A short summary of the Austrian hyperinflation after WWI

The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.

Ludwig von Mises  (1881-1973)

Take Away

… when prices of goods and services rise monthly by over 90%.

At the outbreak of WWI, the Austro-Hungarian Empire like other warring European nations, resorted to the printing press to cover rising military expenditures.  In July 1914, the Monarchy’s currency in circulation stood at 3.4 billion Crowns and by the end of the war the quantity of money had grown to 33.5 billion Crowns, an increase of almost 1,000%. The cost of living index,  at 100 in July 1914 has risen to 1.640 by November 1918. During the same time the gold backing of the Crown shrunk to less than 1%.  On November 11, 1918, Austria’s last Emperor, Charles I was forced to abdicate and on the next day a provisional government made up of Socialists and Christian Democrats declared the small, landlocked German speaking part of the monarchy, as the Republic of German-Austria.  After the loss of some 5 million dead or wounded, fragmented and cut off from the Empire’s former Crown Lands, the rump state soon found itself faced with massive war debts, hyperinflation and almost insoluble economic and socio-political problems. Note: A billion is the equivalent of one thousand million. A trillion corresponds to one thousand billion.

Fin-de-siècle Vienna

After the Austro-Hungarian Compromise was finally reached in 1867, timidly and slowly an era of classical liberal ideas began and permitted the Habsburg Empire to advance into a modern state and thrive. Scholars, intellectuals and artists of this multi-ethnic Empire flocked into imperial Vienna and soon began to dominate the sciences and the arts worldwide. The culturally and politically vibrant fin-de-siècle Vienna developed into a hotbed of ideas. However the ominous thunder of coming revolutions and wars was hard to overhear. The shots fired in Sarajevo on  June 28, 1914 and the Empire’s declaration of war on Serbia just one month later triggered a war so murderous and destructive that a new term was invented for it: WW I.

On August 4, 1914, an Imperial Decree cleared the Austro-Hungarian Bank of its constitutional duty to assure currency stability for the Empire. Within days the bank started not only to sell gold from its holdings to pay for desperately needed war materials. The bank also began to cover the huge domestic expenses for the full mobilization of the military by printing additional banknotes. Thus, an ever rising amount of paper money was offset by a rapidly decreasing amount of gold as collateral. While the  gold backing of the Empire’s Crown had fallen from 74.6% to 0.9 % between 1914 and the end of WWI,  the circulation of the Crown increased from 3.4 billion Crowns in July 1914 to 33.5 billion Crowns in November 1918. In other words the money supply had expanded by 977 %.  In addition, the cost-of-living index that stood at 100 in July 1914 had risen to 1,640 by November 1918.

After almost 5 million dead or wounded, a ceasefire was signed near Padua (Italy) on Nov. 3, 1918 with the exhausted Empire’s multiethnic army surrendering to Italy. The horrific slaughter of “the war to end all wars” (W. Wilson) finally came to an end and the venerable institutions of the Monarchy began to disintegrate. After nearly 640 years of Habsburg’s rule, Austria’s last Emperor Charles I (1887-1922) was forced to abdicate on November 11, 1918 and the Republic of German-Austria was proclaimed shortly thereafter, with not much hope to endure on her own. Cut off from the resources of its former Crown Lands, dismembered into a landlocked country and a totally wrecked currency, the new rump state struggled for survival. The economic as well as social situation was dire and made drastic financial reforms within the state unavoidable and imperative.

Restructuring plans

At the recommendation of Rudolf Hilferding (1877-1941), the well-known and politically highly ambitious Joseph A. Schumpeter (1883-1950) was appointed State Secretary for Finance in March 1919. It can be assumed that Schumpeter’s small book Krise des Steuerstaates (1918) played a decisive role in the appointment. Schumpeter argued there that the tax state should be made capable of revitalizing its exhausted economy on its own and called for a one-time high wealth tax, to be introduced as quickly and as comprehensible as possible. His main points were the avoidance of  national bankruptcy, the termination of the printing of more money bills, adjustment to the reduced value of money and the procurement of a foreign loan.

Following his own advice, Schumpeter first put forward a robust financial and restructuring plan with which a definitive recovery of state finances could be attained by the end of 1923. As suggested in his Krise des Steuerstaates, the plan also included a one-time substantial property tax intended to reduce the war debt, a significant increase of  indirect taxes and the stabilization of the money without the restoration of the old parities.

As a second action Schumpeter demanded the development and creation of the necessary political conditions. Since the peace treaty of St. Germain stipulated the complete liquidation of the Austro-Hungarian Bank under the supervision of the allies, Schumpeter suggested the establishment of a new, independent Austrian Central Bank and the restoration of the creditworthiness of the remaining Austrian industrial enterprises. Somewhat naively Schumpeter also had confidence  in a continuation of a post war economic cooperation between the Monarchy’s former Crown Lands of the Danube Basin and that an acceptable and comprehensive peace treaty would soon be concluded with the Entente.

Schumpeter’s financial and restructuring plans introduced in October 1919, prompted significant differences between him and both coalition parties, but especially with the Austro-Marxist Otto Bauer (1881-1938), his former fellow student in E. von Boehm-Bawerk’s famous Viennese seminar. Bauer in his newly assumed official role of State Secretary of Foreign Affairs sharply contested Schumpeter’s ideas largely on ideological grounds. As no agreement could be reached, the support for his program crumbled and the Cabinet Council wanted to leave the decision to the political parties. Unlike many of his fellow academics and intellectuals Schumpeter also firmly opposed any idea of an annexation (Anschluss) of little Austria to Germany. Moreover, he was accused of repeatedly misjudging political situations and advocating projects that subsequently proved hopeless. Despite his proven innocence he was also charged of being the culprit in the so-called Kola Affair. After barely seven months in office, on October 17, 1919 Schumpeter was forced to resign as State Secretary for Finance and left the government.

205% of inflation in 1921

During Schumpeter’s  7 months tenure, the supply of new Austrian Crowns increased from 831.6 million to 12.1 billion.  Due to the fact that no agreement on his restructuring plan could be reached, the quantity of the Austrian Crowns shot up to 30.6 billion in October 1920, in 1921 it stood at 174.1 billion and culminated by the end of 1923 at 7.1 trillion. In other words, the money supply of the new republic had increased by 14,250%.  When the terms of the St. Germain treaty also ordered a full invalidation and replacement of all Crown bills still circulating in the Empire’s successor states, the “old Austrian” Crown bills were stamped in their respective territories and an immediate wild speculation against further devaluation of the Crown began. A bank run started and nervous masses drained their accounts in order to invest the little rest of their funds in real assets. Consequently, prices rose dramatically during this period. The cost-of-living index, which had risen to 1,640 by November 1918, had gone up to 4,922 by January 1920 and three years later in January 1923 it had shot through the roof with 1,183,600.

As there is mostly one exchange rate but a myriad of prices of goods and services in an economy, the measuring of Austria’s inflation rates is more exact by closely correlating and tracking the Crown with the currency exchange depreciation. Accordingly, shortly after Schumpeter’s resignation, Austria’s inflation rate dramatically began to accelerate. While between the end of 1914 and 1918 the average annual inflation rate was about 85%, it climbed up top 149% and continued rising to 205% in 1921. However, the monthly inflation rate between October and December 1921 jumped twice above 130% and reached a staggering 150% monthly rate between June and August 1922.

As a result, the US Dollar exchange rate, which stood at 16.1 Crowns to one US Dollar in mid 1919 and in May 1923 one US Dollar traded for 70,800 Crowns.

F.A.von Hayek (1899-1992) often entertained his audience by referring to his own experiences during the years of hyperinflation in Vienna: To merely keep up with prices that almost doubled every day, after a very modest breakfast he left his flat for the office with an empty suitcase in order to carry home the huge number of worthless 500,000 Crown bills once he got paid in late afternoon.

The unpremeditated Austrian government paid for its expenditures by running the printing press more or less constantly. Those people in charge of the financial operations seemed to have not been totally aware of the consequences of their excessive use of the printing press and could not really identify any feasible alternatives. In light of the political situation in the spring of 1920 it was impossible to keep government expenditures within tax capacity without provoking violent unrest and social chaos in Austria and its neighboring independent but unstable former Crown Lands.

Foreign financial assistance needed

The inflation shaken rump stat of Austria was in a dire economic and politically unpredictable situation and foreign financial assistance was needed. On September 16, 1920 a humiliated Austria joined the League of Nations in Geneva. After several vain petitions on October 4, 1922 the Geneva Protocols, a comprehensive treaty that was supported by the United Kingdom, France, Italy and Czechoslovakia was signed by the Austrian Chancelor Ignaz Seipel. The terms however stipulated that the landlocked new republic would remain independent, develop a feasible framework for economic reconstruction that was based on a loan of 650 million gold Crowns and include a restructuring program to consolidate the state budget. In addition Austria was required to pledge the proceeds from customs duties and the tobacco monopoly to the four nations and was not permitted to enter into any political or economic alliance with Germany. Until July 30, 1926, state finances were supervised by a Commissioner General of the League of Nations. Commissioner Alfred Zimmermann (NL) was put in charge to strictly monitor Austria’s finances until the end of July 1936. Although often criticized and ridiculed as a “League of Nations Colony”, at least for the time being the ill-equipped Austria was saved from an instant catastrophic collapse dangerously paired with an explosive breakdown of its sharply divided society.