Learning from History

Between 1850 and 1914, world trade grew tenfold. The trend was driven by several factors: faster and bigger ships, transcontinental railways, and the establishment of international news and information systems, most prominently the telegraph, telephone and international press agencies. Furthermore, the leading industrial nations based their currencies on gold. Banks and investors had a high level of trust in the leading currencies, resulting in flourishing cross-border investments. Foreign exchange transactions where predictable as the gold price was internationally fixed and bills could be easily exchanged into gold.

Then, on August 1st, 1914, World War I broke out.

Several nations entangled in the war had to cease the backing of their currency through gold as their gold reserves were simply not large enough to cover the cost of war. The money printing machines started to work overtime.

After 1918 and the end of WW I, the powers in the world changed dramatically. Central Europe suffered substantial destruction and had lost over 16 million people with an additional 21 million wounded. France and Britain had significant liabilities with the United States as they financed the war largely through debt.

The democratically elected politicians on both sides of the isle are well advised to change their communication patterns to become more consistent and concrete, less Pathos and, above all, less aggressive and more to the point. Admittedly, this requires both parties to find some common ground on the issues at hand. Looking at history is a useful tool which can replace ineffective and unproductive hostility with experience, knowledge and an educated decision which can be intellectually communicated to the public.

While Germany also borrowed heavily to fund the war, the Treaty of Versailles, signed in May 1919, had a determining impact on the monetary policy of the country. It dictated the payment of substantial punitive reparations, well in excess of the country’s total gold and foreign exchange reserves. As the European economies were shattered, they had to buy goods and food from the United States, payable in cash. The US economy grew sharply. Germany, one of the leading economies in Europe, had to further pump money into circulation to service its debt and reparation obligations.

Germany went into a state of Hyperinflation.

On July 1, 1914, one US dollar was worth 4.20 Reichsmark. By the summer of 1921, the value was at 100 Reichsmark. In June of 1923, the value of the U.S. dollar skyrocketed to 150,000 Reichsmark, and shortly after, on November 20, 1923, it reached 4.2 trillion Reichsmark.

That was the day when the Reichsmark ceased to exist.

It was replaced by a new currency, the Rentenmark. With it came a new administration and a massive reduction of debt. But large parts of the population had lost everything – the nation became poor.

This was the brewing ground of one of the darkest periods in the history of mankind.

There are some striking similarities to current times. First, an exponential increase of international trade. Then, the financing of two major wars through debt. Third, an economic collapse of global proportions and, with it, substantial unemployment. Fourth, major deficit spending and a significant influx of fresh money on the market.

What can we learn from these historic events?
To what extend could history repeat itself?

Let me say this first: I do not believe that the United States and the world are heading into a hyperinflation or the devastating political landscape we experienced in the 1930’s and the first half of the 1940’s. For that, our capital markets are too strong; our democratic establishment is too deeply rooted and, after all, the economic downfall not steep enough. But we are left with the understanding that we can produce our economic output with a reduced workforce. This results in social disparities and political pressures. It inadvertently affects our social order. We also need to comprehend that our debt has reached “code red” levels and the proposals in discussion to reverse the spending trend and reduce the nation’s debt are homeopathic. We will have to make unpopular decisions and we will have to manage the effect on people’s confidence and therefore consumption. Furthermore, we are increasingly entangled in an international dispute regarding the re-balancing of the international trade to strengthen domestic output.

Implications on the Political Landscape

As the Republicans and Democrats fight over the right course to solve the issues at hand, significant parts of the population are suffering from a devaluation or loss of assets, increased personal debt, and unemployment. They are focused on their personal problems and look for leaders who promise to solve them quickly. This is an incubator for extremism, either from the left or the right. When looking at Germany’s political development during the 1920s, we can study how the suffering population was open to almost any grouping which promised a way out of misery. This allowed extremist right and left-wing thinking to be initially tolerated and, later, welcomed by the public. The democratic parliament was crushed between the push from the right, the NSDAP, and the communist left, the KPD.

While I do not see any such development reoccurring, we find the political establishment busy with a rather unproductive political Stellungskrieg, a positional warfare, while in its wake moderately extreme groupings are emerging and growing in popularity. It is time that we take certain measurements to reduce public debt, increase domestic output and consumption, and prepare the country for a new international balance of power where China is the global powerhouse along the United States. The key to acceptance and success of major political decisions is the management of the public’s opinion.

Implications on Managing the Public Opinion

Public perception determines the political process which affects the economic health of a country. Perception is reality and the careful management of the public opinion is a crucial element to the success of any political action.

Let’s look back to the 1920’s when mass media was in its infant shoes. The radio was the first platform which delivered any real time information to a disperse mass audience. Otherwise, newspapers and magazines were the main source of information. At the time, the media in Germany was largely controlled by Alfred Hugenberg, a right-wing extremist par excellence. He misused his media power to influence and infiltrate public perception which supported the brewing ground for fascism. News was replaced with hate-filled propaganda.

As times are very different today, I do not see the risk of repetition. But we are faced with a polar-opposite situation where virtually everybody can easily express his or her opinion using the digital space, at little or no cost. We have an abundance of message outlets in all disciplines: print, television, radio, and digital. There has never been a time where we consumed more “news” than today.

The risks of a controlled media environment versus a freely available mass communication platform are similar in certain ways. In times of hardship, people look for solutions which, over time, can lead to a change or loss of the person’s view and value system. Every time the leading democratic parties are occupied with their territorial battles, people look for other places to find solutions. Every time eloquent political statements are made without adequate substance and a clear path of “who, when, what, and anticipated costs, funding and results”, people lose confidence and look for alternatives. During the past election, the country did not primarily look for change, they were searching for leadership.

The current public relations work of both major political parties is weak, which creates a message vacuum to be happily filled by groups with extreme views, to whatever degree and with whatever color. They can reach the masses cheap, quick, constantly and in real-time.


Implications for the Economy

As in the 1920’s, we are looking for ways to reduce unemployment. To shift the production / consumption equilibrium upwards, we increasingly look at an old strategy: Protectionism and a push for other industrial nations to alter their fiscal policies to improve our domestic economy.

The world has changed in that we have never been as dependent on each other as today. The global market place is a reality and it is erroneous to believe that protectionism, to any degree, is an instrument to tackle the problems.

We must understand that we have changed the substance of our economies.

Largely driven by volume consumption and the correlated price pressures, over the past decades, we changed the relative composition of our economic sectors. While Germany maintained its strong roots of industrial production and export of goods, the United States has largely abandoned industrial output and transferred this sector initially to NAFTA states and, during the last decade, predominantly to Asia with China at the core. The US has become a service industry dominant economy where technology is at the center of gravity. In that respect, it is noteworthy that the country is facing a major education issue. We increasingly import brainpower with our technological advancements driven by foreign scientists and engineers. They are attracted by financial incentives and a higher standard of living compared to their home countries. As America weakens and other nations have an increased need of intellectual talent, we will see the attractiveness of location shifting. The educational system and implication on the future is a substantial topic which requires a separate discussion.

Looking back at the early 1930’s, when President Roosevelt launched the “New Deal”, unemployment was predominantly battled through public projects such as the electrification of the Tennessee valley. The idea was twofold: in the short-term it created jobs; in the long-term it improved the territorial infrastructure which creates or strengthens the competitiveness and attractiveness for the private sector. Hence, the public sector is an incubator for employment while sustainability is provided by the private sector. Beside the issue of education and the implications on innovation, we need to rethink our approach to economic sector composition. China has become the industrial workbench of the Western Hemisphere fueled by our domestic pricing and profit pressures with cheap Chinese labor being the remedy. Furthermore, China had little to no regulation on safe and ecologically responsible production processes which provided further cost advantages. We transferred whole industries, technology, and product knowledge. As the world exponentially increased the purchase of products made in China, jobs were created, hard currencies flowed into the economy, and the average standard of living improved considerably. A middle class emerged which keeps growing at a breathtaking rate. Looking forward, China will evolve from an exporter with rather basic domestic consumption to the biggest consumer market in the world; production capacities will shift from export to domestic needs, shortening supply volumes for the Western Hemisphere. With the growth of the Middle Class, salaries and wages will increase exponentially. China will adopt increasingly tighter regulations on production; environmental concerns will fundamentally change the industrial sector and with that the price of goods sold. China will eventually lose its status as a low cost country.

We have largely dismantled our industrial sector as it was easy and cheap to produce abroad. These advantages will diminish. Industrial capacities will be redistributed and split over various regions and countries as no single territory can absorb the industrial volume provided by China. We must also take into account the political implications discussed earlier; we have to consider repatriating industrial production to meet domestic consumption. This would reduce our international dependencies and will make us less vulnerable to foreign pressures. We need to understand and accept that the U.S. will not have the same global, political, and economic power that we enjoyed since WW II.

The argument against industrial repatriation are higher costs of goods sold leading to higher prices which are not supported by the consumer. For the reasons listed, I do not foresee hyperinflation but I believe that the downward price spiral will come to an end and we will enter into a period of steadily upward creeping consumer prices. We will have to deal with a certain degree of inflation. The key will be our ability to improve our labor market to significantly reduce unemployment. Prior to the recent recession we certainly had higher consumption but we also had an ineffective utilization of human resources. As demand returns, companies who now enjoy a higher profitability through better resource utilization will not reverse the trend by increasing the human cost back on a per unit basis to pre-recession levels. Consequently, we will only overcome unemployment through innovation and new industries as well as structural changes by creating new or repatriated production and services.

Implications on the Relative Strength of the Leading Nations

As discussed, due to the global shifts in economies, the political powers are redistributed with the US losing strength to China and other emerging nations such as India. Compared to historical events in Europe after the Weimar Republic or the US / Russian area during the 1950’s to late 1980’s, the power shift is not driven by ideological, territorial, and military struggles. Looking at the Cold War era, the administrations at the time forged their policies, public spending, and ultimately their economy based on an enemy view and the need to counter a threat to the foundation of our nation. The public support was strong and military spending was a powerful driver of research, technology, and production, reaching well beyond the military complex.
Looking at the US / Chinese relationship, we certainly see ideological difference but the relationship is not determined by a concept of an enemy. The old policies are of no use. We will have to understand the opportunities of the new world order rather than struggle with the loss of dominance. With the exception of few industries such as automotive and the luxury industry, we see China largely as a workbench. We fail to see the consumption opportunity in China, India, and other high growth and emerging markets. As many of these countries are protecting their markets through duties, import restrictions, ownership restrictions, and other regulations, we must concentrate on using our strength to open these markets for US goods and services. It is no longer about fighting ideologies. The military struggle of the past evolved into an economic battlefield.

Finally, we need to fundamentally rethink our foreign policy as it relates to international military intervention. We will certainly have to continue maintaining and defending our national security but we need to refocus domestically and resist the urge to be the World’s Police. During the second half of the last century, we engaged at times in conflicts based on our principles as a world power rather than tangible national interests. Looking at our national debt crisis and weakening public support for such engagements, we simply cannot afford a continuation of this policy. Additionally, with the shifts of international powers, the burden to maintain a certain level of global security has to be shared as well. In that respect, it will be interesting to see the engagement of China, Japan, and Europe in the recent political turmoil in the Middle East. As the region destabilizes, we will experience unfavorable implications on the oil market which will put pressure on virtually every economy around the world.

The world community should be very alert and engaged in mastering the crisis in the Middle East as it certainly has the potential to derail the global economic recovery.