MEFO Bills: Or how the Nazis created a Ponzi scheme to rearm Germany

 This little blog post is about a bit of economic history that tends to be glossed over in many history books, at least those without a strong economic focus. In fact, it's both ingenious and moronic in equal measure, but the Nazis made heavy use of it to rearm for what would be World War II and I wanted to cover it.

First some background. After World War I, Germany was forbidden to rebuild their military beyond a pitiful level, mostly because the guys who won did not want Germany trying to go for round 2. Of course, the Nazis had every intention of going for round 2, but they needed to find a way to pay for the rearmament expenses without getting caught, and also do so without scaring away people because they were a terrible credit risk. It's really hard to do both because credit requires public records of your ability to pay back debts to act as a basis for your ability to get credit. At least, that's how it usually works.

The Nazis thus had to get a ton of money by hook or by crook, mostly the latter, but it had to be able to hide how much money it pumped into military spending. This required both they and the people they had received funding to be able to hide where it came from and the amount spent. This required the Nazis, the industries who collaborated with them, and most important, the Reichbank (the main bank of Germany then) to all cooperate for this goal in a corrupt and shamelessly illegal scheme to move tons of money secretly without getting caught. Worse, tons of money it ordinarily did not have and had to lie about to move under any circumstance.

The Nazis were obviously going to keep their mouths shut, and the industrialists were also going to keep their mouths shut, but how do you get a bank to shut up, especially when they are required by law to be public about the money they lend, even to and especially the government and major industry to prove both sides are solvent and able to toss around huge amounts of money without going broke?

Enter Hjalmar Schacht.

Schacht was president of the Reichsbank when the Nazis came to power and one of the guys in on the Nazi plans to rebuild the military. Unfortunately, the Nazis started during a worldwide depression, there were official caps on the interest rate and max amounts of loans the Reichsbank could issue, and ordinarily, even if all parties agreed to hide the records, what they could NOT hide was how the official books of the money being moved around did not match up. Given they had to work with banks from other countries, this was really important for international trade, honesty was required so they knew they could give and send money and the other guy would not stiff them.

Even inside Germany itself, you can't just print money in bulk without it becoming valueless because the ability of it to be redeemed in real currency is far outstripped by the fact you printed a ton of paper with nothing to back it like gold, silver, or market value of goods to give it value. Such was the theory even then and is still true for basic finance in any competent economics course.

Schacht hit upon an ingenious way to pull this off called the MEFO bill.

MEFO is short for "Metallurgische Forschungsgesellschaft" (Society for Metallurgical Research), a shell company that was set up as a front for this little scheme. The company existed only on paper, its address was a letterdrop for appearances but it did not do any business at all. Instead, it existed so the Nazis could pay for their rearmament without being caught. The Reichsbank via Schacht was in on this, and they used MEFO to launder the money.

Established in 1934, MEFO could, like any legitimate company, make bills of exchange for goods and services rendered. The thing is, the bills they issued were backed by nothing except a promise they were worth money. That would be the kiss of death for them legally if the guys who were paid with said bills were not in on it. IRL, this is textbook fraud and the slightest transparency would see all involved sent to prison for money laundering and illegal financing.

Since all the parties involved were in this scheme, this was not a problem. In fact, what would happen is MEFO would issue a MEFO bill to a company that needs a certain amount of Reichsmarks (the then German currency). The Reichsbank being in on it, would accept the bill and convert it into a set amount of actual Reichsmarks as a loan to a company. The Reichsbank had a hard cap it alone (without someone else being willing to cover the liability if the debt was not repaid) could be issued legally, but the MEFO company did not have this constraint, and since all sides involved agreed to hide all the records, none of the actual money exchanged was officially recorded.

Now, given these bills legally had 90 days before they had to be cashed and thus recorded, you'd think this scam to provide money out of nowhere from a fake company in collaboration with the highest German bank would come out, right? Well, the Nazis considered that and made sure to officially delay the need to record any transactions for a five-year delay. If it wasn't for the fact everyone involved was keeping secrets, this would never fly in reality and smacks so hard of fraud and money laundering that it would be flagrantly illegal. Worse, a delay of that long makes no sense usually because you need to know you can actually get a loan in real money and have it paid back before the interest rate of the money gets too high from failure to pay (unless you want to have to pay back far more than you borrowed).

That said, despite the fact this was supported by no proof the money loaned was backed by anything, all parties concerned had reasons to never reveal the truth. The German military and Nazis needed to rearm, the industrialists they worked with needed the money to help them do this, and the Reichsbank via Schacht also wanted to see rearmament and was willing to flout both German finance law and the Treaty of Versailles (the World War I ban on the rearmament of Germany post WWI).

This little Ponzi scheme finally went public in 1938 (when the Nazis shed any remaining desire to hide their rearmament even though the whole world had already figured it out by this point), but even then they presented heavily cooked books to show a false amount of MEFO debt being recorded. Of course, in building up all this phantom debt that needed real money to cover it, they had to do all sorts of shady accounting tricks and robbing Peter to pay Paul (in many cases literally, they expropriated property from the Jewish people they persecuted and sold it off to cover some if not all of the debt, and also ripped off places like Austria and Czechoslovakia after taking them over), but the Nazis figured a successful war would net them so much profit the debt and its interest would be paid off by conquest.

And so, in 1939, they went to war figuring they could steal all they needed to pay back the immense debt this fake money scheme built up from everyone they conquered. It kinda worked short-term, but long-term, since Germany was defeated, that financial chicken came home to roost and the whole ugly scheme was laid bare during the Nuremberg Trials in 1946.

The following links are recommended for further reading:

https://greydynamics.com/the-economics-of-war-mefo-bills/

https://avalon.law.yale.edu/imt/chap16_part12.asp