How Financial Collapses drive Extremism and War

A functional financial system is essential to peace, order and good government, and to liberal democracy. A broken one leads to totalitarian governments.

Above: the 30 Years’ War in Europe

"Those who fear for democracy’s future should remember Roosevelt’s 1944 words.
“People who are hungry and out of a job are the stuff of which dictatorships are made”

In their paper Politics in the Slump: Polarization and Extremism after Financial Crises, 1870-2014, Trebesch, Funke and Schularick studied how politics played out after financial crises. What they found was that politics tended to “take a hard right turn.”

“After a crisis, voters seem to be particularly attracted to the political rhetoric of the extreme right, which often attributes blame to minorities or foreigners. On average, extreme right-wing parties increase their vote share by 30% after a financial crisis… Both before and after World War II, we observe a significant increase of votes for far-right parties. In contrast, parties on the far left of the political spectrum did not have comparable electoral successes after crises. Second, we also find that political polarization increases substantially after financial crises as measured by weaker government majorities, a stronger opposition and a greater fractionalization of parliaments. These effects are considerably more pronounced after World War II than before”

What’s more, these very divisions paralyze governments and drag out crises.

“Increasing fractionalization and polarization of parliaments makes crisis resolution more difficult, reduces the chances of serious reform and leads to political conflict at a time when decisive political action may be needed most. A number of authors have linked political gridlock to slow recoveries from financial crises.”

Financial crises, deprivation and desperation for solutions creates political divisions that lead to extremism, violence, nationalism, socialism – and sometimes, national socialism.

There is a fairly simple explanation for this, which is that money and trade provide a peaceful way for people to interact with and persuade one another. When money becomes meaningless, and people can’t buy what they want or need, they take it, sometimes by force. War is not just mass killing – it is mass theft, of property, towns, homes, businesses, and natural resources from fields and rivers to mines.

The pattern of economic crises driving upheaval and war goes back centuries, including World War I, World War II, and even the 30 years’ war in the 1600s.

When money disappeared

In his introduction to The Anatomy of Melancholy, Robert Burton describes a world in 1624 - 400 years ago - that is strangely like our own.

“I hear new news every day, and those ordinary rumours of war, plagues, fires, inundations, thefts, murders, massacres, meteors, comets, spectrums, prodigies, apparitions, of towns taken, cities besieged in France, Germany, Turkey, Persia, Poland, &c., daily musters and preparations, and such like, which these tempestuous times afford, battles fought, so many men slain, monomachies, shipwrecks, piracies, and sea-fights, peace, leagues, stratagems, and fresh alarms.”

Burton goes on to list the chaotic burbling of news, good and bad, serious and frivolous. Wars and gossip are side-by-side. Even the places where conflicts are taking place are the same as today. The territory covered by Turkey, Persia and Poland in 1624 takes modern-day Syria, Iraq, Iran, Ukraine and Israel, where there have been ongoing conflicts for centuries, and where there are active conflicts right now.

What was happening? It turns out that Burton was writing at the beginning of the 30 years’ War, which lasted from 1618 to 1648, and raged across Europe, killing millions. While religious divisions between protestant and catholic factions defined the combatants, there was also an economic crash at the beginning of the conflict.

In Keynes’ Notes on Mercantilism, at the end of his General Theory, he writes that mercantilists (who were anti-free traders) recognized the connection between a lack of money and unemployment. There were, at the time,

“Debates in the English House of Commons concerning the scarcity of money, which occurred in 1621, when a serious depression had set in, particularly in the cloth export. The conditions were described very clearly by one of the most influential members of parliament, Sir Edwin Sandys. He stated that the farmer and the artificer had to suffer almost everywhere, that looms were standing idle for want of money in the country, and that peasants were forced to repudiate their contracts, “not (thanks be to God) for want of fruits of the earth, but for want of money”. The situation led to detailed enquiries into where the money could have got to, the want of which was felt so bitterly. Numerous attacks were directed against all persons who were supposed to have contributed either to an export (export surplus) of precious metals, or to their disappearance on account of corresponding activities within the country.”

In fact, there were several economic crises during the 30 years’ war. One, from 1619 to 1623 was the Kipper und Wipper. It was a time when states - and individuals - were manipulating their money, minting counterfeit coins.

“Kipper” means “clipping” because people would take coins made from precious metals, and trim the edges off, pile the trimmings together, melt them down, and make fake coins. (The ridges on the edge of coins were invented to prevent clipping. They were invented, or at least introduced, by Sir Isaac Newton, who was the head of the Royal Mint).

“Wipper” refers to the scale, teetering back and forth, because people also mixed other metals in with precious ones to make more coins.

The states would mint lower cost coins and send them to another state, where they would be exchanged for better ones - ones with more precious metal content. Then the process would continue. It turned into a boom that undermined the rest of the economy, even before the crash: peasants and farmers could make more money clipping coins than they could doing their regular work.

“Mints sprang up ‘like mushrooms after warm rain’ and debased coinage ‘poured from them in avalanche proportions.’” The financial craze affected everyone. One source wrote, “Doctors leave the sick and think more of profits than Hippocrates … judges forget the law. The same is true of other learned folk, studying arithmetic more than rhetoric and philosophy.” Another said “Agriculture laid down the plow... arts disdained mechanical tools… Goods became Proud.”  

One account says that “various states in the Holy Roman Empire attempted to finance the Thirty Years’ War by creating new mints and debasing subsidiary coins, leaving large-denomination gold and silver coins substantially unaffected.”

However, this strange formulation puts the historical cart before the horse - no one could have known, at the time, that the war they faced would last for 30 years.

Rather, the economic collapse that followed printing “debased coins” helped cause the war, because when people can’t use money to get something they need, instead of barter, they may just take stuff – by force, or stealing, or war.

The process drove inequality - the rich got richer as the poor got poorer.

It was a textbook example of what is known as “Gresham’s Law” – of “bad money driving out good”.

Some peasants were duped into trading their good metal for bad coins. The rich hoarded massive stores of coins and precious metals - which held their value - while the poor suffered. From 1619 to 1621, in Augsburg, Germany, workers’ wages fell by half in just two years. Trade ground to a halt because merchants refused to be paid in the debased coin, and riots broke out as people broke into exchange houses or confronted councils. Hundreds of people were injured, and many were killed.

When we write of history, the focus is on storytelling - on characters, conflict, beliefs. It’s said that our brains are driven by the “four Fs” - fighting, fleeing, feeding, and fornicating. Because stories - good stories - are defined by conflict, clashes, and dealing with threats, narratives tend to focus on fighting and fornication.

It’s worth saying that of the four Fs, the ones that are the focus of stories - fighting, fleeing and fornication - are activities that you could, in theory, spend an entire lifetime without doing. Feeding, on the other hand, is something you need to do nearly every day, and you will inevitably die if you go without for a few days.

The fifth F, which is ignored, is finance. Money and financial matters tend to be overlooked or misunderstood as a driving factor in history.

People focus on stories about character, values and ideology, as well as recessions, depressions, and financial crises, but they do not always recognize their devastating effects. Our classical economic models, and the neoclassical ones we use today exclude banks, debt or money, which means that these critical factors in social organization are ruled out as a cause.

When money ceases to have value, you cannot buy food. You may not be able to buy what you need to grow food, or to pay people to help. Money is something we use to control and persuade others. People with a lot of money have power, and people without don’t - but money provides people with a peaceful way of negotiating and bargaining, while ensuring that both sides of the bargain get something of value.

What is left when there is a crisis? Sometimes pleading, begging, succour, threats of violence or actual violence, theft, organized crime.

When money collapses in value, people no longer have that power of persuasion. Being able to pay for the necessities of life like food and shelter matter. It is possible for people without money to starve and suffer in the midst of plenty when they don’t have money. This is why economic crises matter. 

There is an attitude - or at least a stubborn lack of understanding - about how devastating a financial crisis can be. There is an attitude that it can’t possibly have been that bad.

Kindleberger mentions this, noting that some writers doubt that the disruption to money could really have harmed people, saying that “the economic and demographic catastrophe of the Thirty Years’ War is, if not a myth, at least exaggerated.” People closer to the events argued that when comparing the damage of war to the damage of money losing all its value, that the damage from the economic crisis was worse.

Historians closer to these events did make these arguments - that the economic catastrophe was worse than the Black Death. Following a coin clipping crisis that precipitated a market meltdown in England, required the coin to be reissued 1696, Macaulay wrote:

“Yet it may be doubted whether all the misery which has been inflicted on the English nation in a quarter century by bad Kings, bad Ministers, bad Parliaments and Bad Judges, was equal to the misery in a single year caused by bad crowns and shillings.”

It may be difficult to understand how money going wrong could possibly do more damage than a war, which involves death and atrocities. While the scars of war are lasting, the destruction stops and the possibility for healing and restoration begins with peace.

When money becomes worthless, it all stops working, and there may be no recovery, unless there is a deliberate, economy-wide effort at some kind of restoration or reform.

The violence of war is localized – the effects of economic collapse affect everyone. It renders people who had some power or control of their lives powerless. The damage, decline and deprivation persist without relief and will not stop until the system is fixed - until new money is introduced or the system is reformed. That can take years, or decades - or it may just result in collapse and there will be no recovery at all. There are modern examples of booms, busts, and stagnation, like Japan.

These European wars are often described as religious in nature. I wrote earlier that the religion defined the groups of people who were fighting - but all of what they did - especially fighting - has to be paid for. Societies have depended on money and finance for thousands of years, and that when money fails, it leaves people powerless, even in the midst of material plenty.

Again, as Sir Edward Sandys said in the British Parliament, farmers and artisans alike couldn’t work, and peasants couldn’t pay their bills, “not (thanks be to God) for want of fruits of the earth, but for want of money.”

The history we tell of wars and crises often fail to fully convey the ways in which people suffer lasting hurt, in ways that define lasting attitudes, not just because leaders in political systems are spared (they are) but because the systems are engineered to protect the privileged and shift the bad risks to people who can’t afford it.

Trauma is about lasting hurts from real injuries, mental and physical. War, natural disasters, and economic disasters are all collective mass trauma events. When people are traumatized by loss, or discomfort or fear, it leaves scars in the psyche, and our response to it - how we understand it and react to it – is written into us like a second reflex. We may not remember the injury, but we have retained a lesson from it, whether it is the right lesson or the wrong one.

In these historical analyses, conflicts often appear to be defined by power struggles defined by public or evident differences in identity – defining group identities of gender, ethnicity, faith, nationality or more, as well as struggles around status within groups.

But there is another fundamental that defines power relationships and ties between people: money. That includes whether you own property, your income, or allowances, who you buy from, and who you work for. If you are a manager, your relationship to the owners and customers. This also includes everyone’s relationship to the major flows of money  – government and banks, both in terms of getting money and paying it back.

This network of financial ties and obligations defines your position in society, and in many ways, who you are. It establishes the power and control you can exert over your own life, effectively defining what your freedoms are, because some things in life require an enormous amount of money to access. This financial network – the ways we are controlled, and control each other, through money, is more than just “the market.” It is the way our economic system shapes and limits our society.

When a financial system collapses, and money stops having meaning, it means that people cannot use money to get what they want – or to get relief from their distress. Even when a war is raging, an economy that still has working money means that people can still engage and trade with neighbours in their own community peacefully.

What we have failed to recognize is the deeply disruptive and scarring role that financial crises play in fuelling division, extremism, and war. Political extremism is a form of organized panic – or weaponized desperation.

Our instincts, when financial disasters happen, is to treat consuming less as the answer - as if it is crops that have failed, not a market. Politicians advocating for cuts say that everyone has to “tighten their belts” and everyone needs to consume less - that we can get through this tough time together with shared sacrifice. The idea - or intuition - that things will get better if everyone cuts back make sense if there is real scarcity, and there isn’t enough food to go around.

Money is not food. When people start gambling with borrowed money and lose it, it’s the money has been lost, not the things that have real value. Crops have not been destroyed, and houses have not been burned. If you live in a society where you believe that the distribution of money is a law of nature, and not a political choice, people will starve to death and die homeless in the midst of plenty.

In this desperation, political polarization offers two options which appear to offer freedom and new stability: total government (communism) promises to people that they will be freed of the costs of being controlled by private power. The opposite solution, fascism, is to promise freedom from the costs of government through control by private owners.

The problem is not a problem of supply and demand of actual goods or services, is political and financial. We judge the world to be a failure because it does not match our models, instead of adjusting finance to reflect the reality of the world. Instead, we distort people, business and societies to match unstable finance expectations.  

Compound interest means that debt obligations can double, and double again. Debt grows inexorably, and interest grows in ways that it becomes exponential. There is a famous story of the invention of chess - an 8 x 8 board with a total of 64 squares. When its inventor presents it to a ruler - of Persia or India, in different tellings - he asks to be paid in wheat or rice. One grain on the first square, two grains on the second, four grains on the third square, and so on.

The ruler agrees, and tells his treasurer to pay the sum, only to be told that the cost is more than all the treasure in the kingdom. In fact, it is much more than that. By the 64th square, the number of grains is almost impossible to calculate - over 18 quintillion grains - 1.199 trillion metric tons. That is equivalent to the entire modern global wheat harvest, multiplied by 1600 years.

This is why debt is extractive: as its premise, all investment must take out more than it puts in – it is fundamentally destabilizing to economies and societies alike, because the extraction is asymmetrical.

We try to solve poverty problems by moving food or people, instead of addressing the reason for poverty, and lack of food, which is not just a lack of money – but the fact that debts are extracting money from families and business faster than they can pay.

It is nearly impossible to convey the dangers of financial collapse, and almost all of the wrong lessons have been learned from it. This is part of the reason that Paul Romer called our current macroeconomic theories “post-real”. It does not remotely describe reality, and for it to have any real value, it should be able to predict disasters, and it fails miserably at that.

In developed countries, right now, in the midst of plenty, people go without food, shelter and medication because they just don’t have the money for it. There is more than enough food to feed everyone. There is no shortage of pills. There are enough empty houses and apartments to give everyone a roof over their head. The problem is that people can’t pay for it. Some have jobs and are working full-time. Some have many part-time jobs. Their income isn’t up to the expenses they must spend on - food, shelter, medications.

This should be obvious. It is not. Some of this is because the experience of different generations of work, saving and buying a house is completely different. It is not easy to explain or understand why this is not as obvious as it should be. Some of it is that debts and money are taboo and private. Private debts tend to be just that - individual, and private. Poverty and debt are often considered shameful or something that has happened as a result either of vice or excess. The German word for debt is the same as the word for “shame”.

Roughly between 1945 and 1975 was the greatest period of economic growth in human history. More goods were manufactured in that period alone than all the rest of human history before that. In Europe and North America there was a new and prosperous middle class, and as the economy grew, it grew for everyone.

One of the reasons for this is because after the Second World War, governments took a radically different approach than they had after the First. The First World War was used to extract the maximum reparations from Germany. After the Second World War, the U.S. “Marshal Plan” was used to help rebuild and reindustrialize Europe.

The 20th Century: Debt Crises, Austerity and War

Financial crises, debt and desperation have led to wars - including the biggest, most destructive wars of the 20th century - the First and Second World Wars.

In Canada and around the world, on November 11, we mark Remembrance Day, or armistice day, to commemorate the First and Second World Wars. The story and conflicts of the Second World War are better understood and clearer than the First – not just because it is closer to our current experience, but because the players and conflict were so much more clearly defined – Hitler, Stalin, Hirohito, Churchill, FDR. 

In 1929, there was a huge Wall Street Market Crash, which was followed by a global depression. In the years that followed, there were doubts about democracy and capitalism as systems of government, as the Communist Soviet Union and Fascist Italy and Germany seemed to be getting better economic results than the UK, and certainly than the U.S. and Canada. Hitler struck a deal with Stalin, and invaded Poland, triggering the Second World War. The U.S. entered the conflict after Japan attacked Pearl Harbor, and as conflict raged around the world, the allies – including the Soviet Union – defeated Germany in Europe and ended the war by dropping two atomic bombs on Japan.

Both the First World War and Second World War were preceded by financial crises and stock market crashes – and the choice to pursue austerity drove extremism and helped elect extreme parties.

The Great Crash Before the Great War

In Canada we remember the sacrifices and misery of WWI, but less of what it was about. The story is complicated – how to explain that millions of people died because of a conflict sparked by the assassination of Archduke Franz Ferdinand of the Austro-Hungarian Empire by a Serbian Rebel, Gavrilo Princip? This murder triggered a series of political events in which countries, all declared war on one another and blundered into one of the deadliest conflicts in history.

Overlooked in this is that in the lead-up to 1914, there had been a series of economic “shocks,” including some of the worst stock market results outside the Great Depression.

In the summer of 1914, one of the largest stock market disruptions in history occurred. As Europe went to war, the U.S. was in debt to Europe. Many of the owners of US infrastructure, like railways, were in Europe, and there was fear that the Europeans would immediately call in their debts or sell off their assets - including railroads - in exchange for gold, which would be shipped from the U.S. to Europe.

In “self-defense” the U.S. shut down the New York Stock Exchange when war was declared on July 28, 1914. “In the days to follow, most major bourses closed in concert: Montreal, Toronto, Madrid, Vienna, Budapest, Brussels, Antwerp, Berlin, Rome, St. Petersburg, Paris and throughout South America. London, the world financial center, closed on July 31, 1914.” They all remained closed for months.

It is easier to list the three exchanges that stayed open: Tokyo, New Zealand, and the Denver Mining Exchange.

This was in the midst of a different era of “globalization” - an era of European empires. What is remarkable is how little known this stock market crisis is, even though it led to the financial centre of gravity of the world moving from London to New York. It goes unmentioned in Margaret MacMillan’s book on the causes of the First World War, The War That Ended Peace: The Road To 1914.

Debt also played a role in the Russian Revolution. In 1913, close to the outbreak of war, Russia had colossal foreign debts, and many of its businesses and resources were owned by foreign interests - especially in France. As the war dragged on, it only got worse. Russia borrowed to finance its effort in the Great War, but the economy collapsed in a period of hyperinflation.

After the Communist Revolution, one of the decisions was to repudiate the debts that had been taken out by the Tsarist Russian Government - to refuse to pay them. It was a colossal amount. “Russian public debt amounted to £ 930 million (roughly 50% of GDP) in 1913. Between the beginning of the war and Bolsheviks’ accession to power with their left-wing Socialist Revolutionary allies, the debt soared to £ 3,385 million, about 3.5 times what it had been.” The newly formed Soviet Union also confiscated foreign assets and the state took control of them instead.

The decision on the part of the Communists in the Soviet Union was to cut themselves off from the international finance system. Incredibly - or perhaps not so incredibly - people held on to the bonds, and in 1996, after the fall of the Soviet Union and the reinstitution of the Russian Federation, investors were paid out $400 million so that the Russia could re-establish its creditworthiness.

Financial crises are debt crises, and they have been a cause behind domestic and international events and conflict for centuries.

1919 and All That: How to Create a Depression

There are many ways in which the political and economic decisions around debt and austerity drive desperation, deprivation and political radicalization.

John Maynard Keynes was so dismayed by the revenge-minded Versailles peace talks of 1919 after the First World War, that he quit and wrote a book warning that the harsh reparations imposed on Germany by the victorious allies would lead a war within 20 years. He was right.

The details of what happened in that period are critically important because the lessons we have drawn from it are mostly wrong – quite dangerously so.

People know that there was a period of hyperinflation in Germany when the value of money dropped so badly that people were wheeling money around in wheelbarrows or used it as wallpaper (all true). This happened in the early 1920s. They also know that after this period, Hitler and the Nazis came to power. People make the mistaken conclusion that hyperinflation led to the rise of fascism and the Second World War.

This is totally inaccurate history and is sometimes used as a reason to warn of the dangers of inflation (Keynes also warned of the dangers of inflation in his “Economic Consequences of the Peace”). 

This matters for many reasons, and the real story is worth repeating, to get the order of events straight. In the 1920s, Germany was faced with massive debts to France and Belgium, to pay war reparations.

“According to French and British wishes, Germany was subjected to strict punitive measures under the terms of the Treaty of Versailles. The new German government was required to surrender approximately 10 percent of its prewar territory in Europe and all of its overseas possessions. The harbor city of Danzig (now Gdansk) and the coal-rich Saarland were placed under the administration of the League of Nations, and France was allowed to exploit the economic resources of the Saarland until 1935. The German Army and Navy were limited in size. Kaiser Wilhelm II and a number of other high-ranking German officials were to be tried as war criminals. Under the terms of Article 231 of the treaty, the Germans accepted responsibility for the war and, as such, were liable to pay financial reparations to the Allies, though the actual amount would be determined by an Inter-Allied Commission that would present its findings in 1921 (the amount they determined was 132 billion gold Reichsmarks, or $32 billion, which came on top of an initial $5 billion payment demanded by the treaty).”

The hyperinflation in Germany is one of the best known such episodes in history. To give an indication of the level of inflation, a loaf of bread that cost 160 marks at the end of 1922 cost 200,000,000,000 (200 billion) marks a year later.

Many economists, historians and news articles will seek to explain the dangers of hyperinflation by citing Germany, but the history is almost entirely wrong. The Nazis did not come to power until more than half a decade after the hyperinflation had come to an end. The explosion in money-printing in Germany in 1922 and 1923 was not by the government at all.

A clearer story had been produced in a working paper of the International Monetary Fund (IMF).^[1] It was, in fact, a consequence of a policy blunder by the Allies, who insisted that the government be stripped of its role in supervising or running the central bank:

“The Reichsbank president at the time, Hjalmar Schacht, put the record straight on the real causes of that episode in Schacht (1967). Specifically, in May 1922 the Allies insisted on granting total private control over the Reichsbank. This private institution then allowed private banks to issue massive amounts of currency, until half the money in circulation was private bank money that the Reichsbank readily exchanged for Reichs­marks on demand. The private Reichsbank also enabled speculators to short-sell the currency, which was already under severe pressure due to the transfer problem of the reparations payments pointed out by Keynes (1929). It did so by granting lavish Reichsmark loans to speculators on demand, which they could exchange for foreign currency when forward sales of Reichsmarks matured. When Schacht was appointed, in late 1923, he stopped converting private monies to Reichsmark on demand, he stopped granting Reichsmark loans on demand, and furthermore he made the new Rentenmark non-convertible against foreign currencies. The result was that speculators were crushed and the hyperinflation was stopped. Further support for the currency came from the Dawes plan that significantly reduced unrealistically high reparations payments…. this episode can therefore clearly not be blamed on excessive money printing by a government-run central bank, but rather on a combination of excessive reparations claims and of massive money creation by private speculators, aided and abetted by a private central bank.”

So, it was not the German government that was responsible for hyperinflation at all. It was the private central bank, which allowed private banks to print their own currency – to offer credit that was convertible into government marks on demand. Effectively, it gave private banks a license to print money, and they did.

The collapse in the value of money – when it effectively becomes useless – means that debtors will start to seize things of real value. France and Belgium sent their armies into Germany’s Ruhr valley to seize coal and steel.  

This is what causes hyperinflation - a country having to pay off debts in another country’s currency. If there is an economic downturn - and there is a change in the exchange rate, it can trigger a downward spiral. There is no evidence that creating money for investment in public benefits causes uncontrolled inflation - it is always printing money associated with paying off foreign debts. It is usually triggered by “private money” creation – banks advancing more credit than they have the reserves to cover.

The hyperinflation stopped when Germany introduced a new currency, in November 1923. It was a period of serious economic disruption - but it is not what led to the rise of fascism. Hitler did not come to power in 1923. In the German elections of 1924, the Nazi party only received 3% of the vote.

After the hyperinflation, until 1929, Germany had the fastest-growing economy in the world. That growth ended in 1929, with the Wall Street Crash and financial crisis that started the Depression. The top five economies around the world were all shrinking, and for the first years, they all pursued cuts and austerity.

Learning the Right Lessons from Bad History  

” . . . the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”- John Maynard Keynes

Austerity as a Dangerous Idea

When Keynes talks about ideas being so important and being “dangerous for good or evil” it is because certain ideas can be a lens through which we view the world.

As Mark Blyth has argues at length in his outstanding book, “Austerity: History of a Dangerous Idea” - is that it doesn’t work, and results in very nasty politics.

The austere response to the Depression and financial collapse around the world helped create the social conditions for the Second World War.

After 1929, in Germany, conservatives and social democrats alike pursued austerity. The Nazis stayed a fringe party over several elections, with their vote growing as economy sputtered and suffering got worse, until they were elected in 1933 on a promise of jobs. Hitler and the Nazis did get the economy running again, mostly by building up the military. 

In the 1930s, France might have been able to put a check on Germany’s expansion by also investing in a military buildup, but they opted for cuts and austerity instead, and were in no position to offer any meaningful resistance to a German invasion.

In Japan, the major target for budget cuts was the military. Over the 1920s, the military’s share of the government budget was cut in half. After a number of years, and continued cuts, the response from the military was increased radicalization and outright assassinations. A number of senior officials were assassinated by the military, including two Prime Ministers, and a number of bank officials.

In late 1931, an army plot to overthrow the government was uncovered - which was related to the years of cuts. “A decade of austerity had convinced the Japanese military that they were ‘at war with the entire civilian political elite.’”  A number of other officials were murdered in a failed coup in 1936, but the die was cast, and spending opened up for the Japanese military and war on China in 1937.  

Austerity means stripping people of money - and stripping them of control and leaving them powerless. The assumption is that the economy will just recover its balance - and come back to equilibrium on its own. It won’t. As people fight over scarce resources, it leads to conflict and the splintering of societies, along any number of tribal and tribal nationalist lines.

It wasn’t hyperinflation that led to the Nazis. It was austerity. It was austerity that led to the extreme nationalism and militarism of Japan. These were the two major axis powers in the Second World War, who pursued empires through invasion and conquest as a means to acquire wealth.

After the Second World War, the victors learned some lessons from the mistakes of the First World War. Instead of imposing of reparations, which led to economic misery and instability, and radicalized populations who blamed “the other,” the Allies moved forward with a “Marshall Plan” that included debt forgiveness and investment to rebuild after the War.

In 1948, “the Allied Powers replaced the reichsmark with the Deutsche mark, wiped out 90% of government and private debt and paved the way for West Germany’s economic miracle.”^[2]

This was a rare departure from the toxic ideology that treats debt as a uniquely protected kind of investment – where the lender is supposed to be paid back, not just in full, but with every penny of interest, even if it breaks the borrower. It is an ideology that is separate from the ideologies of capitalism, or socialism, or fascism or communism – and pre-dates them all. This iron-fisted ideology is not humane, good sense, and it is ultimately destructive to the economy and the societies that follow it.

The unchecked growth of debt, crashes, and the desperation that follows can be incredibly destructive. With no control in their own lives, people gravitate towards people who promise to control it all, by crushing others: strongmen and authoritarians at both extremes of the political spectrum.

These include ideas of right and wrong. One of the most dominant and most damaging ideas is the idea that all debts – however unjust, or cruel, or impossible - must be repaid. The other is that we are blind to the harm that a collapse in the financial system can cause.

There are many examples of religious taboos around debt, usury, and interest, in Judaism, Christianity, and Islam, for the very reason that debt, and interest were recognized as being damaging.

The unique treatment of debt as guaranteed “investment” in our society

In a modern context, debt occupies a special place in both legal and moral perceptions – with the expectation that a loan must always be repaid in full. This an ideological and moral belief that is at odds with the way we treat almost every other investment, and it has had profound, and profoundly unfair consequences.

When people cannot pay their debts, their debts may be sold for pennies on the dollar to a collection agent, who will try to collect it in full. This can happen at the level of an individual or at the level of an entire country.

We are told all the time that debt can be a kind of investment, but it is not treated like other kinds of investments. Usually, we recognize that investments involve risk, and you may end up losing some of your money. High risk investments are less certain and can lead either to large gains or to large losses. Low risk investments are more certain and can lead to more modest gains or losses. That is the nature of risk-taking.

Lending is treated differently, because it’s taken for granted that the entire amount needs to be repaid, with interest, no matter what. This is why we had debtors’ prisons in the past. The law will guarantee that your lender will be forced to pay back everything.

But this creates a question around risk-taking. If debt is an investment that has a guaranteed return – what is the risk involved? There is no risk. It is guaranteed. What should the interest rate be? One would think it would be zero. But it’s not.

One way of thinking about interest is that it is a price on risk. If you are making lots of loans, and a lender is less sure a loan will be paid back, the interest rate is higher. If you are more confident that a borrower will pay you back, you have a lower interest rate. Higher interest rate loans help make up for losses when people default. (Of course, interest can also be a function of a power imbalance – where poor or desperate people are preyed upon by people who charge extraordinary interest.)

People who are lower risk and are more likely to pay back their loans have lower interest rates, while people who are higher risk are less likely to pay back their debts. While higher interest rates are a self-fulfilling prophecy that makes it more likely that borrowers won’t be able to pay back their loans, the interest itself is a kind of built-in insurance for the lender – they help to protect the lender from losses when some of the borrowers can’t pay back.

It is difficult to understate the damage caused by debt crises and financial collapse: war, famine, environmental damage, and the collapse of democratic government as it is replaced by oligarchs and property owners – rentiers – who live off the private debt of others – the rich growing richer as the poor grow poorer.

With other investments, the investor is expected to bear the losses of their risk-taking, but debt is considered sacrosanct. If you spend money starting a business and it doesn’t work out, you lose your stake. If you buy shares in a corporation or on the stock market and they go down in value, you lose the money. The idea when you lend as an investment, that it must be paid back with interest, and penalties and fees that may be added, is that a contract is a contract. This is an idea that would appear to be moral and just and fair – but the nature of debt itself means that it is not, because debt will always extract more than it puts in.

And if you’re wondering about why this applies today - we had a Global Financial Crisis in 2008, which has not been resolved, and the world is a much more unstable place. Yet, governments across the developed world are, quite literally, using the same models that created the crisis, failed to predict it, and have continued to make it worse.

This is one of many reasons we need to heed the advice of William White and consider reforming central bank policies, as I have written elsewhere.

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^[1] https://canadiandimension.com/articles/view/whatever-happened-to-the-saskatchewan-ndp

https://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf

^[2] https://moneyweek.com/economy/uk-economy/601055/debt-jubilee-will-our-debts-be-written-off