Schacht's policies: More harmful than helpful?

Discussions on the economic history of the nations taking part in WW2, from the recovery after the depression until the economy at war.
HistoryGeek2019
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Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 13 Jan 2020 23:04

Hjalmar Schacht is usually lauded as a financial/economic genius who enabled Hitler to carry out rearmament in the 1930s without causing hyperinflation. But is this really true?

Schacht is generally known for two key policies: (1) MEFO bills and (2) foreign exchange controls. MEFO bills served a variety of purposes, but the main one was to keep the extent of Germany's rearmament secret because they were not part of Germany's official spending/budget. But this post is intended to focus on Schacht's other major policy: foreign exchange controls.

Adam Tooze describes Schacht's foreign exchange policy as follows. First, Schacht maintained the government's tight control of foreign exchange that was imposed by his predecessor:
However, from the summer of 1931 onwards private holdings of foreign currency in Germany were nationalized. Any resident who received foreign currency in any form was required to exchange it for Reichsmarks provided by the Reichsbank. Anyone requiring foreign currency could obtain it only by application to the Reichsbank and all such applications were subject to severe rationing. Foreign currency was allocated to importers as a fixed percentage of the volume of their foreign transactions in the twelve months prior to the crisis. The Reichsbank thus acquired a direct means for regulating all imports to the German economy.

Tooze, Adam. The Wages of Destruction (p. 20). Penguin Publishing Group. Kindle Edition.
Schacht then sought to increase the government's centralized control of foreign trade:
At the end of 1931 he put before some of Germany’s leading industrialists a new trade plan. Using an organization reminiscent of that employed during World War I, all German imports would be subject to central control. They could then be used to force those countries supplying Germany with goods, to accept at least equal quantities of German exports.

Tooze, Adam. The Wages of Destruction (pp. 28-29). Penguin Publishing Group. Kindle Edition.
And again:
The Reichsbank would allocate the available foreign exchange on the basis of the export returns. It would reserve the funds required to make agreed debt repayments and to ensure that Germany could meet its short-term obligations. The remainder would then be handed to a group of supervisory agencies, twenty-five in total, one for each major class of commodities. The proposal that Schacht had originally drafted in 1932 for import monopolies modelled on those of World War I, was modified to provide for a greater degree of decentralization and private initiative. The supervisory agencies would not themselves engage in the import trade. Their job was to sift applications for foreign currency from private importers and to allocate the limited funds according to their national priority. Top priority, it was clear, was to be given to exporters and to suppliers to the armaments effort.

Tooze, Adam. The Wages of Destruction (p. 90). Penguin Publishing Group. Kindle Edition.
Tooze summarizes: "Under the pressure of the balance of payments problem and the refusal to devalue, Schacht was imposing a system of ever more comprehensive bureaucratic control on the German economy and on German business."

The reason for Schacht's tight control of foreign currency was Germany's refusal to abandon the gold standard or even to devalue the Reichsmark. Contrary to the long-running Nazi party commitment to abandon the gold standard, Schacht partnered with Hitler to keep the Reichsmark at its existing value as a sign of national prestige, to prevent dreaded hyperinflation, and supposedly to make it easier to repay Germany's foreign denominated debts.

It seems to me that Germany would have been better served by abandoning the gold standard and eliminating the government/Reichsbank's mandatory hoarding of all foreign currency. When Hitler came to power in 1933, inflation was not a threat to the economy. Deflation was the problem in the economy. It is by now accepted economic policy that anti-deflationary measures should be sought when a country is going through a recession/depression.

As for repaying foreign debts, Germany wasn't able to repay them even with Schacht's tight foreign exchange controls. Germany was perpetually short of foreign exchange throughout the 1930s. Schacht and his apologists blame this on Hitler's vast armaments expenditures eating into goods manufactured for export, but that is viewing the economy as fixed sum from a centralized, bureaucratic approach. A better approach would have been to allow the Reichsmark to float freely (as Britain did with the Sterling in 1931) and allow private individuals and businesses in Germany to hold and spend foreign currency as they saw fit. This free-market liberalization would have allowed the private sector to find appropriate sources of foreign currency and export opportunities.

This has parallels with German armaments production, which was managed by government bureaucrats who followed Schact's economic policies, such as Georg Thomas. The government was obsessed with preventing "war profiteering" so it tightly regulated the production of armaments and Thomas controlled allocations of raw materials to each service. When Germany finally abandoned this bureaucratic management of arms production in 1942, production soared.

The same thing arguably would have occurred if Germany had abandoned Schacht's hyper-regulation of foreign exchange and abandoned the gold standard in the early 1930s. Private businesses would have found the foreign markets and currency they needed. Germany would have had to default on its foreign loans, but that was a foregone conclusion in any event, and France and Britain had already done the same on their American loans.

The issue is that once Germany came close to full employment, military spending would have been limited by the free-market sector of the economy. Germany arguably would not have been able to spend as great a portion of its economy on the military, but the economy as a whole would likely have been bigger. Germany also would not have been desperately short on foreign currency, which is what prompted (in part) the annexations of Austria and Czechoslovakia and perhaps even Poland.

Thoughts?

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Re: Schacht's policies: More harmful than helpful?

Post by GregSingh » 15 Jan 2020 03:33

Only a decade ago Germany managed to quash hyperinflation which devastated middle class and only 3-4 years have passed since collapse of banking system in much of the Europe.
How popular among the German population do you think would be a decision of a new Hitler's government to remove Germany from partial gold standard and to start officially money expansion ?
It was not about doubtful long term benefits to the economy, but more about trying not to damage confidence in the new government. We have to remember that confidence is easily lost, but quite difficult if not impossible to regain. Also our hindsight is not helping here.
If we become increasingly humble about how little we know, we may be more eager to search.

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Re: Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 15 Jan 2020 04:54

Since the Nazi party was publicly committed to dropping the gold standard and was the largest party in the Reichstag, it would have been at least as popular as any other political proposal in 1930s Germany.

Hitler likely was afraid of dropping the gold standard, since he didn't understand international finance and the idea of having the currency backed by gold sounded like a way to make the country's currency (and therefore the country) strong. But it sounds like Schacht was interested in accumulating as much power over the economy (and therefore the country) for himself as possible. Hitler needed Schacht in his coalition in the early years of his government, but by the time Schacht's monetary policies had painted Germany into a corner and required Germany to annex Austria and Czechoslovakia just to get the currency needed to finance Schacht's foreign exchange system, Schacht was essentially let off the hook for the war by exiting from the scene.

Schacht also ruined Germany's trade relationship with the United States and turned Germany into a competitor with the United States for Latin American markets, giving the United States yet another reason to oppose Germany in the war.

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Re: Schacht's policies: More harmful than helpful?

Post by Gorque » 15 Jan 2020 11:19

Smoot-Hawley anyone? Bueller? Bueller?

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Re: Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 15 Jan 2020 17:29

The Reciprocal Trade Agreements Act of 1934 anyone? Bueller? Bueller?

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Re: Schacht's policies: More harmful than helpful?

Post by Gorque » 15 Jan 2020 18:55

Say boys and girls...what came first; Smoot-Hawley or the Ricprocal Trade Agreements Act. Come on now, what number is smaller, 1934 or 1930?

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Re: Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 15 Jan 2020 19:59

If you have a substantive point to make, why don't you just say what it is.

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Re: Schacht's policies: More harmful than helpful?

Post by Georg_S » 15 Jan 2020 22:32

Hello

According to AHF:s rules, we demand that every One stay polite to each other. Even egen you disagree you don't have to be Rude.

"The first rule of the forum is: "No insults are tolerated (that includes serious national and religious insults)." Personal remarks in posts are strongly discouraged, and personal insults are forbidden here."

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Re: Schacht's policies: More harmful than helpful?

Post by Gorque » 15 Jan 2020 23:44

HistoryGeek2019 wrote:
15 Jan 2020 19:59
If you have a substantive point to make, why don't you just say what it is.


I did and I tried to use humor to make it. Sorry my humor failed you. Moving on.

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Re: Schacht's policies: More harmful than helpful?

Post by Gorque » 15 Jan 2020 23:46

Georg_S wrote:
15 Jan 2020 22:32
Hello

According to AHF:s rules, we demand that every One stay polite to each other. Even egen you disagree you don't have to be Rude.

"The first rule of the forum is: "No insults are tolerated (that includes serious national and religious insults)." Personal remarks in posts are strongly discouraged, and personal insults are forbidden here."

Regards
Georg
Message received loud and clear.

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Re: Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 20 Jan 2020 20:00

Germany's monetary policy was unique in the 1930s. It was the only country that kept the gold standard, refused to devalue, and implemented a highly regulated system of foreign exchange control:

German foreign exchange policy.png
Source: Barry Eichengreen and Jeffrey Sachs, Exchange Rates and Economic Recovery in the 1930s, The Journal of Economic History
Vol. 45, No. 4 (Dec., 1985), pp. 925-946.
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Re: Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 20 Jan 2020 20:15

Schacht's massive regulatory bureuacracy extended not only to foreign exchange controls, but to virtually all capital investment in Germany. According to Martin Wolfe, the Reich Credit Law of December 1934 gave Schacht complete control over the policies of all banks, insurance companies, and mortgage institutes. Every large loan was subject to approval by a government official, and companies seeking to invest in new plant were required to obtain government approval. To issue new securities in the capital markets, a government permit was necessary, and Wolfe writes that these were rarely granted. (Martin Wolfe,The Development of Nazi Monetary Policy, The Journal of Economic History, Vol. 15, No. 4 (Dec. 1955), pp. 392-402.

To get a sense of the size of the bureaucracy Schacht created, Adam Tooze notes that the German government/Reichsbank employed 18,000 administrators and clerks to manage foreign exchange controls, and private companies were forced to hire thousands more to manage their compliance with government regulations.

Thus, the Third Reich's economy can best be described as a "bureaucratic regulatory state" rather than a free-market capitalist state or a communist or socialist state. Private enterprises were allowed to own capital and produce goods and services, but they were subject to intense government regulation.

This bureaucracy pervaded the armaments industry as noted above, such that army bureaucrats monitored and regulated arms production, producing such inefficiency in production that the Ministry for Economics State Secretary Landfried suggested in 1942 that the best thing Germany could do to boost arms output would be to send half the staff of the armaments inspectorate to the front. (Bernhard R. Kroener. Germany and the Second World War: 5 (Germany & Second World War) . OUP Oxford. Kindle Edition.)

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Re: Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 21 Jan 2020 22:43

This table, perhaps more than any other, shows how just how bad the Nazi/Schacht foreign exchange policy was:

International Gold Reserves 1930s.png

It is often suggested that one of the main reasons Hitler annexed Austria and the Czechs, and invaded Poland, was to get more foreign exchange and gold reserves. This table suggests there is a lot of merit to that theory.
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Re: Schacht's policies: More harmful than helpful?

Post by TheMarcksPlan » 22 Jan 2020 03:43

Thanks for this thread, I hadn't realized the extent to which Germany's financial/monetary strategy was singular for the pre-war period, not even from reading Tooze, who harps on this point quite a bit.
HistoryGeek2019 wrote:This bureaucracy pervaded the armaments industry as noted above, such that army bureaucrats monitored and regulated arms production, producing such inefficiency in production that the Ministry for Economics State Secretary Landfried suggested in 1942 that the best thing Germany could do to boost arms output would be to send half the staff of the armaments inspectorate to the front. (Bernhard R. Kroener. Germany and the Second World War: 5 (Germany & Second World War) . OUP Oxford. Kindle Edition.)
Idea for a research agenda:

There remains considerable controversy over the characteristics of the German war economy. Was it under-mobilized until too late? That view once prevailed but has largely been undercut. Was it inefficient? Most serious commentators say yes, though they disagree over the magnitude and causes of inefficiency and of later efforts to improve efficiency. In this article, HistoryGeek2019, using previously-available but under-remarked archival documents, will show that inefficiency in arms production was representative of inefficiency in the broader economy stemming from excessive bureaucratic regulation motivated by a singularly counter-productive monetary policy. Whereas previous commentators have emphasized a supposed Prussian insistence on needlessly high quality standards for Army products, our view is that standard institutional studies concepts regarding bureaucracy and its self-reinforcement better explain the German war economy's under-performance in World War 2.

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Re: Schacht's policies: More harmful than helpful?

Post by HistoryGeek2019 » 22 Jan 2020 04:19

TheMarcksPlan wrote:
22 Jan 2020 03:43
Thanks for this thread, I hadn't realized the extent to which Germany's financial/monetary strategy was singular for the pre-war period, not even from reading Tooze, who harps on this point quite a bit.
HistoryGeek2019 wrote:This bureaucracy pervaded the armaments industry as noted above, such that army bureaucrats monitored and regulated arms production, producing such inefficiency in production that the Ministry for Economics State Secretary Landfried suggested in 1942 that the best thing Germany could do to boost arms output would be to send half the staff of the armaments inspectorate to the front. (Bernhard R. Kroener. Germany and the Second World War: 5 (Germany & Second World War) . OUP Oxford. Kindle Edition.)
Idea for a research agenda:

There remains considerable controversy over the characteristics of the German war economy. Was it under-mobilized until too late? That view once prevailed but has largely been undercut. Was it inefficient? Most serious commentators say yes, though they disagree over the magnitude and causes of inefficiency and of later efforts to improve efficiency. In this article, HistoryGeek2019, using previously-available but under-remarked archival documents, will show that inefficiency in arms production was representative of inefficiency in the broader economy stemming from excessive bureaucratic regulation motivated by a singularly counter-productive monetary policy. Whereas previous commentators have emphasized a supposed Prussian insistence on needlessly high quality standards for Army products, our view is that standard institutional studies concepts regarding bureaucracy and its self-reinforcement better explain the German war economy's under-performance in World War 2.
Unfortunately I don't know German, so someone else would have to take up that endeavor.

I recently finished DRZW Volume V I, which makes a good case that low output was due to both the massive bureaucratic regulatory apparatus and Funk's policies at the Ministry for the Economy, which sought to retain as much production of consumer goods as possible.

If I had to guess, I'd say the regulatory bureaucracy was the greater problem. There was no need for it, other than to make Schacht and Thomas feel important. The correct approach would have been to just tell the largest private firms what the army needed, and let them mass produce it. There was no need for Georg Thomas to be controlling steel allocations. That's what the price system is for.

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