The Arrival of Inflation Heralds the Dawn of a Great Partitioning

Part II of Volume II, Issue I

Cheap money—an incredibly popular and influential feature of finance that led to a surge of wealth, speculative trading and booms in ridiculous investments such as meme stocks and digital images of cartoon monkeys—died suddenly in 2022. It was 14 years old. Cheap money is survived by its estranged relative, expensive money.

The death has been attributed to a surge in consumer inflation that forced central banks around the world to aggressively lift interest rates to the highest levels in a decade and a half. The end of cheap money has been mourned throughout the financial world, most loudly in the US stock market, which saw its worst decline since 2008 amid the disappearance of what had come to be known as the “Fed put”: the belief that the Federal Reserve would always come to the rescue with a more market-friendly policy if stocks tumbled.

Cheap money’s demise caused similar grief in the bond market, where total returns were the most negative on record. Even the Treasury’s inflation-protected securities, the bonds known as TIPS that are meant to shield retail investors from the damage that inflation does to savings, lost almost 12% in 2022. The despair reached deep into the cryptocurrency market, which lost 70% of its value in 2022.

Now that the calendar has flipped to 2023, it’s clear the grief will continue while financial professionals and amateurs alike confront a new investing regime, the likes of which few have experienced… For market participants whose careers hold more tomorrows than yesterdays, 2023 will be the first full year of navigating a climate that’s not dominated by the halcyon glow of cheap money and plentiful liquidity...

- Bloomberg Businessweek, January 2023

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Editor’s Note: This is Part II of Volume II, Issue I of The Macro Value Monitor. Part I, Kipper und Wipperzeit, can be found here. A full PDF of this issue is available here.

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The story of Albrecht von Wallenstein, and the Kipper und Wipperzeit inflation of 1619-1623, is less well-known than some of the more infamous inflationary episodes in history, such as the Weimar inflation three centuries later in the same region, or the Great Inflation in the U.S during the 1970s. 

Yet it remains a poignant and relevant reminder to this day, both for its similarities to our present circumstances, and for what it holds in common with monetary devaluations throughout history.

Regardless of the events which push monetary authorities toward devaluation, and regardless of whether the currency being devalued is made of precious metals, or of paper and digital line items, the similarity of the end results echoes through history.  Once a devaluation begins, there is usually an initial economic boom as new currency floods into the economy.  That boom is eventually followed by rising prices, as goods and services equilibrate to the increased money supply.  As the rise in prices accelerates, the citizenry begins to lose confidence in the currency, and a financial bust ensues.

During the Kipper und Wipperzeit devaluation, the increasing output of copper-infused coins from the mints in realms loyal to the Holy Roman Emperor initially sparked a boom of production and trade.  As princes throughout the empire prepared for war after the defenestration in Prague, a competitive devaluation ensued as armies were raised and equipped. 

While Wallenstein and his consortium increased the copper content of their coins, neighboring states found themselves flooded with coins with less and less gold and silver, and those bad coins were being traded for their good coins of the same denomination.

In response, rulers in the surrounding realms “cried up” the value of their good coins by increasing their face value, which in turn impacted the exchange rate. 

In Vienna in 1618, Holy Roman Reichsthalers were traded one-for-one with gold Florins from the Republic of Florence.  By 1622, however, it took 10 copper-infused Reichsthalers to obtain just one Florin. 

As we discussed last year, a similar devaluation took place a century later in France.

As John Law employed the Banque Royale to increase the supply of paper livres by leaps and bounds, confidence eventually began to erode in the underlying value of the notes as prices began to rise. 

Despite decrees prohibiting the ownership and use of gold and silver in all but the smallest transactions, the note-denominated price of gold and silver eventually began to rise as well, as citizens increasingly lost confidence and exchanged their notes for the security of real assets. 

When Law realized that faith in the paper notes was eroding, he concluded that unless he reduced the number of notes in circulation, there would eventually be a crisis of confidence, since the number of paper livres then circulating had grown to double the value of gold and silver that existed in France. 

Yet when he announced his solution, a reduction of the supply of Banque Royale notes, along with a controlled devaluation of Company of the West shares in May 1720, it triggered the very crisis he feared, as a panicked rush out of paper livres into gold and silver ensued.  By early 1721, the price of silver had increased by an order of magnitude to 1000 paper livres.

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It is tempting to consider these episodes to be ancient history, except a nearly identical revaluation occurred just fifty years ago.