The process of rearmament for the German military in the leadup to the Second World War was extremely expensive. It cost the German government 1% of GDP in 1933 and nearly 20% of GDP by 1938 [source]. Due to the massive costs associated with rebuilding its army and keeping up with the massive advances in technology and doctrine over the interwar period, the German government would increasingly begin to rely on budgeting tricks, most important of which were the MEFO Bills.
1. The MEFO Company
Rather than spending taxpayer money and borrowing vast sums of money that the German government could not sustain, the Nazi hierarchy used its close political ties with German industrial leaders to found the Metallurgische Forschungsgesellschaft in 1934 [source]. Best known as the MEFO company, this shell corporation existed outside of the German government and had no real operations. Rather than existing to provide goods or a service, the company’s sole purpose was to serve as a vehicle for the exchange of its MEFO Bills from the government to companies as payment for delivered armaments.
Not only did this company allow the government to sidestep the constraints of its own legal loan interest rates, by providing the government the ability to take on debts with companies at lower interest rates by paying with MEFO bills, but it also allowed rearmament to continue stealthily [source].
2. MEFO Bills
The German government issued MEFO bills as notes of payment that could be exchanged with the government. The government then provided any company exchanging this note an equivalent amount of gold-backed Reichsmarks to its face value alongside interest after six months, or before for a discounted amount [source]. The German government found these bills easy to issue due to their lower interest rates. Businesses took advantage of the influx of otherwise unavailable spending. Simultaneously, these businesses collaborated with Nazi Party officials to concentrate this wealth [source] [source]. Furthermore, despite the 90 day mark for return, the German government extended this day for five years, allowing it to avoid actually paying this vast quantity of debt for far longer.
By 1938, the German government officially reported that it retained 19 billion Reichsmarks in debt. However, it did not report the additional 12 billion Reichsmarks of MEFO bills that it owed money on. This unreported debt allowed the government to conceal its massive expenditures on rearmament from other governments and domestic audiences. As a result, this hidden debt hid the dire finances with which the Nazi regime built the German economy and army on [source].
3. Payment
Several million Reichsmarks of capital accumulated under the MEFO company’s name backed these MEFO Bills, via government and private investment. The German government made payments for discounted MEFO bills using money from not only the Reichsbank, Germany’s central bank, but also through funds stolen and seized from Jewish citizens and businesses [source]. Furthermore, by committing to the MEFO bill program, these armament companies were also able to benefit from the government’s good will in its“Aryanization” programs, where the government forced the sale of Jewish owned businesses to approved businesses at rates far below market value [source].
4. Effect
Through the MEFO Bills program, which ended on 1 April 1938, the German government funded a rapid expansion of industrial armaments production and employment programs that led to an economy with nearly no unemployment and low inflation [source]. Through this system of MEFO bills, which functioned as a second currency by 1936, the German government was able to break the constraints of its own budget by leveraging the wealth it stole from its people and later, the forced transfers of the gold reserves of Austria [source].
5. Why Does it Matter?
The development of MEFO bills showcases the manner in which even a poor government, lacking in revenue, can fund a serious program of armament. The international community targets rogue states with sanctions and other forms of economic warfare, in attempts to deprive them of critical weapons components and economic stability often required to finance military activity. And yet, countries such as North Korea under multiple different overlapping and interlocking sanctions regimes is able to maintain significant production of military armaments, to the point of being a major exporter of small arms and light weapons [source]. Furthermore, the North Korean elite live lavish lifestyles despite the economy of North Korea not being able to produce the kind of wealth that such lives depend on.
The economics of war do not need to be conventional, as a number of heterodox approaches exist for states to conduct armament. The Russian Federation has been in a state of default for its public debt due to much of its dollar reserves being inaccessible and in possession of the United States due to sanctions [source]. In order to utilise its economic influence abroad and continue to pay debts and incur further debts to finance its war in Ukraine in case of an energy price drop, which would cripple Russian finances, the Russian Central Bank is now considering the use of cryptocurrency for backing its loans and settling foreign transactions [source], allowing it to not only sidestep dollar constraints but also better hide its armament campaigns, much like MEFO Bills.
States, non state actors and individuals can improve their ability to forecast and predict state capabilities by understanding these out of the box financial options that are available to states, and the recourse states will adapt to in order to pursue goals on the international stage.
