Mefo Bills: A Historical Embodiment of Modern Monetary Theory Principles

Abstract

Mefo bills, a financial instrument employed by Nazi Germany from 1934 to 1938, have traditionally been understood as a clandestine mechanism for deficit spending to fund rearmament while evading Reichsbank lending limits, which were capped at 100 million Reichsmarks, and Versailles Treaty scrutiny. By April 1938, approximately 12 billion Reichsmarks were outstanding, rivaling the 19 billion in official bonds. These bills expanded the money supply through a state-guaranteed, interest-bearing (4%) quasi-currency that circulated among firms and was unconditionally rediscounted at the Reichsbank. Viewed through the lens of Modern Monetary Theory, Mefo bills reveal structural parallels: sovereign credit creation funding priorities beyond taxes, constrained by real resources rather than solvency concerns. This paper delineates their mechanics, highlights their functional equivalence to MMT principles, and discusses the economic implications of off-books credit expansion.

1. Introduction

Modern Monetary Theory posits that currency-issuing sovereigns face no financial constraint in funding government priorities. Spending creates money ex nihilo, while taxes primarily function to control inflation and shape demand. Deficits expand net private assets if productive resources are available. Mefo bills, devised by Reichsbank President Hjalmar Schacht, mirror this logic. A shell company, Metallurgische Forschungsgesellschaft m.b.H. (MEFO), capitalized at 1 million Reichsmarks by arms manufacturers such as Krupp, issued promissory notes to pay government contractors. These notes were backed by the Reich and rediscountable at the Reichsbank, effectively bypassing legal restrictions on direct government borrowing. By 1938, approximately 12 billion Reichsmarks in Mefo bills had been issued, representing a peak deficit impulse of roughly 20-25 percent of GDP. This policy drove unemployment from 25 percent to near-zero by 1938, without immediate consumer inflation due to strong output growth and price controls. Although not legal tender, Mefo bills were functionally monetary, as firms frequently discounted them for wages and supplier payments, injecting Reichsmarks into the broader economy.

2. Mefo Bills: Structure and Function

Armaments firms received six-month Mefo bills, extendable up to five years, for Reich orders. MEFO, a shell company, accepted the bills and paid 4 percent interest. Holders could trade the bills among firms, discount them at commercial banks for cash, or redeem them at the Reichsbank, which provided unconditional rediscounting. Key structural features included:

• State-backed claims functioning as money: Mefo bills were negotiable like commercial paper, yet backed by the Reich, allowing them to circulate as quasi-currency in the industrial sector.

• Financing beyond revenue: The 12 billion Reichsmarks issued between 1934 and 1938 vastly exceeded the 100 million Reichsmark legal lending limit. New bills could pay off maturing ones, effectively allowing indefinite rollovers.

• Concealment: Mefo bills were off-books, hidden from public view and international scrutiny, until 1938. This allowed rapid rearmament without immediate inflationary effects.

• Liquidity injection: Approximately half of the bills were discounted for wages and supplier payments, spreading purchasing power into the broader economy while delaying inflationary pressure.

The limitations on Mefo bills—sectoral focus and termination in 1938—were administrative and political decisions, not structural constraints.

3. Modern Monetary Theory: Conceptual Framework

Modern Monetary Theory argues that a sovereign government issuing its own currency is unconstrained by revenue. Spending occurs first, creating money; taxes follow to manage inflation and redistribute resources. Deficits expand private net financial assets when productive resources are available. Rollovers of obligations can be perpetual, provided the real economy absorbs spending. MMT highlights the role of inflation and real resource limits as the true constraints, rather than solvency.

4. Structural Equivalence of Mefo Bills and MMT

The functional parallels between Mefo bills and MMT principles are clear:

Feature	Mefo Bills	MMT (Sovereign Fiat)
Mechanism	State-backed promissory notes, Reichsbank-monetized	State-issued fiat currency (reserves, keystrokes)
Purpose	Fund government priorities (rearmament) beyond revenue	Fund government priorities beyond revenue
Duration	Rolled 6 months → 5 years; indefinite structurally	Perpetual rollovers possible via issuance or central bank operations
Constraints	Real resources, output capacity, political tolerance	Real resources, inflation; taxes control excess demand
Political leverage	Bypassed budget scrutiny and lending bans	Budgets serve as policy instruments; no solvency constraint

Addressing Critiques

• Deferred, conditional claims: Mefo bills were functionally monetary as they circulated in business networks and were redeemable at the Reichsbank.

• Closed industrial network: While initially limited, discounting and wage payments injected funds broadly, indirectly reaching consumers.

• Reichsbank dependence: Monetization through the Reichsbank ensured that the bills functioned as state-backed credit, effectively equivalent to central bank financing in MMT terms. Differences, such as opacity and sectoral focus, reflect historical contingency rather than structural limitation.

5. Implications

Viewing Mefo bills through an MMT lens demonstrates:

1. Governments can operate beyond revenue constraints if sovereign credit is available.

2. Technocratic decisions about capacity, as exemplified by Schacht’s administration, shape the real limits of such systems.

3. Inflation serves as the primary economic check, rather than legal or political limits.

4. Off-books, state-backed credit can sustain significant economic mobilization, with output and price stability maintained until real capacity is reached.

Mefo bills, if continued indefinitely, could have financed governance and militarization beyond traditional budgetary limits, constrained primarily by real resources and output.

6. Conclusion

Mefo bills embody the principles now formalized as Modern Monetary Theory. Though historically temporary, sector-specific, and politically constrained, they structurally demonstrate how state-issued credit can fund government priorities independently of taxation. Recognizing their equivalence to MMT enriches our understanding of economic history and highlights the enduring power of sovereign credit mechanics.

References (Selected)

Alesina, A., & Ardagna, S. (2010). Large Changes in Fiscal Policy. Tax Policy and the Economy.

Blanchard, O. (2019). Public Debt and Low Interest Rates. American Economic Review.

Borio, C. (2014). The Financial Cycle and Macroeconomics. BIS Quarterly Review.

Hein, E., & Truger, A. (2010). Modern Monetary Theory and Its Implications. Journal of Post-Keynesian Economics, 32(2), 301–328.

Jordà, Ò., Schularick, M., & Taylor, A. (2015). Leveraged Bubbles. Journal of Monetary Economics.

Kelton, S. (2020). The Deficit Myth. PublicAffairs.

North, D. (1990). Institutions, Institutional Change, and Economic Performance. Cambridge University Press.

Peacock, A., & Wiseman, J. (1961). The Growth of Public Expenditure. Princeton University Press.

Tooze, A. (2006). The Wages of Destruction: The Making and Breaking of the Nazi Economy. Penguin.

Wikipedia. “Mefo bills / MEFO” (citing primary sources, Nuremberg EC-436).

Haas, et al. (2024). “The Mefo Operation.” SSRN.