The Mefo Operation. A Macro-Financial Analysis of Camouflaged Sovereign Borrowing through Off-Balance-Sheet Fiscal Agencies, 1933-1945

Abstract

In the summer of 1931, Germany faced the nadir of the Great Depression. After the Machtergreifung of the Nazis in 1933, Hjalmar Schacht was appointed president of the Reichsbank and invented the “Mefo operation” to circumvent the Reichsbank’s legal constraints for credit expansion and finance German rearmament against the terms of the Treaty of Versailles. Mefo stands for “Metallurgische Forschungsgesellschaft”, a letterbox company set up by five German blue-chip companies and operated by staff from the Reichsbank and the military. Endowed with an equity of 1 million Reichsmark, Mefo was the debtor of commercial bills amounting to 12 billion Reichsmark. Despite its historical significance, the Mefo operation is still insufficiently theorised from a monetary theory perspective and is often explained away through the myth of “financial wizardry”. We approach the Mefo operation through the prism of the Monetary Architecture framework and perceive the Mefo company as an off-balance-sheet fiscal agency introduced to finance re-armament as a politically desired large-scale transformation of capital stock. We divide the Mefo operation into three distinct periods—the covert monetary financing stage (July 1933 to February 1936), the shadow money stage (February 1936 to March 1938), and the consolidation and war finance stage (April 1938 to May 1945)—and use balance sheet methodology to re-construct the underlying financial mechanics. On the one hand, we provide transactional balance sheets for an idealised depiction of flows and sketch stocks via snapshots of the monetary architecture as webs of interlocking balance sheets. On the other hand, we discuss how expansion, funding, backstopping, and contraction was planned ex ante and played out ex post. We find that against Schacht’s original plan, the Mefo bills ended up on the Reichsbank balance sheet where they were permanently funded until the collapse of German state structures in May 1945. We connect our balance sheet analysis to quantitative data of the Mefo company and the wider macro-financial environment in order to draw conclusions about the significance of the Mefo operation for the financial expansion after 1931.

Keywords: War Finance, Rearmament, Reichsbank, Monetary Financing, Shadow Money, Commercial Bills