Game Theory Strategies - When money becomes worthless

Written by Barry Hughes Friday, 10 February 2012 15:22
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Taken from Barry's site: Game Theory Strategies

Rudolf Havenstein was the president of the Reichsbank, the German national bank, from 1908 through the war years. After the war he was in charge of an economy struggling with burden of debt that had been used to finance the war and the need to pay reparations to the victorious countries. The government had printed money to finance the war and this had led to growing inflation. During the four years of the war there had been a four-fold increase in the amount of money in the German economy and prices had more than doubled.

Prices continued to rise rapidly until by early 1920 prices had risen five times from where they had been at the end of the war, just two years earlier. At this point inflation slowed and Havenstein, along with the rest of the German government may have thought that the worst was over.

The chance to stabilise the economy was missed and the government continued to print more money. In the middle of 1921 inflation started to rise again and within a year prices had increased by 700%. Then the problems really started…

One trillion Marks

The following year the German people started to lose confidence in the Mark and tried to move their money into real goods like diamonds or gold. As demand for these stores of money rose their price rose and to fulfil the demand for more money to pay for the goods the government continued to print more. This lead to rapidly spiralling prices, known as hyperinflation.

Workers were paid two or even three times a day and rushed to spend their money before its value dropped. People even burned bank notes to keep warm as they had become worth so little and it was cheaper than buying coal. Havenstein had the Reichsbank’s printing presses running through the night and printing larger and larger denomination notes, eventually ending up with a trillion Mark note. It was worth one dollar.

The solution

Havenstein died in November 1923 and his successor, Horace Schacht, introduced a new currency, the Rentenmark. This new currency was backed by land and industrial goods and because of this it regained the confidence of the German people and the hyperinflation was stopped.

Coordination game

The example of hyperinflation in 1920s Germany shows how people only think paper money has a value through a huge coordination game. Money is ultimately just a fancy piece of paper. It only has value if everyone else thinks it has value. The financial system requires all the players in the game to believe that the bits of paper in their wallets and purses have a value.

It only takes a few people to start to doubt whether others will accept their paper money in return for goods and the system collapses very rapidly. Once the coordination between all the players is lost then the equilibrium will very quickly unravel and the paper money becomes worthless.

Last modified on Friday, 10 February 2012 15:40

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