Early 20th Century Germany: A Disastrous Stock Market

Benjamin Franklin was so enthralled by the prospect of long-term compounding that he found a way to teach Americans about it even after his death. When he updated his last will in 1789, two thousand pound sterling (about $4,444) each to Boston, Philadelphia, Massachusetts, and Pennsylvania and called for 200 years of compounding. At the 100 year mark, Franklin called for 75% of the money to go towards public improvements, and the remaining 25% should be allowed to compounding until 1989 when the remaining funds would be dispersed for public investment projects that would serve the purpose of improving the community and teaching Americans about the value of long-term compounding.

Franklin anticipated that, even with the 75% distribution at the 100 year mark, the $4,444 investment would grow into $36 million at the 200 year mark. That didn’t happen–in 1989, the final disbursements only hit $6.5 million because city managers charged high fees and spent long periods of time sitting on the money in cash. Franklin inadvertently taught us a few extra things about the finance industry, and how theoretical calculations about compounding can be obstructed by frictional fees and general interference with the uninterrupted act of owning productive assets that Franklin envisioned.

But the long-term lesson is that, even when things go wrong, compounding over the super long term can still give you favorable outcomes in the end. When someone gets skittish about the long-term future of the stock market in the United States, I direct them to study the long, long term results of the German stock market.

There is almost no major economy that had to face worse conditions than Germany in the first 25 years of the 20th century. World War I wiped out two-thirds of stock market returns in under four years, a period of time loosely analogous to America’s Great Depression. The inflation rate in 1923 was over 2,000,000,000%, delivering devastation to fixed-income retirees that were receiving fixed mark payments for life. This set the stage for the worst dictatorship ever seen in the Western Civilized world, and the German market met further hardship thereafter. Between the day that Hitler rose to power and his eventual suicide, the German stock market lost an additional 88% (this is on top of two-thirds market decline that had characterized the WWI years.)

During the 1910s, 1920s, 1930s, and 1940s, you could not have been in a worse place than relying on the German businesses that made up the stock market to deliver wealth. And yet, the eventual recovery of productive assets in Germany was so substantial that even German investors on the eve of this disaster still generated positive returns in the end.

The recovery of Germany got kickstarted between 1949 and 1959, a decade that saw 4,300% growth in the stock market. German stocks returned 13% annually from 1949 through 2014. Sustained periods of high-compounding like that can do wonderful things to cover up disaster. If you bought the German stock market in 1914, and held through 2014, you earned 4% annually over the century. You had Hitler…you had billion percent inflation in a year…you had 88% market declines. Those are characteristics that should be associated with permanent wipeouts.

Meanwhile, someone investing in German fixed income made no money over the century. If you had 1,000 marks in 1914, you had the equivalent purchasing power in euros today. You made no profit. There were no riches. No gains in purchasing power. You could have bought 1,000 Bratwursts in 1914, and you could have bought 1,000 Bratwursts in 2014. The German stock market investor, however, got to buy 38,000 Bratwursts a century later.

Ready for the really crazy part? The German stock market opened in 1685 as part of the Austria-Hungary Holy Roman Empire. It was one of the first things done by Charles VI after succeeding Joseph I. The returns since then have been 7% annualized, although certain parts of the late 1700s and early 1800s have been guesstimated because of unavailable records (the estimates are based on the economic output necessary to sustain colonial and war activities).

A mark invested in Austria-Hungary in 1685, without taking into account the required tax payments which would be considerable, compounded to $1.1 trillion euros today. A dollar! You’d own one-fourth of the modern German stock market if you had a mark in 1685 and managed to live for 330 years without paying taxes. Given the economic hardships and monetary policy disasters that occurred over that time frame, it is miracle that the compounding rate is so high (the United States has only delivered 8% compounding since 1802.)

It turns out, the story of Germany’s finest companies–Bayer, Allianz, SAP, BASF, and Siemens–growing from nothing to multinational powerhouses more than offset the failures everywhere else. Their performance was so strong that it even survived a near total annihilation of the currency, enabling stockholders to build long-term wealth while honest people seeking the safety and stability of bonds backed by the German government made no money over a century.

This is all a testament to the strength of productive assets. A lot of people think it took 25 years for the U.S. stock market to recovered from the 1933 crash. The beginning of 1959 is usually cited as America’s return to the peaks reached before The Great Depression. There’s a certain illiteracy involved in looking at the sticker price without understanding the mechanics behind it. Those Dow Jones figures neglect: (1) the removal of IBM from the Dow Jones Index as selected by Wall Street Journal editors, and the Dow missed out on a period of 19% annual growth, and (2) the very high dividends paid out during the Great Depression.

Chevron’s predecessor, the Standard Oil of California, had a 13.5% dividend yield during the worst of the Depression, and did not cut the dividend. It had more cash assets than its stock market valuation! People were getting 10% yields from AT&T. With reinvestment, people broke even by 1937. You had recovered from the Great Depression during the Great Depression if you possessed the resources to remain in the market and actually withstood the fear of the greatest test of economic fortitude in the country’s history.

These stories are important because they help us understand what an important force large businesses can be over the long haul. They are brute forces that conquer economic misfortune and disastrous monetary policy. Bonds do well as a hedge against the bankruptcy of individual firms, but are highly susceptible to inflation. I consider Germany a worst-case scenario, and even it overcame the early 20th century destruction.

And plus, my estimates assumed lump sum investments on the eve of disaster. Most people don’t invest like that–they gradually add as money from labor and other activities becomes available. A dollar-cost-averaging approach would have radically improved your results, although sadly, I don’t have the specific data to calculate the actual returns on the way to the 88% stock market decline that occurred over the span of Hitler’s rule. There is a reason Germany earned the nickname “the locomotive of Europe.” Its core material, consumer goods, and industrial businesses have driven the Germany economy and stock market forward out of the abyss and into the modern era in which it has the largest economy in Europe.