Inflation and the Velocity of Money – Lesson from the Weimar Republic


wealthymatters.comInflation in the beginning is like a drug, sort of a good feeling in the economy to start with because there are more jobs, more goods, house values are increasing, the stock market rises, etc.  It isn’t until the money velocity accelerates that you begin to feel that something is wrong.  And that’s when everybody begins running faster and faster just to keep up.

Velocity of money is the turnover of money in the economy.  As you start printing more money the depreciation of a currency begins, more money goes into circulation, but not all of it gets turned over very rapidly.  Some of it goes into foreign hands, like when Germany had to buy imported goods for war materials.  Also, some people may decide to hold onto the excess currency like they did during the war, hoarding cash which also kept the money velocity low (in the beginning stages).  So even though the supply of money was increasing in the economy and along with it the cost of goods and services, Germans were savers, saving the marks that they got which kept this increasingly large quantity of money moving slow, therefore building up the inevitable effects of inflation but delaying the impact.

During the last months of the great inflation (at its worst), there was a direct correlation between the quantity of money in circulation, it’s exchange value with the US dollar (which was the main currency still backed by gold at the time), and a direct relationship between wholesale prices and inflation.  In other words, if the money supply increased 10% in a week, the price of goods would increase 10% in a week and the value of the currency would drop by 10% in a week.  Eventually the people began catching on to what was going on in the country and they started getting rid of the currency, pulling it out from under their mattresses to buy something with it, to somehow dump it back into the system, realizing it’s increasing worthlessness, which further increased money velocity.

By 1921 and 1922 money velocity really started to pick up and by 1923, money velocity just went through the roof – the end or terminal stage of the great inflation.

Hope something like this never happens in our lifetimes.But if it does, remember this story and react fast!

About Keerthika Singaravel
Engineer,Investor,Businessperson

6 Responses to Inflation and the Velocity of Money – Lesson from the Weimar Republic

  1. jefferysikes says:

    Few people understand the velocity of Money and fewer still understand the currency by Government Fiat (Fiat currency) finds its value in transactions which take place in its name, relative to the velocity of the currency supply. Spreading transactions across a larger and larger pool, reduces velocity. Reducing both the transactions and increasing the pool of fiat currency results in a vastly deflated Fiat currency value. The Weimer republic was a prime example of this effect as was the loss by the British of the reserve status of the pound.

    America is headed straight into the the perfect currency storm today.
    1) Americas money velocity (M1) is at the same level as it was in Q4 1975 (6.2)
    2) In Jan of 2007 the velocity of Americans Fiat currency was 10.5 (a 40% reduction).
    3) The actions in the Middle East have Saudi and Kuwait surrounded by Russian/Iranian allies which is threatening the control of Saudi and Kuwait oil.

    Americans need to be mindful that all Saudi and Kuwait oil transactions (about 5 – 6 trillion or 1/2 the current money supply) take place in American dollars. If those transactions were to go to another currency (say a BRICS currency) then Americas currency velocity would be cut in half or worse, putting America into territory it has not seen since the depression of the 1930’s. There would be no instant fix as, monetizing (increasing the money supply) would only exacerbate the problem.

    • A very interesting comment Jeffery. Thanks. You increased my understanding of the topic.
      We can’t totally disregard the scenario of the oil producing countries choosing to be paid in a BRICs currency. But I don’t see that happening unless each of these countries’ economies strengthens multi-fold and/or there is some major geo-political shift in the power equations of the world.
      I am Indian, so by default, I do most of my day to day transactions in Indian Rupees. But I don’t like the way it is weakening against the USD.I have export earnings in Roubles, but I choose to get paid in USD not Roubles, despite the existence of the Rupee-Rouble trade. I don’t like the Russian’s lack of commitment to honouring their debts and their tendency to try to use the defence card to screw us Indians on trade.
      I know of friends who export to China. But they too are careful to take payment in USD and not park money in Yuan for any length of time. Similar is the case with the Brazilian Real.
      Sure occasionally we will trade with the Iranians, who will accept payment for oil and gas in Rupees. But most of us like Euros and Dollars.
      There is historic precedence of India demanding to be paid in Gold and not debased Roman coin. The Arabs share a long trading history in India and have a similar attitude towards currency.
      The USD has its defects, but its still perceived as the best bet we have today. If trade in Dollars becomes impossible, barter as India has with Iran /Iraq or payment in bullion are the more likely choices.
      All the talk about the BRICs creating an alternate means of doing international trade is at the government level, not the preference of the common people.
      Indians are more likely to accept payment in bitcoins.
      But any of these scenarios will still leave ordinary Americans with a big problem……..

  2. zap197842 says:

    thanks

  3. Pingback: Don’t Get Too Used To Your Money « Wealthymatters

  4. Vera says:

    I think other site proprietors should take this site as a model; very clean and wonderful design as well as good content. You are an expert in this topic!

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