The Brüninger obsession 10-16-2008
Many believe that the ECB’s rigorist approach is justified by Germany’s fear of going through a period of hyperinflation like that which led to the Nazis coming to power.
However, this reasoning is historically way off base.
Hyperinflation is not what sunk the German economy but one of the most violent phases of deflation in the history of the XXth century.
At the time, Chancellor of the Reich Mr Brüning (1930-1932) insisted on plunging the entire world into deflation via huge salary cuts (20-25% in 1930), re-launching the export machine (thus exporting deflation) in order to bring German salaries back to the levels of 1913.
This, along a competitive 20% devaluation of the Reichsmark (prepared in secret) would have allowed him to negotiate a moratorium or a suspension of war debts (reparations) that the Reich owed its former enemies.
With the complicity of Reichbank President Herr Luther, he also prevented credit growth, rejecting the plan proposed by the “List” think tank of which both Lautenbach (cabinet director of economy minister) and Luther himself. This plan proposed a government debt issue of 1.5bn marks to finance credit lines for businesses, re-discountable with the central bank (multiplier effect).
All that may be more relevant today than one might think at first glance.
If Central Banks must error, it would be better to error on the side of lower rates, and then quickly increase them if inflation starts taking off again, rather than running the risk of a deflationary spiral due to a Brüninger like obsession with wage levels, “à la ECB”.
As such, we continue to favour government fixed-income instruments, which will either benefit from ECB rate cuts, or from a flight to quality fuelled by a deflationary explosion.
As such, the situation on stock markets is increasingly fragile.