Last week, in a little-noticed story, the German government announced that on October 3 — the twentieth anniversary of German Unification — Germany would make the final payment on the debts it acquired through the allied demand for reparations in the aftermath of World War I. The timing of this development is interesting. It brings to mind one more example of the misguided economic policies that came in the wake of the First World War, which contributed to the financial collapse that brought about the Great Depression. We now know that these polices — which included the passage of the Hawley-Smoot Tariff that raised import duties to their highest level in American history, competitive devaluation of currencies among the leading industrialized nations, and other protectionist measures such as exchange controls — were contributing factors to the onset and severity of the Depression. They also helped propel Adolf Hitler into power in Germany and hence had horrific consequences far beyond mere economics. How did the world get into this mess? And are we in danger of repeating some of the same mistakes today?
In the wake of the carnage wrought by the world’s first truly “total war” — the British alone lost over nineteen thousand men on the first day of the Battle of the Somme — the desire for revenge against Germany was very strong, especially in France and Belgium, where large areas were devastated by the conflict. This sentiment, coupled with the fairly widespread belief among the allied powers that Germany was responsible for starting the war (Germany certainly bore a large share of the responsibility, but there were other forces at work as well), led to ever-increasing calls for Germany to pay for it. The allies had also taken on huge debts during the conflict, mostly owed to the United States, which emerged from the war as the world’s leading creditor nation. Based on these determinations, the allies included the so-called “war guilt clause” in the Treaty of Versailles, which stated that Germany must accept responsibility for “causing all the loss and damage to which the Allied and Associated Governments and their nationals have been subjected as a consequence of the war…”
Having concluded that Germany was liable for the cost of the war, the allies imposed a reparations regime upon Germany that called for a payment of 269 billion gold marks. The treaty also stripped Germany of her overseas colonies and investments, drastically reduced the size of her military, eliminated her merchant marine, and split the country in two so as to provide a corridor to the sea for the newly reconstituted country of Poland.
Needless to say, these measures placed a significant economic (not to mention psychological) burden on the inchoate Weimar Republic. This was especially true with respect to the reparations, for as John Maynard Keynes observed in his landmark work The Economic Consequences of the Peace, the reparations not only involved payments of gold and/or foreign currency, they also transferred important coal, iron and steel properties from Germany to France and prohibited their utilization by German industry. The treaty as such struck at the very heart of the German economy and made it much more difficult for Germany — even then the most important economic unit in Europe — to fully recover from the war.
It was only a matter of time before the German government defaulted on its reparations payments. When it did so in 1922, the French responded by invading Germany’s industrial heartland, the Ruhr. This in turn led to a campaign of passive resistance among German workers and the decision by the German government to continue to pay them, leading to hyper-inflation and the collapse of the German economy.
Even though the United States had rejected both reparations and the Treaty of Versailles, it was the US that ultimately came to Germany’s and Europe’s rescue in response to the 1923 “Ruhr crisis.” Under the terms of the Dawes (1924) and later Young (1929) plans, the total reparations due was reduced to 112 billion gold marks, and millions of private American dollars were pumped into the German economy to stabilise its currency and make it possible for Germany to pay her reparations. This in turn made it possible for the British and the French to make their war debt payments to the United States.
This inherently unstable system worked fine so long as American investors were willing to keep the flow of dollars moving into Germany. But when the bottom fell out of the US stock market in 1929 the flow stopped, the German economy once again collapse,; and with unemployment soaring, the popularity of the Nazi Party rose dramatically. In 1928, for example, the Nazis held only 12 seats in the Reichstag, but in 1930 they polled 107 seats and in 1932 they took 230, making Hitler’s party the largest in the German Parliament. Within a matter of months, Hitler was appointed Chancellor of Germany and the fate of the world would never be the same.
None of this happened overnight. It took some time for these events to unfold, which is why in hindsight the actions of the governments involved look so disturbing. With Germany experiencing a rapid economic decline after the 1929 crash, for example, the allies offered to reduce the reparations demands, but only if the United States would be willing to do the same with respect to the war debts. The Hoover Administration, however, refused to do so, even going so far as to insist repeatedly that there was no link between the two issues. Hoover did offer — and instigate — a one year moratorium on all inter-governmental debt in 1931, but this was too little too late. Moreover, to make matters worse, the US by this point had instigated the Hawley-Smoot Tariff, making it even harder for the European nations to earn the dollars they needed to pay off their American debts. By 1931, the situation had reached crisis proportions, and in response the British and many other smaller nations abandoned the gold standard and depreciated their currencies in an attempt to promote their exports and revive their domestic economies. This in turn hurt American exports and placed further downward pressure on domestic American prices, deepening an already bleak economic picture.
When Franklin Roosevelt took office in 1933, there were great hopes in London and Paris that he would be much more sympathetic to the British and French desire to reduce or even eliminate the war debts. This may have been the case privately, but the US Congress was in no mood to compromise. So the matter was left unresolved, and as the Depression continued, eventually the payments ceased.
As for the German reparations payments, they were suspended in 1931 and were not recognised as legitimate under the Nazis. But in 1953, the West German government agreed at a conference in London to resume paying its foreign bond obligations from the inter-war years. By the early 1980s, the entire principal on these bonds had been repaid. Also included in the London agreement was an understanding that Germany would not have to pay the interest on this foreign debt until it had achieved unification. With this accomplished in 1990, Germany began paying off the interest in annual installments, making the final payment of 70 million Euros last Sunday.
The experience of the inter-war years — including the determination that World War II was caused largely by economic forces — helped inspire the creation of the American-led postwar multilateral economic system based on freer trade and the free movement of capital that for the most part served the world well. But the nationalistic “beggar-thy-neighbour” impulses of the interwar years have not disappeared and are clearly on the rise. Witness, for example, the tensions between China and the US over China’s refusal to raise the value of its currency (what Treasury Secretary Geithner calls “competitive non-appreciation”); the response of the US House of Representatives, which just passed a bill targeting Chinese imports; the widespread speculation that these tensions and others among the world’s emerging economies will lead to an all-out currency war; and the emerging anti-free trade stance among members the extreme right-wing of the Republican Party (61% of Tea Party members say they are opposed to free trade).
The experience of the 1920s and 30s taught our parents’ generation that economic nationalism is a double-edged sword. Recent events seem to indicate this is one lesson this generation has either forgotten or is prepared to reject, with unknown consequences for the future.
David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute.