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Citi: When thinking about monetary policy today, think about hyperinflationary 1920s Germany

Sam Ro
Managing Editor

Trillions of dollars worth of bonds around the world now offer negative interest rates. In other words, trillions of dollars worth of bonds promise to lose money for investors.

This unusual situation is the result of easy monetary policy unleashed by central banks attempting to stimulate their local economies. In theory, the holder of cash is incentivized to spend, rather than put their money into a bank where negative interest rates eat away at their capital.

Unfortunately, there isn't a whole lot of precedent for negative interest rate policy. In fact, some warn that they theory is just flat out wrong.

"Negative interest rates don't do what they're theoretically supposed to do," DoubleLine Funds’ Jeff Gundlach said on Tuesday, citing Japan today. He added that negative interest rates "aren't leading to higher economic growth."

In the 1920s, German banknotes lost so much value that people would use it as wallpaper. (Image: Wikimedia Commons)

Germany, Havenstein, and Hyperinflation

In a note to clients on Friday, CitiFX analyst Gregory Marks considers the experience of Rudolf von Havenstein, president of Germany's Reichsbank from 1908 to 1923.

“During Havenstein’s time at the Reichsbank, it was widely believed that the rate of inflation and the money supply had nothing to do with each other,” Marks wrote. “For some context, the gold standard was suspended during WWI and Keiser Wilhelm II did not enact an income tax (unlike France) to pay for the war, choosing to pay by borrowing. The war was lost and over with, but the debt remained. In order to ‘help’ the government and people, old Havenstein went on a printing spree. Good idea right? Remember, at that time it was believed that the rate of inflation and the money supply had nothing to do with each other. The end result was crippling hyperinflation, economic collapse and a negative shift in the political spectrum.”

The structure of this thought experiment is a popular one. At various points in history, the world was flat, earth revolved around the sun, and bread was good for you. All of those ideas were later proven to be at least somewhat flawed.

“[W]e should be invoking Havenstein to identify the present flaw in institutional thinking around current monetary policy, specifically negative rates,” Marks added. “In other words, the lesson here is that, unfortunately, people believed in the efficacy of a completely irrational policy because it was put in place by a qualified and experienced policymaker­ this instead of questioning the common sense merit of its possible outcome.”

Long-term interest rates are negative in Switzerland and Germany. Meanwhile, rates in the US remain historically low. And central bankers around the world haven't ruled out the possibility that rates could go even lower.

"There are laws that prevent the medical industry from adopting experimental procedures before they become, well, less experimental,” Marks noted. “To not have those laws in place would be dangerous. Experimental procedures can produce unintended consequences and their efficacy must be rigorously tested before wide release and adoption. So as a society, we do not let doctors perform experimental procedures on everyone who walks through the hospital doors."

"Yet for some reason, there are a lot of PhD holders from a different industry who are doing just that to entire nations and economic zones. This isn’t a theoretical petri dish. It’s the global economy.”

Sam Ro is managing editor at Yahoo Finance.

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