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Guest Post: When German Interest Rates Hit 9% Per Week

Tyler Durden's picture





 

Submitted by Bryan Taylor via Global Financial Data,

Yields on United States 10-year bonds rose above 3% at the beginning of January.  The yield on the 10-year had reached its lowest point in history in July 2012 at 1.43% as a result of the Fed’s policy of Quantitative Easing.  Since then yields have doubled as markets have incorporated the impact of the Fed tapering their purchase of U.S. Government securities. This raises the question, how high could interest rates go from here?  Could interest rates move up to 3% per quarter? U.S. interest rates were that high back in 1981 when the yield on US 10-year Treasuries hit 15.84% and 30-year mortgage rates hit 18.63%.
              
What about 3% per month?  That works out to 42% per annum compounded.  Although interest rates have never been that high in the United States, they have been that high in other countries. The yields on 3-year bonds in Mexico were over 50% back in the 1990s.  Other countries, mainly in the developing world where inflation was more common in the 1970s to the 1990s also experienced double or triple digit interest rates.

The Impact of Hyperinflation
              
Interest rates at that level can only occur because of inflation.  The problem is that as inflation rates rise, they become more unstable and unpredictable.  Consequently, the maturity of debt instruments shrinks as the uncertainty increases.  Annual interest rates become meaningless, and the maturity shrinks to months or days.

What about 3% per week?  At this level, the compounding of interest rates takes over.  An interest rate of 3% per week works out to 365% per annum.  Interest rates rose significantly beyond even this level during the German hyperinflation of 1923.  The interest rate charged at the Berlin Stock Exchange in October 1923 hit a high of 7950%, the equivalent of 9% per week.
              
Although this interest rate is high enough to even make a Payday Loan store blanch, it didn’t even come close to compensating for the inflation that occurred in October 1923. The monthly inflation rate in Germany during October 1923 was 24,380%, which far exceeded the 45% monthly interest rate implied by the 7950% interest rate the Berlin Stock Exchange charged. During that month, the US Dollar exchange rate went from 242 million Marks to the USD on October 1, 1923 to 100 billion Marks by November 1, 1923.

Investors and Speculators Get Wiped Out

At these levels of hyperinflation, interest rates become meaningless.  When prices are rising at the rate of 30% per day, as occurred during Germany in October 1923, fixed-income assets are completely wiped out by the inflation, and no one will deposit or lend cash that will become worthless in a few days.  During hyperinflations, the future ceases to exist and cash becomes the only medium of exchange as the value of assets with a maturity over a few days is completely wiped out.

Interestingly enough, government bonds rose in price along with inflation during 1923 in Germany.   The German 3% bond paying 3 marks in interest actually traded for 37 million Marks in September 1923, right before the inflation came to an end.  This provided a yield on the bond of less than one-ten millionth of a percent (i.e. 0.0000001%).  The price on the bond had risen from 475,000 Marks just one month before, and a chart of the stock is illustrated below.

Why, you might ask, would someone pay 37 million Marks for a bond that pays 3 marks in interest?  The answer is easy, speculators were hoping that once the inflation was over, the government would redeem the bonds at their inflation adjusted value.  The people buying the 3% Perpetuities of Germany thought the government would revalue the bonds providing them with both a hedge against hyperinflation as well as a huge profit.

The government, however, had a different point of view.  What is the point of having a hyperinflation if you don’t at least wipe out your government debt?  By October 1923, the German government was issuing 100 Billion Mark (100,000,000,000) banknotes (equal to 100 Trillion Marks by US measurement), and when the government finally did convert the currency from old Marks into Rentenmark, it took 1 trillion old marks to get a new Rentenmark.

What about government bonds?  What happened to them?  Did the speculators reap a windfall from the revaluation of the currency?  Of course not.

The German government decided that all outstanding bonds would be redenominated at one-tenth Pfennig on the Mark.  In other words, a government bond that had originally been issued at 100 Marks was now worth 10 Pfennig.  In effect, investors lost 99.9% of their investment.  The price of the bond traded up from there to reflect higher interest rates after the inflation was over with, but the difference was small.

The German bonds also traded in London where the price reflected the devaluation of the currency.  The value of the bonds on the London Stock Exchange fell from 100 Pounds to 5 shillings (25 pence), a loss of almost 99.9%. 

This proves two things. First, markets are efficient.  The net price in Berlin after the inflation and in London after the devaluation ended up the same.  Second, don’t try to outsmart the government who deals the deck of cards.  You will lose.
 

 


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Thu, 02/13/2014 - 15:41 | Link to Comment ACP
ACP's picture

Isn't that what the coming downturn is for, to get people back into gubmint debt?

Thu, 02/13/2014 - 15:45 | Link to Comment cossack55
cossack55's picture

Can't happen soon enough.

Thu, 02/13/2014 - 15:54 | Link to Comment James_Cole
James_Cole's picture

What about government bonds?  What happened to them?  Did the speculators reap a windfall from the revaluation of the currency?  Of course not.

...and everyone lived happily ever after. 

Thu, 02/13/2014 - 15:46 | Link to Comment PartysOver
PartysOver's picture

At least it was not a Default.  So they had that going for them.

Thu, 02/13/2014 - 16:02 | Link to Comment Occident Mortal
Occident Mortal's picture

A soaring stock market is no good for herding people into MyRA.

Let's be clear, all the USG is interested in now is getting domestic buyers to put money into financing UST.

It's the fucking law.

Thu, 02/13/2014 - 15:42 | Link to Comment Jonas Parker
Jonas Parker's picture

Coming soon to a country near me!

Thu, 02/13/2014 - 15:44 | Link to Comment PartysOver
PartysOver's picture

Break out the lube buddy.  Gonna need it.

Thu, 02/13/2014 - 15:46 | Link to Comment James-Morrison
James-Morrison's picture

It's what happens when the Government runs out of other people's money.

Thu, 02/13/2014 - 17:40 | Link to Comment Hobbleknee
Hobbleknee's picture

It will print more.

Thu, 02/13/2014 - 15:46 | Link to Comment Remnant_Army
Remnant_Army's picture

Here the Word.

Your money will be worthless and the only way to trade...

 

http://www.thewarningsecondcoming.com/media-and-other-censorships-to-com...

Thu, 02/13/2014 - 17:12 | Link to Comment epicurious
epicurious's picture

You forgor your sarc. notation.

Thu, 02/13/2014 - 15:48 | Link to Comment 0b1knob
0b1knob's picture

Actually if a person purchased German government bonds before the inflation and held them through to the issue of the rentenmark, they did get some sort of settlement.   They had to produce proof that they owned the bonds continuously during that period.   There was also some sort of settlement for people who had bank accounts continuously during that period.  They weren't made whole but they did get something.  Very few could provide such proof.

The German government refused to reward speculators.   Much like the US government today is stiffing the stock and preferred holders of Fannie and Freddie.   What else is new?

Thu, 02/13/2014 - 15:49 | Link to Comment monopoly
monopoly's picture

Are you kidding. 3% interest rate increase per year would destroy the global economy. At some point it will be over and the grand reset will take place. I know that it will happen, I just do not know when.

Thu, 02/13/2014 - 15:56 | Link to Comment CrashisOptimistic
CrashisOptimistic's picture

This "Great Reset" meme is popular on ZH, and it's wrong.

A "reset" implies that it is a fix and the world becomes buoyant and happy and all things are right and proper from then on.

What's coming is not a reset.  It's devastation, and it's of the F word variety.  Forever.

Thu, 02/13/2014 - 16:15 | Link to Comment Uber Vandal
Uber Vandal's picture

You mean THIS reset button?

 

Thu, 02/13/2014 - 15:51 | Link to Comment CrashisOptimistic
CrashisOptimistic's picture

Silly article.  Rates have been in decline for 30 years.  What precisely has happened that says GDP growth is about to explode, which is what is required for the yields to reverse their 30 year trend.

And no, don't talk about default.  The Fed deals with that.

Thu, 02/13/2014 - 17:01 | Link to Comment saveandsound
saveandsound's picture

Scarcity can trigger inflation. No need for GDP growth.

Did Zimbabwe have GDP growth prior to 2009?

So where is scarcity going to come from?

We will see.

Thu, 02/13/2014 - 17:58 | Link to Comment chubbar
chubbar's picture

The fed will deal with the default alright but they'll have to do so by monetizing the debt. 3%/quarter is north of 500 Billion in interest payments on gov't debt of 17 trillion and growing. That is in excess of tax receipts IIRC or close to it, annualized. I don't suspect there will remain a whole lot of confidence in the dollar as a store of value following that little revelation.

Thu, 02/13/2014 - 15:50 | Link to Comment Dr. Engali
Dr. Engali's picture

"Second, don’t try to outsmart the government who deals the deck of cards. You will lose."

Isn't that what the 200 million civilian owned guns are for?

Oops did I say that in my out loud voice?

Thu, 02/13/2014 - 16:35 | Link to Comment superflex
superflex's picture

Quite correct Doc.

I read the other day, the number of registered deer hunters in Wisconsin, Michigan and Ohio totals more than the 4th largest army in the world.

 

Thu, 02/13/2014 - 15:53 | Link to Comment Smegley Wanxalot
Smegley Wanxalot's picture

So we can hedge against this by buying turkish Lira, right?

Thu, 02/13/2014 - 16:29 | Link to Comment thamnosma
thamnosma's picture

I'm putting everything into Kazakh tenge...

Thu, 02/13/2014 - 15:55 | Link to Comment optimator
optimator's picture

The only ones that reaped enormous rewards were those in the Gold Mark, gold, or currency outside Germany such as the Dollar.

Thu, 02/13/2014 - 16:17 | Link to Comment Little Boomer
Little Boomer's picture

24,380% per mpnth bonds, bitches!

Thu, 02/13/2014 - 16:28 | Link to Comment youngman
youngman's picture

What is amazing about that time is that when they issued the new currency.....that people just accepted it...and all the hyperinflation stopped....it worked for some reason...and that was very very good for them..pretty amazing actually

Thu, 02/13/2014 - 16:40 | Link to Comment kaiserhoff
kaiserhoff's picture

Yes, that needs to be explored.  I suspect the liquidation of the old debts was the largest factor, but I've never seen a compelling explanation of why it worked.  Has never worked for Argentina, or any other place I'm aware of.

Thu, 02/13/2014 - 16:31 | Link to Comment CapitalistRock
CapitalistRock's picture

Speculators were driving the worthless bonds into the stratosphere? No. The central bank was. Just like they are today. This is a critical distinction. As America chugs into a high inflation environment "interest rates" as measured by treasuries will remain near zero because the federal reserve is doing all the buying using their new dollars. The same happened in Germany.

Thu, 02/13/2014 - 16:30 | Link to Comment TeddyBear
TeddyBear's picture

 

This post is not on rates.

RED ALERT!!!

Charts tell me terror attack soon!!!

Bonds & gold up. Transports down.

Lets see if I can call this from charts alone:)

 

 

Thu, 02/13/2014 - 16:36 | Link to Comment superflex
superflex's picture

Silver just broke $20.50.

You may be on to something.

Thu, 02/13/2014 - 16:56 | Link to Comment NotApplicable
NotApplicable's picture

According to the chatter I've seen, isn't the collapse supposed to be this Saturday?

Wed, 02/19/2014 - 21:28 | Link to Comment TeddyBear
TeddyBear's picture

 

 

Yes I can!!!

US issues warning about shoe bombs on airplanes bound for US By REUTERS 02/20/2014 01:35 WASHINGTON - US authorities issued a warning on Wednesday to airlines flying to the United States to watch out for militants who may have hidden bombs in their shoes, US government sources said.
The warning came from the Department of Homeland Security, the sources said, and it is consistent with concerns security agencies have about militants trying to smuggle explosives onto airplanes in shoes, cosmetics or liquids.
The sources said the warning principally applied to flights originating overseas and heading for the United States, rather than domestic flights or planes headed overseas from the United States.
http://www.jpost.com/Breaking-News/US-issues-warning-about-shoe-bombs-on... ------------------------- People are trading on news not yet public. A la Martha stwTard... My Charts don't lie. Gold should retest 1300, New buys will spook & sell it to 1270s.
Do NOT follow this link or you will be banned from the site!