People often wonder how the hell inflation got so badly out of control in Weimar in Germany. Well, you’re about to find out. And not just because I’ll write about it here…

You see, the same forces are at play again today. Fear of unemployment’s political ramifications for those in power, the need to fund bankrupt governments with newly created money, and a complete misunderstanding of how inflation actually works are the key elements which allow inflation to run riot.

Once these are in place, it’s a game of denial – how long you can ignore the obvious.

Does this mean we’re headed for hyperinflation? Sort of, but it’s still pretty unlikely. The chances of a change in course at some point are still far higher. Still, it’s the direction of travel, for now.

The Bank of International Settlements, which more or less predicted the financial crisis, is warning that high inflation is at risk of getting entrenched. And that entrenchment makes it all the more expensive to bring back under control. That’s the underlying force of hyperinflation, by the way. The cost of bringing moderate inflation back under control can feel too high.

We’re talking bankrupt governments, soaring unemployment, insolvencies and political revolution, as we’ll get to.

But, just as the general manager of the Bank of International Settlements explains: “The key for central banks is to act quickly and decisively before inflation becomes entrenched”.

So, pick your poison. Inflation, or risking a major financial, economic and political crisis.

In the short term, central bankers are trying to break inflation’s back… for the most part. Japan and the eurozone have bigger problems, apparently, and are focusing on the risk of a financial, economic and political crisis instead.

But why is stopping inflation so important? What could matter more than the financial system, the economy and the government?

“If it does [become entrenched], the costs of bringing it back under control will be higher. The longer-term benefits of preserving stability for households and businesses outweigh any short-term costs”.

So, if you agree that inflation must be brought under control at some point to prevent full-blown hyperinflation, you’re only increasing how dangerous things get over time if you delay. The longer you wait, the bigger the crisis and, at some point, it will deteriorate to the point where you might as well keep printing the money.

In the 1970s, central bankers and politicians decided to take the pain, eventually. During the Weimar period they did, too, but not until inflation ran completely out of control.

Sometimes the pain of ending inflation leads to nasty political consequences, as Adam Fergusson wrote in his book When Money Dies:

The reestablishment of monetary sanity, which bankrupted thousands, robbed millions of their livelihoods, and killed the hopes of millions more, indirectly exacted a more terrible price which the whole world had to pay.

Many people believe that the Weimar hyperinflation gave the Nazis their tailwind. But it was the deflationary shock and the work of bringing that under control that tells a more plausible story. Not that the two don’t go together.

The Bank of International Settlements’ entrenched inflation is what central bankers are trying to prevent right now. But, inside the eurozone, the appropriate monetary policy for high inflation would cause serious financial, political and economic issues.

Not only that, alongside the Bank of Japan, the European Central Bank (ECB) is worried about keeping its governments themselves funded. Their debts are so high that moves to steeper interest rates are unaffordable.

What explains the divergence between the central banks of the world? They’re all facing the same commodity prices and supply chain disruptions, after all.

Well, I’m a big fan of the public-choice school of economics. Ironically, given its name, public choice’s key tenet is that individuals – not institutions – make decisions.

The ECB and Russia don’t do diddly squat. The head of the ECB and Putin, however, do. Alongside all the other individuals in those places.

And, as impossible as it may seem, they all respond to the incentives they face as individuals, just like you and I do, not to “the greater good” or institutional mandates or some other rationale.

If you want to know what the Bank of England will do next, look at the incentives its leaders face, not the institutional structure or the law. It doesn’t matter what the Bank of England is supposed to do, or is tasked with.

Of course, mandates with consequences for breaking them matter to individual’s incentives. And we like our reputations to be good. But the idea of public-choice economics is that you should look at the incentives of the individuals in charge.

“Show me the incentive and I’ll show you the outcome,” explained Charlie Munger, summing up public choice economics in one sentence.

So, what incentives do central bankers face?

Do they get into any sort of trouble when inflation gets too high?

What about when their tight monetary policy triggers a recession?

As far as I can tell, there are no consequences for any of them. Except the Bank of England’s famous statutory requirement to formally explain away high inflation in a formal letter…

It’s not like you become a central banker in order to be popular with the public either.

No, central bankers are career bureaucrats and academics who are hired to do a job and do the job they are hired to do. That explains why their previously strongly held convictions go out the window when they’re hired and float right back in again after they’re too old to be hired for any similar job. Alan Greenspan being the best example, but that’s another story.

As for consequences for causing monetary mayhem, Christine Lagarde has already escaped any, despite being criminally convicted for financial negligence during her time as head of the French Finance Ministry. Perfect for running the ECB at a time like this, then, isn’t she?

I say that because the true incentives faced by modern central bankers today are different to the official version – what they’re supposed to care about.

The ECB is supposed to focus on inflation, for example. And yet, Lagarde must also try to keep the Italian government funded. It’s run by her predecessor at the ECB, after all. Who just happened to take over the ECB shortly after Lagarde departed from her post as French finance minister, during the European sovereign debt crisis…

Fund my deficit and I’ll fund yours…

But the point I want to make about public choice theories is that central bankers don’t all face the same sets of incentives.

In the US, UK and Australia, for example, inflation is the primary concern. And that’s why those central banks are tightening ahead of their peers elsewhere.

But that may be about to change thanks to the Weimar history tune playing in the background as I read the news.

A recession looks likely, bringing unemployment with it. Bond markets are already wobbling. Governments are polling badly. Debt is incredibly high because of the pandemic.

We face the choice again. Should we take the pain of bringing down inflation now, or later? I wonder what our politicians and central bankers might choose…

Nick Hubble
Editor, Fortune & Freedom