusual and catastrophic event that required unorthodox thinking to address its dramatic consequences. Therefore no one (in Germany or abroad) thought special remedies should be applied to a situation that, although difficult, was considered within the realm of ‘normality’.?   The “Big question” here is: could it have been done before January 1933? Could the German governments that presided over the period of the Great Depression have implemented measures that could have avoided and/or reversed the tragic slump into unemployment experienced up to the rise of the Nazis? This question can be disassembled in the following component parts:? Was there an alternative policy? (Or as Borchardt put it, ‘the question of technical availability’);? Could Hitler’s recipe have been applied by the Weimar governments? (Or as Borchardt put it, ‘the question of political availability’);?   A question that is not for us here to answer (although it remains in the background): Would more pro-active economic policies by the Weimar governments have saved Germany from the scourge of Nazism? Here it is worth returning to Borchardt’s thesis. He clearly posited the historiographical problems associated with the use of ex-post insight. Until the beginning of 1931 no one thought the Great Depression to be a “Great Depression” an unusual and catastrophic event that required unorthodox thinking to address its dramatic consequences. Therefore no one (in Germany or abroad) thought special remedies should be applied to a situation that, although difficult, was considered within the realm of ‘normality’.?  

13. Technical availability “If we attune ourselves to the state of knowledge of contemporaries during the crisis – rather than to our own which is of course much more complete since we already know the consequences – then we must first observe that, for the German policymakers, and indeed for all others throughout the world, until early 1931 there was no compelling motive to handle the crisis in any other way than the path actually taken. The situation did not look so severe from the outset as to make one fear the worst. And even fearing the worst – who could then know that things would get so bad, or that, for instance, in 1932 the annual average unemployment of workers would be 30 per cent?” (Borchardt, K, Perspectives on modern German economic history and policy, Cambridge: Cambridge University Press, 1991, p. 145) It is only in the summer of 1931 that Governments media and public realise that the nature of the crisis is different from previous ones and that the expected upswing might not materialise. (First plan to use government spending to stimulate the economy Braun memorandum of May 1931); By then it is far too late to implement policies that would prevent unemployment from reaching 6 million in the winter 1931/32 and thus to prevent the rise of Nazism. In the period 1929/30 and even beyond then the slump could be read as a sharp but not unusual contraction not dissimilar from cyclical downturns experienced in the previous decades. People could readily point to the example of the crisis of 1925/26 when production fell by a third within eight months. And there are a number of similar cases such as the adjustment crises experienced by various countries after WW1. According to the prevailing economic thinking of the period such episodes were a necessary, and even desirable, cleansing process that often followed distorted growth phases. Governments were advised to leave the invisible hand to do its job and purge the healthy body of the economy from speculative excesses. Given this intellectual setting, it is therefore of primary importance to detect the moment in which the crisis became to be appreciated as an exceptional event. In other words we need to decide when the Great Depression became the “Great Depression”? ? According to Borchardt the moment in which the exceptionality of the Great Depression became evident was in the summer of 1931. Therefore, the possibility that different economic policies could have been implemented to change the course of events that led to the ascent to power of the Nazis and eventually to the Second World War is dismissed by Borchardt firstly on timing grounds. ? By the summer of 1931 there was no time to prevent unemployment from reaching the 6 million mark by the following winter. Economic policies need time to run their course and change the macroeconomic outlook. According to Borchardt, however good, these counterfactual macro policies would have not been able to stop the Great Depression from producing those traumatic effects on employment that helped the Nazis into power. Borchardt though was writing in the early 1980s. Had he written ten years later, after the rational expectations revolution, he would have probably been even more cautious of the possibility of a counterfactual expansionary fiscal policy. On the other hand today his dismissal of such an alternative scenario on timing grounds seems less convincing. In the period 1929/30 and even beyond then the slump could be read as a sharp but not unusual contraction not dissimilar from cyclical downturns experienced in the previous decades. People could readily point to the example of the crisis of 1925/26 when production fell by a third within eight months. And there are a number of similar cases such as the adjustment crises experienced by various countries after WW1. According to the prevailing economic thinking of the period such episodes were a necessary, and even desirable, cleansing process that often followed distorted growth phases. Governments were advised to leave the invisible hand to do its job and purge the healthy body of the economy from speculative excesses. Given this intellectual setting, it is therefore of primary importance to detect the moment in which the crisis became to be appreciated as an exceptional event. In other words we need to decide when the Great Depression became the “Great Depression”? ? According to Borchardt the moment in which the exceptionality of the Great Depression became evident was in the summer of 1931. Therefore, the possibility that different economic policies could have been implemented to change the course of events that led to the ascent to power of the Nazis and eventually to the Second World War is dismissed by Borchardt firstly on timing grounds. ? By the summer of 1931 there was no time to prevent unemployment from reaching the 6 million mark by the following winter. Economic policies need time to run their course and change the macroeconomic outlook. According to Borchardt, however good, these counterfactual macro policies would have not been able to stop the Great Depression from producing those traumatic effects on employment that helped the Nazis into power. Borchardt though was writing in the early 1980s. Had he written ten years later, after the rational expectations revolution, he would have probably been even more cautious of the possibility of a counterfactual expansionary fiscal policy. On the other hand today his dismissal of such an alternative scenario on timing grounds seems less convincing.

14. Temin’s macro regime change 1. Importance of clear policy statements (announcement effect); 2. role of market expectations (change in behaviour becomes largely irrespective of the actual size and effectiveness of the policies announced - a threshold effect?); 3. Brüning only needed a well-publicised abandonment of any attempt to balance the budget. Since the late 1980s there has been a substantial change in theoretical perspective with the introduction of the concept of regime change. The work of Temin on regime change in Germany and the US has clearly shown the importance of clear statements of intentions insofar the general guiding lines of Governmental economic action. If such a dramatic shift occurs and it is properly announced, people would adjust their expectations and therefore change their behaviour. This change of expectations and consequent behaviour is largely irrespective of the actual size and effectiveness of the new policies announced and implemented. If this is the case then a regime change (in this case the announcement that the government now prioritised economic recovery over for example “crypto-inflation targeting”) could have rapidly made investors more willing to invest, consumers more willing to spend, and savers more willing to deposit. The announcement effect has the power to change immediately the economic outlook by virtue of a change in the economic behaviour of the public. In turn the public changes its economic behaviour in expectation of a fundamental change of behaviour on the part of the government. It follows that recovery is only indirectly set in motion by policy implementation, rather than being directly affected by it. In the theoretical framework of a ‘macroeconomic regime shift’ the announcement should not necessarily have implied the introduction of a set of work-creation schemes as the traditional Keynesian prescription would have wanted. The only thing that the Brüning government needed was a well-publicised abandonment of any attempt to balance the budget. On the contrary Brüning remained committed to an orthodox policy of neutral fiscal policies which, given the major contraction in revenues due to reduced economic activity, translated in an equally major contraction of public spending even in conditions that should have been naturally conducive to a more accommodative stance. If the balanced-budget policy had been abandoned - and ‘abandonable’ (and I will explain what I mean by abandonable) - then the continuation of all those policies intended to compress expenditure by reducing salaries, pensions, social welfare, and public building activity and social infrastructure would have largely become unnecessary. Although of little consequence on their own, the very preservation of these expenditure chapters would have allowed the public to change its perspective on the overall direction of the government’s action. Clearly, any announcement of public work schemes, however small in relative terms, would have reinforced the message. Were policies of this kind suggested during the Great Depression? Here the debate has raged about the status of those that proposed such measures in 1930/31. In particular, were they insiders or outsiders in their relationship with government circles? In other words were their voices close enough to those in charge to be heard or were they just part of an indistinct political cacophony in the background of economic policy-making? Holtfrerich argues that a considerable number of reflationary programmes were discussed within and outside the government from the summer of 1931 to the following summer. The fear of hyperinflation was increasingly reduced by the bitter resentment against unemployment and by the other ill effects of continued price deflation. Pressure groups were mostly turning to favour the implementation of some sort of reflationary measure. The message must have reached the government, and therefore, it is the latter that is to blame for not changing its views on how to deal with the crisis. Yet, even if the government had been more receptive to these suggestions, and even if there was still time to avoid the worst effects of the Great Depression it remains to be seen if an expansionary fiscal policy was viable anyway? Here we return to Borchard’s second question that of political availability. Since the late 1980s there has been a substantial change in theoretical perspective with the introduction of the concept of regime change. The work of Temin on regime change in Germany and the US has clearly shown the importance of clear statements of intentions insofar the general guiding lines of Governmental economic action. If such a dramatic shift occurs and it is properly announced, people would adjust their expectations and therefore change their behaviour. This change of expectations and consequent behaviour is largely irrespective of the actual size and effectiveness of the new policies announced and implemented. If this is the case then a regime change (in this case the announcement that the government now prioritised economic recovery over for example “crypto-inflation targeting”) could have rapidly made investors more willing to invest, consumers more willing to spend, and savers more willing to deposit. The announcement effect has the power to change immediately the economic outlook by virtue of a change in the economic behaviour of the public. In turn the public changes its economic behaviour in expectation of a fundamental change of behaviour on the part of the government. It follows that recovery is only indirectly set in motion by policy implementation, rather than being directly affected by it. In the theoretical framework of a ‘macroeconomic regime shift’ the announcement should not necessarily have implied the introduction of a set of work-creation schemes as the traditional Keynesian prescription would have wanted. The only thing that the Brüning government needed was a well-publicised abandonment of any attempt to balance the budget. On the contrary Brüning remained committed to an orthodox policy of neutral fiscal policies which, given the major contraction in revenues due to reduced economic activity, translated in an equally major contraction of public spending even in conditions that should have been naturally conducive to a more accommodative stance. If the balanced-budget policy had been abandoned - and ‘abandonable’ (and I will explain what I mean by abandonable) - then the continuation of all those policies intended to compress expenditure by reducing salaries, pensions, social welfare, and public building activity and social infrastructure would have largely become unnecessary. Although of little consequence on their own, the very preservation of these expenditure chapters would have allowed the public to change its perspective on the overall direction of the government’s action. Clearly, any announcement of public work schemes, however small in relative terms, would have reinforced the message. Were policies of this kind suggested during the Great Depression? Here the debate has raged about the status of those that proposed such measures in 1930/31. In particular, were they insiders or outsiders in their relationship with government circles? In other words were their voices close enough to those in charge to be heard or were they just part of an indistinct political cacophony in the background of economic policy-making? Holtfrerich argues that a considerable number of reflationary programmes were discussed within and outside the government from the summer of 1931 to the following summer. The fear of hyperinflation was increasingly reduced by the bitter resentment against unemployment and by the other ill effects of continued price deflation. Pressure groups were mostly turning to favour the implementation of some sort of reflationary measure. The message must have reached the government, and therefore, it is the latter that is to blame for not changing its views on how to deal with the crisis. Yet, even if the government had been more receptive to these suggestions, and even if there was still time to avoid the worst effects of the Great Depression it remains to be seen if an expansionary fiscal policy was viable anyway? Here we return to Borchard’s second question that of political availability.

15. Big question: could recovery have been achieved through expansionary policies before January 1933? Decomposes into: 1. Was there an alternative policy? (Or as Borchardt put it the question of technical availability); 2. Was Hitler’s recipe viable to be applied by the Weimar’s governments? (Or as Borchardt put the question of political availability); 3. A question that is not for us here to answer (although it remains in the background): Would more pro-active economic policies by the Weimar governments have saved Germany (and the world) from Nazism?

16. Political availability Independence of the Reichsbank inscribed in the economic constitution of the Weimar Republic since the stabilisation of 1924. This situation had been recently re-stated when the Reichsbank Law had become part of the system of international agreements of the Young Plan on reparations of 1929 ratified by Germany in 1930. What was at stake? German economic recovery in the late 1920s had been based on the access to foreign capital. German debt owed to the US in 1931 = 100% of German GNP = 25% of US GNP. “The menace of our situation lies in the fact that we cannot maintain our balance of international payments out of our own productive force and export surplus, but only by constantly resorting to foreign credits. If the foreign credits should cease or be recalled and we should be unable to maintain the balance by our own strength and normal commerce, then credit restriction and severe shocks to our economics life will be inevitable.” H. Schacht (1931) The main constraint, here is again one of public finances. The avoidance of deficit spending was inscribed in the post-stabilisation economic constitution of the Weimar Republic. A commitment to it was part of the international Treaties signed by Germany in 1924 and strictly linked with the issue of reparations. The maintenance of gold peg of the Reichsmark required balanced budgets. And since the gold peg was one the main conditions under which extensive American credit reached Germany in the late 1920s it follows that the continued availability of foreign capital was dependent on continued German adherence to a policy of fiscal prudence. Let us remind ourselves what was at stake. In 1931 the German debt owned the US was around 100% of German GNP and 25% of US GNP. Indeed as Schacht never ceased to remind the problem was structural: The menace of our situation lies in the fact that we cannot maintain our balance of international payments out of our own productive force and export surplus, but only by constantly resorting to foreign credits. If the foreign credits should cease or be recalled and we should be unable to maintain the balance by our own strength and normal commerce, then credit restriction and severe shocks to our economics life will be inevitable.” H. Schacht (1931) The main constraint, here is again one of public finances. The avoidance of deficit spending was inscribed in the post-stabilisation economic constitution of the Weimar Republic. A commitment to it was part of the international Treaties signed by Germany in 1924 and strictly linked with the issue of reparations. The maintenance of gold peg of the Reichsmark required balanced budgets. And since the gold peg was one the main conditions under which extensive American credit reached Germany in the late 1920s it follows that the continued availability of foreign capital was dependent on continued German adherence to a policy of fiscal prudence. Let us remind ourselves what was at stake. In 1931 the German debt owned the US was around 100% of German GNP and 25% of US GNP. Indeed as Schacht never ceased to remind the problem was structural: The menace of our situation lies in the fact that we cannot maintain our balance of international payments out of our own productive force and export surplus, but only by constantly resorting to foreign credits. If the foreign credits should cease or be recalled and we should be unable to maintain the balance by our own strength and normal commerce, then credit restriction and severe shocks to our economics life will be inevitable.” H. Schacht (1931)

17. Political availability German access to foreign capital was underpinned by the gold peg of the Reichsmark. The peg depended on continuation of prudent fiscal policies and avoidance of deficit spending (enshrined in the international and constitutional legislation of 1924 – 1930) ? This meant that the central bank could not embark on an expansionary monetary policy. Nor it could finance counter-cyclical Government deficit-spending. ? It follows that counter-cyclical policies were only possible if the government was prepared to abandon the policy of fulfilment and cooperation on reparations (i.e. if it was ready to anticipate the confrontational stance eventually adopted by Hitler); Fear of hyperinflation - SPD external support – domestic debt placements unwelcome (as the failure of both the 1927 and the 1929 Government Loans had already demonstrated); Crowding-out of private investments and consumption (Brauns’ Memorandum of May 1931) ? further rise in interest rates; Who could lend Germany the resources to implement counter-cyclical fiscal policies? US and France. But the first was in the midst of a banking and currency crisis in the autumn of 1931. Also private US investment banks unwilling to lend until reparation issue solved. France had large reserves but attached conditions to its lending. To reinforce the macroeconomic regime established in 1924 and avoid inflationary risks, the now independent Reichsbank was barred, by international and constitutional law, from offering extensive credit lines to the government. It could buy only a very limited number of treasury bills and other forms of state debt. Significantly such commitment on the strict separation between government and central bank had been restated when the Young Plan on reparations was agreed upon in 1929 and ratified by Germany as recently as 1930. We therefore find the first two hard constraints to deficit spending. The first one is strictly political. Running a substantial deficit would have contravened the law and the spirit of the framework of international cooperation that had been at the centre of German political action since 1924. It would have meant assuming a confrontational stance on a formally-made international commitment and by doing so strengthening the hand of France over the issue of the rescheduling of reparations. In other words running a deficit was only possible if the government was also ready to get on the path of international confrontation, as the Nazis eventually proved to be. The second hard constraint was of a more technical nature. Financing for deficit spending could not be obtained from the central bank unless the government was prepared to massively curtail the independence of the Reichsbank. Such a move would have certainly been interpreted as openly inflationary by the German public. This does not mean that it was politically unfeasible, but it means that it could only be associated with a complete reversal of the domestic posture on inflation, and an even more emphatic turnaround in foreign policy from cooperation to confrontation. Clearly, deficit spending requires financing, and if it can not be obtained from the central bank without a major upset of the domestic and foreign political background then it could be obtained by placing debt with the public or by obtaining credit lines from abroad. Placing debt with the public was not a viable option. German savers were very wary of subscribing state issues since the experience of hyperinflation. Banks were in the midst of a crisis and in desperate need of liquidity. Foreign savers were fleeing Germany in search of safer investments. Moreover, as the Brauns Memorandum had already noted in May 1931 raising debt to finance public spending would crowd-out private investments and/or consumption with little, if any, additional effect. As for international credit lines in the summer of 1931 the only manner in which they could be obtained was through collaboration between central banks. The Bank of England was unable to help because it was under considerable speculative pressure against the pound, and losing gold reserves at a very fast rate until the pound came off gold in September 1931. The Federal Reserve, although much better stocked with gold, was facing considerable domestic banking distress, and there were serious concerns about the possibility of a run on the dollar. In these conditions a rescue of Germany with US monies would have been exceedingly difficult from a political point of view. Moreover, the FED was unwilling to help Germany if the latter intended to use such help to implement unorthodox fiscal policies in breach of the stability clauses agreed in 1924 and re-stated in 1929. To reinforce the macroeconomic regime established in 1924 and avoid inflationary risks, the now independent Reichsbank was barred, by international and constitutional law, from offering extensive credit lines to the government. It could buy only a very limited number of treasury bills and other forms of state debt. Significantly such commitment on the strict separation between government and central bank had been restated when the Young Plan on reparations was agreed upon in 1929 and ratified by Germany as recently as 1930. We therefore find the first two hard constraints to deficit spending. The first one is strictly political. Running a substantial deficit would have contravened the law and the spirit of the framework of international cooperation that had been at the centre of German political action since 1924. It would have meant assuming a confrontational stance on a formally-made international commitment and by doing so strengthening the hand of France over the issue of the rescheduling of reparations. In other words running a deficit was only possible if the government was also ready to get on the path of international confrontation, as the Nazis eventually proved to be. The second hard constraint was of a more technical nature. Financing for deficit spending could not be obtained from the central bank unless the government was prepared to massively curtail the independence of the Reichsbank. Such a move would have certainly been interpreted as openly inflationary by the German public. This does not mean that it was politically unfeasible, but it means that it could only be associated with a complete reversal of the domestic posture on inflation, and an even more emphatic turnaround in foreign policy from cooperation to confrontation. Clearly, deficit spending requires financing, and if it can not be obtained from the central bank without a major upset of the domestic and foreign political background then it could be obtained by placing debt with the public or by obtaining credit lines from abroad. Placing debt with the public was not a viable option. German savers were very wary of subscribing state issues since the experience of hyperinflation. Banks were in the midst of a crisis and in desperate need of liquidity. Foreign savers were fleeing Germany in search of safer investments. Moreover, as the Brauns Memorandum had already noted in May 1931 raising debt to finance public spending would crowd-out private investments and/or consumption with little, if any, additional effect. As for international credit lines in the summer of 1931 the only manner in which they could be obtained was through collaboration between central banks. The Bank of England was unable to help because it was under considerable speculative pressure against the pound, and losing gold reserves at a very fast rate until the pound came off gold in September 1931. The Federal Reserve, although much better stocked with gold, was facing considerable domestic banking distress, and there were serious concerns about the possibility of a run on the dollar. In these conditions a rescue of Germany with US monies would have been exceedingly difficult from a political point of view. Moreover, the FED was unwilling to help Germany if the latter intended to use such help to implement unorthodox fiscal policies in breach of the stability clauses agreed in 1924 and re-stated in 1929.

18. France’s conditions A formal commitment to continued reparation payments complete with strict compliance with the current reparation schedule; The extremely unpopular request to abandon the project of a duty-union (a zollverein) with Austria. President von Hindenburg (who allowed Brüning to govern in the face of insufficient parliamentarian support by the extensive use of Presidential Decrees – an effective way to avoid Parliament scrutiny) threatened to resign if there was a formal abandonment of the projected zollverein with Austria. Indeed Hindemburg pushed Brüning towards a more anti-French position in early 1931 (see Ferguson and Temin 2001, p. 23). A presidential resignation would have lead to new general elections with a probable further advance of the Nazis. There remained the Banque de France. The French were replete with gold reserves and were in principle willing to help the German government. Yet there was a very steep political price to pay: A formal commitment to continued reparation payments complete with strict compliance with the current reparation schedule; The extremely unpopular request to abandon the project of a custom-union (a Zollverein) with Austria. EXPLAIN the symbolic importance of the Zollverein.   The second request was particularly difficult for a nationalist government that was facing the astonishing rise of the national socialists. Abandoning the policy of custom-union to get the French money would have also prompted the resignation of the President von Hindenburg on whose personal support the Bruening government relied for its survival. Indeed the result of such a resignation would have been in all probability new general elections with probable further advances by the Nazis. There remained the Banque de France. The French were replete with gold reserves and were in principle willing to help the German government. Yet there was a very steep political price to pay: A formal commitment to continued reparation payments complete with strict compliance with the current reparation schedule; The extremely unpopular request to abandon the project of a custom-union (a Zollverein) with Austria. EXPLAIN the symbolic importance of the Zollverein.   The second request was particularly difficult for a nationalist government that was facing the astonishing rise of the national socialists. Abandoning the policy of custom-union to get the French money would have also prompted the resignation of the President von Hindenburg on whose personal support the Bruening government relied for its survival. Indeed the result of such a resignation would have been in all probability new general elections with probable further advances by the Nazis.

19. Conclusions In summary, one has to conclude that deficit spending in the summer of 1931 would have had profound political implications. In practice it would have been possible only had the government decided either on complete compliance (almost surrender) to the French position on reparations, or if it had chosen the path of default on reparations and open international confrontation. In both cases it was the Gordian knot of reparations that had to be dealt with to implement the suggested alternative responses to the Great Depression.

20. Abandonable? In the event the Nazis went for default and repudiation of reparations with its corollary of increased international tension and eventually war. It is by no means clear that the alternative proposed in a Great Depression counterfactual would have not lead to similarly unsavoury consequences.

21. A postscript. What determined the crisis of May – August 1931? Two sides: Those that see the crisis of 1931 as eminently ‘Political’ (see for example Temin 2008). Crisis precipitated by the attempt of the Brüning government to shore-up its fledging political support by taking a less co-operative stance on the issue of reparations. This proves a tactical political success (the government survives a vote of no confidence in June) but a strategic disaster as it precipitates a currency crisis that eventually kills any hope of recovery and any hope of a democratic solution to the German Great Depression; Those who stress the peculiar instability of the German banking sector in the late 1920s and early 1930s (see for example James 1984 and most of the more recent literature); For this debate see my second lecture on banking in the Lent term.

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