After the Nazi Party took control of the German government, the government wanted to rearm its country and kickstart its country’s commercial activity, which had slowed to a halt in the wake of the Weimar Republic’s hyperinflationary period followed by the Great Depression. However, under the terms of the Treaty of Versailles, Germany was not allowed to rearm, and the country was kept under close surveillance by the United Kingdom and France. As such, the German government could not borrow large amounts of money from the money market (e.g. through the sale of government bonds), as doing so would attract attention from its rivals; if the German Reich were to borrow these large sums of money, the United Kingdom and France would be the first countries to notice and would pay close attention to what the government planned to do with these funds.
The head of the German central bank (the Reichsbank) in the 1930s, Hjalmar Schacht, devised a way for the German government to raise funds without attracting the attention of its rivals through the creation and issuance of MEFO bills. Essentially, Schacht created a fake company, the Metallurgische Forschungsgesellschaft (Metallurgical Research Corporation), which is abbreviated by the acronym “MEFO.” This corporation was a legal entity that comprised solely of a balance sheet, which issued bonds called “MEFO bills,” a form of debt that the German government guaranteed, but the bonds were technically trade bills and not government bonds. These MEFO bills carried a higher-than-market interest rate of 4% and could be converted to Reichsmarks at any point, but they could also be perpetually extended by the issuer in order to postpone the conversion of these notes into Reichsmarks. As such, these bills acted as a means of exchange between the German government and armaments contractors, but they neither raised suspicion from the British and French governments, as they were issued through a corporate entity, nor did they cause inflation since the conversion to Reichsmarks, an act which would increase the money supply, because bondholders would prefer to save the notes and collect the interest rate rather than convert them to cash.
About half of the MEFO bills were converted to Reichsmarks, a conversion which could theoretically cause inflation even if the full effects weren’t realized. As such, you may be wondering if the MEFO bills caused inflation or rises in the price level of the German economy. Given that Nazi Germany was not a free market economy, prices were tightly controlled by a price commissar, which enforced a kind of “price discipline” that prevented a rising price level. However, inflation can also be observed through other effects, not just the rise in price level – in the case of Nazi Germany, shortages were rampant (and continued to rise in severity as the war continued). So while on the surface, these MEFO bills appeared to be effective forms of monetary policy as they enabled the government to run a much larger deficit without experiencing a rise in price level, the inflationary effects of the MEFO bills were observed through shortages, not through a rising price level. Thus, these bills were ineffectual at preventing economic collapse without going to war or liquidating assets from the Jews (and even with these actions, still failed to backstop the effects of an inflating money supply).
While Schacht’s primary intention was to kickstart economic activity in Depression-era Germany, the byproduct of his innovation was the creation of a clandestine way for the German government to pay armaments contractors to restart production of military equipment (Hitler’s regime didn’t necessarily have to use the MEFO bills to finance armaments manufacturing, as this money could have been used towards infrastructure, education, etc., but this would have been contrary to the Nazi Party’s paramount goal of creating lebensraum for the Aryan race). The devastating consequences of this financial innovation were actualized by the German Reich’s militarism, which led to the Second World War. As such, this clandestine method of raising government funds, coupled with an unusually low rise in price-level in Nazi Germany, made the issuance of MEFO bills one of the more consequential policy innovations of the 20th century. By allowing the German Reich to effectively double its deficit spending without attracting the attention of its rivals, these MEFO bills enabled the German war machine to re-establish itself, skirt the Treaty of Versailles, and commit some of the worst atrocities in history. However, the case of MEFO bills may also provide more contemporaneously relevant insights, given the current global economic climate.
Characterized by the emergence of a new, decentralized, crypto-based money supply and a rising price-level of goods and services denominated in the world’s reserve currency (the US dollar), the monetary landscape of 2022 is a strange place, although not completely surprising. In an effort to backstop economic decline resulting from the ongoing pandemic, central governments around the world provided increased amounts of stimulus to corporations, businesses, and households by way of printing money. Further, the ongoing innovations in cryptocurrency have created a decentralized means of facilitating the exchange of goods and services. In this environment, where a whole space of currencies exists outside the regulation of central banks and can be used to facilitate the exchange of goods and services outside the scrutiny of global policymakers, a natural question is to wonder what the interaction effects between cryptocurrencies and the traditional money supply would yield for the world.
When the money supply is much greater than output or production in an economy, the price level can be expected to rise – this is the primary cause-and-effect relationship between currency in circulation and price level, which we normally summarize as inflation. In general, inflation, which manifests as a rising price level of goods and services, is not necessarily bad since improving the output in a country for a given year usually means the economy is growing, workers are becoming more productive, and consumer purchasing power is rising. However, unchecked inflation, especially in periods of growing economic inequality, can result in the general depreciation of quality of life: businesses incur different inflation-specific costs (shoe-leather, menu costs), consumers experience shortages and diminished purchasing power, and society experiences a general breakdown of order in response to growing discontentment towards the rising cost of necessities. As such, the primary mandate of most central banks is to control inflation (along with unemployment), as to reduce the social consequences that stem from a rampantly rising price level.
With respect to the case of MEFO bills, where money was created in a clandestine way that enabled the Nazi government to rearm, cryptocurrencies, as long as they are used as a means of exchange for goods and services, provide a similar means of facilitating private activity. While the ledgers of transactions of a cryptocurrency are usually public, they provide the infrastructure necessary to enable balance sheets to ensconce their assets and liabilities much more easily. Additionally, the money supply of most cryptocurrencies is not “tied” to the non-digital productive capacity of a region or network nor are they backed by any physical assets (e.g., gold), which lends itself to a more complicated rate of inflation. As such, the current macroeconomic environment is complicated by the entrée and popularization of cryptocurrencies, and I am personally unsure of how to make a prediction of what will happen next based on traditional monetarist or macroeconomic models.
The two vectors of complexity—(1) the ability to ensconce or hide transactions through cryptocurrency and (2) the impact on global money supply through cryptocurrencies—make the current inflationary situation different from a traditional macroeconomic model. As such, I am currently wrestling with a few key questions to investigate as the ongoing situation unfolds:
1. What is the impact of cryptocurrencies on inflationary effects?
2. Will a currency that exists outside of a nation’s central bank exacerbate shortages, or could it serve as a stable stand-in that would allow prices to remain level?
3. How will arbitrages between cryptocurrencies and fiat currencies be affected?
4. Will governments or businesses use cryptocurrency to facilitate clandestine fundraises or credit expansions?
5. Will governments print money (via open-market operations, for example) for the express purpose of retaining reserve cryptocurrency?
6. How do traditional macroeconomic tools such as quantitative easing or forward guidance fare when wealth is being banked in cryptocurrency, which cannot be centrally regulated?
7. Can cryptocurrencies stabilize economies that are prone to hyperinflation and provide a means of facilitating the exchange of goods and services when the macroeconomic health of an economy is shocked?
Each question would require its own article in order to unpack the different possible outcomes, but together they capture the scope of my macroeconomic observations over the coming year.
Altogether, the MEFO bills case proved that a nation’s money supply can be manipulated much more flexibly than one might expect to be possible in order to achieve short-term political goals, even without the use of sophisticated technology. As such, with the growing credibility of alternative currencies to traditional national currencies, as well as the rising price level of goods denominated in the global reserve currency (the US dollar), the scope of potential credit and monetary innovations can be expected to increase in response to these conditions as well. Only time will tell in the coming years if these innovations will make economies more productive, stable, and efficient, if they will unravel the existing credit systems into an anarchic banking environment, or if they will have some previously unpredictable effect on global welfare.
A very detailed and informative article.