Welcome

I’m taking a departure from the Japan focused writing to focus on some financial engineering history. German ‘MEFO’ bills were instrumental in re-arming Nazi Germany without technically violating the Treaty of Versailles or causing widespread price inflation. The careful issuance of MEFO bills by central bank president Schacht was the catalyst to restart German industry during the Great Depression and took the country’s military from drilling with wooden weapons to beginning a conquest of Europe within five years.

Background

Germany lost World War 1 and was subjected to the Treaty of Versailles in 1918, which required outlandish war reparations, dismantling the army, and limited military spending. While some argued a demanding treaty would teach Germany a lesson, other prominent economists argued it would ruin the country, breed resentment, and sow social unrest.

By the 1920s, Germany was in a state of hyperinflation – arguably an intentional policy to repay the war debt that was denominated in Marks, the German currency. The poverty, resentment, and embarrassment of the German people is not hard to imagine.

Hitler takes power during the late 1920s, leading the ‘National Socialist German Workers’ party, aka the Nazis. His platform is focused on bringing dignity back to the German working population. Via propaganda and government mandated policies he gives the people something to look forward to. Rebuilding infrastructure, the promise of automobiles, steady wages, meaningful work, and most importantly: removing the yoke the Treaty of Versailles placed on the German people, prove to be a winning platform.

Reload the Cannons

The Treaty of Versailles limited the size and spending of Germany’s already depleted military. Much like Japan after Word War 2, Germany post WW1 was in no position to negotiate. Should they violate the Treaty of Versailles, the hammer would be swift and heavy.

Yet, Hitler and the people were set on reclaiming self sovereignty. As they couldn’t spend Reichsmarks, they turned to financial engineering. Hjalmar Schacht was tapped to lead the Nazi economy in 1934, and charged with financing rearmament.

Schacht was critical in helping Germany make it through the hyperinflation of the 1920s, and the perfect man for the job.

He needed to jump start the industrial economy of Germany without causing inflation or alerting the allies to what was happening. His solution was elegant and ingenious: create a new currency that was only used by the government and industrial sectors related to rearmament. He created the MEFO company.

MEFO Bills

MEFO bills were a simple instrument: issued by the shell company namesake and funded by the German industrialists, these six month bills with a 4% interest rate were used to pay industrial companies key to rearmament.

In 1934 German industry was in a sorry state. Factories operated below capacity or had closed down completely, and there was little confidence in the economy. Powerful industrial families needed funding badly. Due to the circumstances, they willingly accepted MEFO bills as payment. Something is better than nothing! The 4% interest rate was appealing, bills were backed by the government, and could be used to pay for goods and services of other industrial companies.

This funding structure shrouded the rearmament push. No one outside the inner circle knew how many MEFO bills were being issued, and the new ‘money’ was largely contained to the industrial sector. The Treaty of Versailles limited German Reichsmark spending on the military, but not MEFO bill spending!

MEFO bills were due for redemption after 6 months, meaning the Government would owe Reichsmarks to holders of the bills. However, the MEFO company and Schacht planned for this. They were legally allowed to delay redemption for 90 days, infinitely. They took full advantage of this, pushing off redemption of many MEFO bills for years. Companies swallowed this pill due to the relatively high interest rate, ability to trade amongst themselves, and continued funding.

The Great War

Germany went to war in 1939. In 5 years they went from an immaterial standing army to an industrial military powerhouse. Industrial capacity was full, they had natural resources coming from Russia, and were doing everything they could to source within Germany.

Poland fell, then some of the smaller Western European countries, and France. At long last, the Nazi party and MEFO company could begin paying back the MEFO bills. Using spoils of war, MEFO redemptions were handled fairly easily. The financial ingenuity is clear in retrospect.

The Genius of it All

The bills had served their purpose better than anyone could have imagined, and possibly realized. They allowed Germany to reindustrialize and rearm without technically violating the Treaty of Versailles, and avoided causing inflation. All along the plan had been to pay them back with war.

Debt pulls forward future spending. You have money today that you will have to pay back later on. Schacht created a system that allowed Germany to spend money without creating inflation, and be paid back with the money and goods taken during war. They borrowed money from themselves, and paid it back with money of others.

Avoiding inflation was a critical part of the scheme. The scars of Weimar Germany’s hyperinflation a decade earlier were fresh on the mind of everyone. The Nazi party would lose all credibility and support from the working class if they repeated the previous decade. Printing Reichsmarks was out of the question. By keeping the MEFO bills contained to industrial sectors and pushing off redemption no new money entered the broader economy, and the price of everyday goods and services held steady.

This is somewhat of an over simplification. There were other levers pulled by the German economic czars to stymie inflation such as price controls, restrictions on pulling savings out of banks, and more.

It is estimated that almost a third of the German war effort was funded by spoils or confiscation from Jews.

In 1938, four years after the MEFO bills were introduced, it is estimated 12B Reichsmarks were outstanding, while there were 19B in standard government bonds outstanding.¹

Without the MEFO bill catalyst created by Schacht, Nazi Germany would never have been able to rearm and go to war. Financial engineering allowed pulling forward money without inflation, but had to be backed up by big guns and an iron grip on society.

1. Wikipedia, Kopper, Christopher (April 1998). “Banking in National Socialist Germany, 1933–39”. Financial History Review. 5 (1): 60. doi:10.1017/S0968565000001414. ↩︎

Comments

Join the discussion on 'German War Bonds'