How Prices Inflate: Lessons from Germany

In the case that we have inflation, it is a fair question to ask how exactly prices inflate? It seems to be much taken for granted that inflation would cause general rise in the price level. However, it is really not that straightforward. First of all, most people confuse monetary inflation (which is the technical definition of inflation) with price inflation (which is how it is commonly used).

In any case, when the system is flooded with additional dollars, how does this end up getting translated into prices, and furthermore, which prices does it end up getting translated into? Probably the best source to figure this out would be to see what happened during the most famous case of inflation that ever existed - Germany during the Weimar Republic in the early 1920s.

In Germany, the most immediate effect on a huge influx of additional currency in the system served primarily to drive down the exchange rate on the currency vis-a-vis other currencies. This was driven partially by true supply-demand imbalances but also on speculative activity. Given a drop in the exchange rate, the prices for imported goods would therefore rise, including the price of inputs, such as raw commodities. Given the US's massive reliance on foreign-produced goods, this would be a major impact.

While at first, internal prices would remain relatively stable and provide something of an anchor for the exhange rate, at some point if the government persists in printing dollars, internal domestic prices will ultimately rise, as will wages and other items. But that is an effect of persistent monetary inflation, and not short-term inflation. This does not mean that inflation will ultimately be persistent in nature? While the German mark was on a major devaluation trend, there were periods of stabilization and even currency strengthening that led to lower import prices during that interim period. Also during a major inflation, credit creation becomes massive which further increases the money supply.

Clearly there are differences between the US today and the Weimar Republic then. But history may be rhyming. The big difference today is the debt deflation happening. If you think inflation is coming strong, best to get back into, as Jim Rogers says, "unimpaired" commodities as they will once again feel the surest impact of this inflationary boom and dollar devaluation.