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Central bank insolvency is identified as a key driver of hyperinflation in the 1920s in Germany, Austria, Hungary, and Poland. Dr. Ingo Sauer discusses how the hyperinflation, where the German mark was devalued to over 4 trillion marks to one US dollar and prices skyrocketed by well over a billion percent. He highlights that the traditional notion of hyperinflation being caused by excessive money supply overlooks the role of central bank solvency. The hyperinflation in the 1920s was driven by central bank insolvencies rather than standard market demand and supply dynamics.
Dr. Sauer draws connections between the history of central bank insolvency and its implications for the European Central Bank (ECB) today. He warns about potential risks for the Euro system due to risky assets accumulated by the ECB, particularly government bonds. Concerns are raised about the ECB's vulnerability to losses and the potential devaluation of the Euro currency in the face of economic pressures, echoing historical crises in Germany, Austria, Hungary, and Poland.
Dr. Sauer emphasizes the importance of understanding historic central bank recapitalizations to be prepared for potential financial crises. He highlights how recapitalizing central banks was crucial in ending hyperinflations in the past and stresses the need for research on such mechanisms. By analyzing the balance sheets and insolvency factors of central banks in crises, valuable insights can be gained to prevent and manage financial instability.
Dr. Sauer's analysis reveals the intricate relationship between central bank solvency, exchange rates, and price levels. He demonstrates how vulnerable central banks lead to devalued currencies, which, in turn, impact consumer prices. By exploring these interconnected dynamics, Dr. Sauer challenges traditional economic theories that solely link money supply to inflation and exchange rate fluctuations. His comprehensive analysis sheds light on the complex factors influencing hyperinflation and exchange rate stability.
When the money supply increases in a closed economy, it can lead to a devaluation of the currency. The speaker explains how the increase in money supply can cause the currency to lose its value in terms of goods. By analyzing the relationship between money supply and goods, the concept of the quantity theory of money is discussed, highlighting the impact on exchange rates. Furthermore, the central bank's asset side, often overlooked, is addressed as a critical factor in determining currency stability.
The discussion delves into hyperinflation scenarios, drawing parallels with historical instances like the German hyperinflation case. The episode emphasizes the critical role of central banks in hyperinflation episodes, highlighting the need for recapitalization to stabilize exchange rates. It is noted that hyperinflations typically end by recapitalizing central banks to ensure currency stability, with examples including setting fixed exchange rates to external currencies.
The narrative explores concerns regarding the Euro system's vulnerability to insolvency and hyperinflation risks. The asset composition of European Central Bank holdings, such as government bonds, raises questions about solvency in the face of devaluation. The speaker reflects on the potential consequences if crisis countries' bonds lose value, leading to increased vulnerability, drawing comparisons to past hyperinflation scenarios for insights into a potential future economic landscape.
The discussion navigates through the significance of maintaining currency stability through adequate asset backing by central banks. The importance of backing money with valuable assets to prevent vulnerability and ensure exchange rate stability is underscored. Comparisons are drawn between the mechanisms employed by different central banks, highlighting the critical role of central bank assets in safeguarding against currency devaluation and inflationary pressures.
The episode delves into the implications of monetary policies on currency values, particularly in the context of global economic dynamics. The impact of quantitative easing and central bank interventions in stabilizing currency values is explored. The role of central banks as market makers and lenders of last resort is discussed in relation to currency stability and economic resilience amidst potential hyperinflation risks.
The analysis extends to the necessity of financial reforms and central bank recapitalization to mitigate hyperinflation risks. Insights from historical financial crises, such as the German hyperinflation of the 1920s, provide a backdrop for understanding the importance of central bank stability in ensuring currency strength. The practice of recapitalizing central banks to stabilize exchange rates and curb hyperinflation is highlighted as a crucial measure to avert economic collapse.
The difference between the European Central Bank and the Federal Reserve in their approaches towards stabilizing prices is highlighted. In Europe, the ECB engages in purchase programs to stabilize prices, enabling countries like Italy and Spain to manage their debt with lower interest rates. On the other hand, the US Federal Reserve does not directly intervene in states like California during financial distress, showcasing a contrast in monetary policies.
The discussion shifts to the risks associated with central bank insolvency, focusing on factors like interest rate risk and devaluation implications. Issues such as pricing forward depreciation and interest rate fluctuations can impact central bank balance sheets. Concerns arise regarding the Euro's stability and the potential for significant inflation due to the Euro system's decentralized structure and uneven distribution of voting power and liabilities.
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Dr. Ingo Sauer of Goethe University Frankfurt joins Forward Guidance to share findings from his 360 paper on Hyperinflation in 1923 and its connection to central bank insolvency. Sauer argues that severe impairment of central bank assets, and not the printing of vast amounts of central bank liabilities (money), was the primary cause of extreme inflation witnessed 101 years ago in Germany, Austria, Hungary and Poland. Sauer inverts the causal line of exchange rate depreciation, money supply increase, and inflation, and he also shares his concern about the current state of the balance sheet of the European Central Bank (ECB). Filmed on March 5, 2024.
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Ingo Sauer’s YouTube channel: https://www.youtube.com/@wissenhatkeineneigentumeri9889
Ingo Sauer’s 360 page paper, “The Lessons from 1923 for the Euro Area: Enlightening the Dark Side of (In-) Solvent Central Banks’ Balance Sheets”: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4620462
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Timestamps:
(00:00) Introduction
(00:56) Overview Of Dr. Sauer's Theory On The Ultimate Cause of Hyperinflation: Central Bank Insolvency
(07:05) Dr. Sauer's Concerns About The Euro
(11:22) Setting The Stage For German Hyperinflation in 1923
(14:33) The German Mark During World War I
(21:40) The Assets Of The Reichsbank Increasingly Became Dominated By German Government Obligations (Not Commercial Bills / Collateral Advances / Gold)
(30:03) Central Bank Insolvency (Not Money Supply Increase) Caused Hyperinflation in 1923
(34:53) VanEck Ad
(36:48) Failed Attempts To Stabilize German Mark And Inflation, 1919-1922
(41:44) Reichsbank's Holdings Of German Treasury Bills Highly Correlated To (In)Solvency Factor
(45:01) Explaining Sauer's "Solvency Factor"
(47:29) The Mark's Short-Lived Rally In 1920
(51:10) Marker
(57:09) The Mechanics Of Central Bank Insolvency
(59:40) Reichsmark Insolvency Led To Depreciation Of The Mark, Which Led To Hyperinflation
(01:02:34) Money Supply Did Not Cause Hyperinflation, Argues Sauer
(01:15:09) The Explosion In Reichsbank's Money Supply Was Mostly Paper Cash, Not Bank Reserves
(01:23:03) Reparations' Impact On German Solvency
(01:27:22) The Rentenmark And The Halting Of German HyperInflation
(01:30:47) Central Bank Profits and Yield Curve Dynamics
(01:34:58) European Debt Crisis (2009-2015)
(01:36:45) Fed As Dealer Of Last Resort, European Central Bank (ECB) As Market Maker Of Last Resort
(01:38:06) ECB Is Less A Central Bank And More Of A "Headquarters" For Domestic Euro Central Banks (such as Bank of France, for example)
(01:40:23) Origin Of Fed, And Clearinghouse Loan Certificates As National Currency Before The Fed
(01:44:18) Why Has ECB Balance Sheet Expansion Post 2008 Coincided With Disinflation (Or Deflation), And Not Hyperinflation?
(01:47:44) Sauer's Fears About The ECB And The Euro
(02:00:46) The Mechanics Of Monetary Financing
(02:18:32) Interest Rate Risk Is Not A Systemic Concern
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Disclaimer: Nothing discussed on Forward Guidance should be considered as investment advice. Please always do your own research & speak to a financial advisor before thinking about, thinking about putting your money into these crazy markets.
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