Tax Reform, Currency Reform, and Deregulation: Recipe for an Economic Miracle

To even attempt to reconstruct Germany from the near-total devastation of WW2 was an audacious thought. Millions of civilians had died in bombing raids, millions of young German men had died in combat, and millions of Jewish Germans had died in Hitler’s horrific genocide.

Physically, the nation’s infrastructure was utterly shattered: roads, telephone lines, electrical power lines, water pipes, sewage pipes, bridges, and roads were in many places nonexistent.

The economy had been smothered by Nazi policies of wage control and price control: the government had dictated the exact price of nearly every retail product from bread to bedsheets, and had dictated the exact wage of everyone from teachers to dentists.

Hitler had further damaged the economy by printing huge amounts of money: this was how the Nazi government paid for its war efforts. Further, the German civilians had suffered under crushing taxes.

The victorious western Allies kept these Nazi policies in place at the war’s end in May 1945. In the east, the Soviets established a socialist dictatorship which ended any hopes for personal freedom or individual political liberty.

In the West, the Allies - France, Britain, and the United States - retained Hitler’s economics, in part because some of them wanted to ensure that Germany would remain weak. The French in particular were vindictive. The British wanted to continue the damaging policies because they had not realized how utterly such policies would prevent any form of growth or prosperity. Among the Americans, some agreed simply because they didn’t know what to do, and because they wanted to get along with the other Allies. Some Americans, like Henry Morgenthau, wanted to utterly dismantle Germany’s industrial base, and keep it permanently in the ‘third world’ status.

Eventually, the Allies saw that a strong West Germany was the only effective defense against the Soviet Union. The USSR was ready to expand westward, and West Germany was the first line of defense. A weak West Germany would have been quickly overrun by the Soviets.

Gradually, the Allies turned control of the country over to the Germans. Initially, in 1945, the occupying Allied armies controlled everything in the country. By 1949, the Germans were able to elect their first chancellor, Konrad Adenauer, and operate with near-complete independence. The Allies retained some influence, but let the Germans, for the most part, run their own country.

As the Germans regained control of their own country, they worked to shed the economic policies which had caused so much suffering. Freedom returned to ordinary transactions: merchants were free to set prices, and consumers free to bargain.

The oversupply of currency was reduced. Currency oversupply had created inflationary pressures, which had been kept in check only by wage and price controls. But those controls, in turn, had given rise to widespread black market activity.

Concurrent with this deregulation and currency reform, a third aspect of Germany’s economic rebirth was tax reform, as David Henderson explains:

Along with currency reform and decontrol of prices, the government also cut tax rates. A young economist named Walter Heller, who was then with the U.S. Office of Military Government in Germany and was later to be the chairman of President John F. Kennedy’s Council of Economic Advisers, described the reforms in a 1949 article. To “remove the repressive effect of extremely high rates,” wrote Heller, “Military Government Law No. 64 cut a wide swath across the [West] German tax system at the time of the currency reform.” The corporate income tax rate, which had ranged from 35 percent to 65 percent, was made a flat 50 percent. Although the top rate on individual income remained at 95 percent, it applied only to income above the level of DM 250,000 annually. In 1946, by contrast, the Allies had taxed all income above 60,000 reichsmarks (which translated into about DM 6,000) at 95 percent. For the median-­income German in 1950, with an annual income of a little less than DM 2,400, the marginal tax rate was 18 percent. That same person, had he earned the reichsmark equivalent in 1948, would have been in an 85 percent tax bracket.

Adenauer appointed Ludwig Erhard to address economic policy. Together, Adenauer and Erhard took Germany from its Stunde Null - its ‘zero hour’ and historic reset after the war’s destruction - to its Wirtschaftswunder - its ‘economic miracle’ which is not a violation of natural laws, but merely the predictable and replicable application of the laws of economics.

In less than a decade, Germany went from a likely candidate for permanent ‘third world’ status to the most powerful and quickest-growing economy in Europe, and one of the most significant economies in the world.

The Struggle for Economic Freedom: Postwar Germany

The end of WW2 in May 1945 brought freedom for the Germans. A dozen years of ghastly atrocities inflicted by the Nazi government were over. The people would finally be able to experience liberty.

Or so it seemed.

But freedom didn’t arrive easily or quickly.

The eastern portion of Germany was swallowed up into a Soviet socialist dictatorship. Freedom wouldn’t arrive for another 45 years in that place.

The western portion was governed by occupying military powers: French, English, and American. Although these western Allies represented liberty, they kept Hitler’s economic policies in place. These were the policies which enslaved the people and fueled the horrors of the Holocaust.

Nazi economics were based on high rates of taxation, government control of wages and prices, and a huge money supply. The Nazi government dictated the retail prices of everything from bread to shirts, and it dictated the wages of everyone from taxicab drivers to engineers. There were no free choices for consumers.

To pay for its war efforts, the Nazi government printed huge amounts of money. Oversupply of money causes hyperinflation. The Nazis avoided hyperinflation by strict price controls, which led, however, to shortages of retail goods.

The occupying Allies kept this system in place for several years after the war’s end. Historian Thomas Hazlett writes:

The Allies were thorough in their regulation of Germany. Censorship was so tight, for example, that James T. Farrell’s popular novel Studs Lonigan was declared contraband. The victors attempted to administer the economy through a patchwork assortment of price regulations, allocation details, and rationing. In the fall of 1946 the mechanism had reached bankruptcy, the officially rationed food allotment being under 1,500 calories per person per day. Ludwig Erhard was to report: “All attempts at mending matters were frustrated, not only by the prevailing conditions of devastation, exhaustion and disruption, but also by the supposed experts, in and outside Germany, clinging tenaciously to their reliance on controls. The people worked on doggedly, tormented by hunger and exasperated by zonal restrictions, corruption and the black market.”

The Allies gradually allowed the Germans to form their own civilian government. Ludwig Erhard and others persuaded the Allies to let the Germans form their own economic policies.

In 1948, Erhard oversaw a radical currency reform, in which the amount of money in circulation was significantly reduced. At the same time, Erhard phased out wage and price controls.

This was the turning point which allowed Germany to rescue itself from become a permanent member of the ‘third world’ group of nations. This was Stunde Null - the ‘zero hour’ of a massive economic reset. This was the beginning of the Wirtschaftswunder, which was not an ‘economic miracle,’ but rather the predictable and replicable results of economic laws.

In a single decade, Germany would rise to be the strongest and largest economy in Europe, and one of the most powerful economies in the world.

Germany's Big Choice: Postwar Economics

After WW2 ended in 1945, the USSR controlled the eastern part of Germany, and imposed there a socialist dictatorship. The western Allies - England, France, and the United States - administered the western side of the country.

Over the next several years, the western Allies gradually turned control over the Germans, who began to govern themselves. In 1947 and 1948, the Germans were making important decisions about economic policy, but the Allies still had the final power to approve or reject any legislation.

One central question faced the Germans: should they continue the economic policy of control, which the Nazis had imposed on the them in the 1930s and which the Allies had continued to impose at war’s end? This policy meant that the government dictated the retail price of everything from shoelaces to paint, and dictated the wages of everyone from the gardener to the surgeon.

This policy also included high rates of taxation. The combined effects of price controls, wage controls, and high taxes had inflicted misery on the Germans for over a decade.

Ludwig Erhard was an economist who’d opposed Hitler’s government during the war, and now, in peacetime, wanted to free people from the last vestiges of Nazi oppression. The Germans debated among themselves about how to move forward, as David Henderson writes:

Ludwig Erhard won the debate. Because the Allies wanted non-­Nazis in the new German government, Erhard, whose anti-­Nazi views were clear (he had refused to join the Nazi Association of University Teachers), was appointed Bavarian minister of finance in 1945. In 1947 he became the director of the bizonal Office of Economic Opportunity and, in that capacity, advised U.S. General Lucius D. Clay, military governor of the U.S. zone. After the Soviets withdrew from the Allied Control Authority, Clay, along with his French and British counterparts, undertook a currency reform on Sunday, June 20, 1948. The basic idea was to substitute a much smaller number of deutsche marks (DM), the new legal currency, for reichsmarks. The money supply would thus contract substantially so that even at the controlled prices, now stated in deutsche marks, there would be fewer shortages. The currency reform was highly complex, with many people taking a substantial reduction in their net wealth. The net result was about a 93 percent contraction in the money supply.

The debate about the money supply had been a technical one: until 1945, the Nazi government had financed its aggression by printing currency which it used to pay for war supplies. This massive flood of currency would have led to hyperinflation, but the Nazis prevented that by using strict price controls. The price controls tamed inflation, but led instead to extreme shortages.

So, if money supply was the first part of the debate, price controls were the second part. Both were important, but price controls were more easily seen as a direct attack on personal freedom. The German people had been tormented by over a decade of totalitarian controls in which the government dictated the prices on all retail goods.

Ludwig Erhard saw deregulation of the market not only as an economic step toward growth, prosperity, and the rebuilding of a nation destroyed by war, but also as a step toward personal freedom and individual liberty. Consumers were free to go to different stores, compare different products at different prices, and make a choice.

So it was simultaneously that the German government contracted the money supply while deregulating its markets:

On that same Sunday the German Bizonal Economic Council adopted, at the urging of Ludwig Erhard and against the opposition of its Social Democratic members, a price decontrol ordinance that allowed and encouraged Erhard to eliminate price controls.

That was merely the beginning. The money supply was contracted, for the most part, all at once. But the deregulation went on, bit by bit, in different sectors, on wholesale and retails prices.

At the same time, Erhard also began advocating for the strategy of lowering taxes. When Konrad Adenauer was elected to be Germany’s first chancellor in 1949, he would appoint Erhard to oversee economic policy. David Henderson notes that

Erhard spent the summer de-­Nazifying the West German economy. From June through August 1948, wrote Fred Klopstock, an economist at the Federal Reserve Bank of New York, “directive followed directive removing price, allocation, and rationing regulations.” Vegetables, fruit, eggs, and almost all manufactured goods were freed of controls. Ceiling prices on many other goods were raised substantially, and many remaining controls were no longer enforced. Erhard’s motto could have been: “Don’t just sit there; undo something.”

In 1948, Germany faced a monumental choice: continue the oppressive fascist economic system of high taxes and government-controlled prices, or deregulate the economy and create a free market. Because they chose the path of freedom, Germans enjoyed an amazing level of prosperity only a few years later.

Because they went from a ruined nation to a prosperous economy, and because they were not permanently cast onto the heap of ‘third-world’ nations, history books routinely refer to this as the Wirtschaftswunder - the ‘economic miracle’ - which was, in fact, no miracle at all, but merely the predictable and replicable results of the laws of economics.

Women in Germany - Seeking Value and Seeking Values

During the first decade or two of the twenty-first century, women in Germany continue to refine their roles in society, in business, in government, and in the family.

Given that Germany's chancellor, Angela Merkel, is regularly listed not only in Forbes magazine’s list of the world’s most powerful women, but also in its list of most powerful people, German females need little convincing that they can play influential roles.

They seem now to be asking questions, not about what they can do, but rather about what they want to do. Having proven that they can rise to the highest levels, they can now ask if it should be assumed that they must always want to do so.

Rather than fighting for economic or political power, German women seem to be working for the right not to be forced into business or politics. Why should anyone assume that women with university educations automatically want to devote the bulk of their lives to careers?

An interesting consequence of this trend is that men, too, are beginning to ask why professional activities are expected to be the core of man’s identity, instead of, e.g., his roles as husband or father. Germans, who still lead most of the world in efficiency and productivity, are asking if they can prioritize family life above the work world. In July 2014, Rose Jacobs wrote in Newsweek magazine:

Where American women can only dream of a system that encourages men to share more of the burdens of family life, Germany has replaced maternity leave with “parent time,” offering up to 14 months’ paid leave to couples who both take time off after their child’s birth.

Placing family ahead of career doesn’t mean surrendering the option of being active in business or politics. German men and women both want that alternative left open to them. But they don’t want to sacrifice the chance to be fully engaged parents and spouses - two roles regarded by many people as life’s most meaningful experiences.

The numbers show that women don’t have to surrender political influence to be active mothers and wives: while Germany has more full-time stay-at-home mothers than the US or the UK,

The US and the UK both have a lower proportion of women in their legislatures.

So German women win on both fronts: they can fully rival the men in the political world, and yet not be forced into the monotony and drudgery of full-time, lifelong employment in the business or political worlds.

Hitting Bottom: Postwar Germany

When WW2 ended in May 1945, nearly everyone in central Europe was relieved that the fighting was finally over. But other difficulties soon appeared.

The economy and infrastructure had been so damaged that mere physical survival was a full-time occupation for many people. They devoted their days to finding food, and some starved.

Germany had been carved into four sectors, one for each of the victorious Allies: the USSR, the USA, France, and Britain. The Soviet zone soon isolated itself, and the remaining three zones began, for practical purposes, to merge into a single territory, which would eventually become West Germany.

Starting in the early 1930s, the German economy had been savagely abused by the Nazis: the government had controlled the prices of retail goods and the wages of workers. Tax rates were high. These brutal policies kept the populace in misery.

The Allies, who controlled Germany as an occupational force after the war’s end, did not rescind Hitler’s policies. The three western Allies, each for its own reasons, kept the economic cruelty in place. Thomas Hazlett writes:

In the eastern zone, the Russian formula was basic: loot everything of value. In the west, however, there was a different problem: total indecisive ness. As Wilhelm Roepke relates: “Among the victors only Russia could be said to have had a German policy at all.” The western zones were afflicted by an acute case of disarray, and government policy fluctuated among the vengeance of the French, the reformist zeal of the British (Laborites), and the bewilderment of the Americans. About the only consensus to be found anywhere was to rely on economic controls.

It would not be until 1949, when Konrad Adenauer became Chancellor and appointed Ludwig Erhard to address economic concerns, that the suffering would begin to end. Together, Adenauer and Erhard initiated policies of deregulation and lower tax rates.

This was the moment of Stunde Null - the ‘zero hour’ when there was a monumental historical reset: a chance to start over and rebuild the economy.

Adenauer and Erhard allowed the consumers, merchants, and manufacturers to have a degree of free which they’d not experienced in over a decade. The result was the Wirtschaftswunder - the ‘economic miracle’ of amazingly quick growth. Germany would become, within a decade or two, the most powerful economy in Europe, and one of the most significant economies on the planet.

Whither Deutschland - Debating the Direction for the Postwar Economy

Before and during WW2, German scholars saw clearly the misery inflicted by the Nazis, and began to think about how to develop a better politico-economic system. One group of professors in Freiburg formed a group known as the Freiburger Schule.

This group, composed mainly of thinkers in the fields of economics and political science, included Walter Eucken, and had significant influence on the post-war policies of chancellors Konrad Adenauer and Ludwig Erhard.

The Freiburger Schule emphasized that the dignity and value of human life could be respected only in a society whose government also respected property rights: low rates of taxation and free domestic markets.

Parallel to the Freiburger Schule was another group, the Freiburger Kreis. The membership was to a significant extent overlapping between the two.

The Freiburger Kreis was less engaged in technical economics, and more concerned with a moral and cultural analysis of the situation in the late 1930s and early 1940s. It came to the conclusion that people who considered themselves followers of Jesus had a moral obligation to oppose Hitler’s government.

Both the Freiburger Kreis and the Freiburger Schule had connections with anti-Nazi resistance groups throughout Germany, and with anti-Hitler leaders like Dietrich Bonhoeffer. The Nazis executed members of both groups who’d been complicit in the July 1944 assassination attempt on Hitler.

The groups also had contact with a larger underground network outside of Germany. Scholars like Wilhelm Röpke had been forced to flee Germany when the Nazis took over in 1933.

Yet Röpke remained, by means of published articles, a part of the discussions held by the two groups. Referring to the Freiburger Schule as the ‘German school,’ David Henderson writes:

Among the members of the German school were Wilhelm Röpke and Ludwig Erhard. To clean up the postwar mess, Röpke advocated currency reform, so that the amount of currency could be in line with the amount of goods, and the abolition of price controls. Both were necessary, he thought, to end repressed inflation. The currency reform would end inflation; price decontrol would end repression.

The groups in Freiburg dealt with economic questions: how to revitalize Germany which had been devastated by Nazi monetary policies, by wartime bombing, and by the Allied occupation. They also considered social and political forms: how to increase personal freedom and political liberty, to prevent a repetition of dictatorship’s horrors and enable prosperity. They pondered moral and social questions: the obligation to oppose Hitler was tied to the obligation to respect the dignity of human life, including the obligation to respect property rights.

The last point followed from this line of reasoning: if a person spends time working to earn money, and the government confiscates money, the government is essentially confiscating time. Because life consists of time, the government would be confiscating a person’s life, which would amount to slavery or murder, an accurate description of the Nazi regime.

To control retail prices, or dictate wages, is likewise a violation of a human being. These Freiburg discussions, held before the fall of the Nazi government, constituted a radical resistance, treason against Hitler, and a courageous stand for human dignity:

Ludwig Erhard agreed with Röpke. Erhard himself had written a memorandum during the war laying out his vision of a market economy. His memorandum made clear that he wanted the Nazis to be defeated.

Although several members of the Freiburger Kreis and the Freiburger Schule were murdered by the Nazis, those who lived faced opposition after the war.

As the postwar situation clarified, two large political parties emerged in West Germany, the SPD and the CDU/CSU, alongside several minor parties. Among those minor parties was the FDP. The SPD wanted to keep in place the same economic program which had been in operation since the mid 1930s.

More a scholar than a politician, Ludwig Erhard eventually made his home in the CSU/CDU. He could have easily wound up in the FDP. Both the CDU/CSU and the FDP were friendly, in slightly different ways, to Erhard’s views. David Henderson describes the opposition to the program of the Freiburger Schule.

The Social Democratic Party (SPD), on the other hand, wanted to keep government control. The SPD’s main economic ideologue, Dr. Kreyssig, argued in June 1948 that decontrol of prices and currency reform would be ineffective and instead supported central government direction. Agreeing with the SPD were labor union leaders, the British authorities, most West German manufacturing interests, and some of the American authorities.

Despite this opposition, Adenauer and Erhard were able to implement policies of lower taxation and deregulation. This ushered in the Stunde Null - the ‘Zero Hour.’ This was a pivotal historic reset, a chance to restart after the destruction of the war.

Adenauer became chancellor in September 1949 and held office until 1963. Erhard was chancellor from 1963 until December 1966. During these years, the high tax rates from the Nazi era were reduced, and the price controls and wage controls largely eliminated.

The free market was, at first, a strange experience for ordinary German consumers, who hadn’t experienced such a thing for well over a decade. Ludwig Erhard introduced education programs for shoppers, helping them learn to look for good prices.

As obvious as it may seem to some readers, it was an odd notion for postwar Germans that the same package of coffee could be sold for three different prices in three different stores. They had to learn the skill of comparison shopping.

The effects of deregulation appeared quickly, and in nearly every metric: production rose, unemployment fell, infrastructure was rebuilt, and general economic health appeared. This was the Wirtschaftswunder - the ‘economic miracle’ - which was no miraculous violation of natural laws, but rather the predictable and replicable result of economic principles.

The growth during the years of Adenauer and Erhard formed the foundation for, and provided the momentum of, the German economy in the following decades, when it became not only the most powerful in Europe, but one of the most powerful in the world.

Freedom Revitalizes a Decimated Nation: Postwar West Germany

The chaos which followed the war’s end in May 1945 brought most economic activity to stop, and of what little production continued, much of it was carried out off the books, either as black market activity, or as barter.

Germany was a nation largely destroyed. Millions of people had died. Physical infrastructure was nonexistent in some part of the country, badly damaged in others.

The economy had been demolished, bit by bit, since the early 1930s, when the Nazis imposed high tax rates, controls on retails prices, and strict regulation of wages. This lead to a decline in economic activity.

In an effort to escape Hitler’s harsh economic policies, buyers and sellers engaged in off-the-books black market activity, which the Nazis in turn harshly persecuted.

After more than a decade of suffering at the hands of Hitler’s National Socialist market regulators, the Germans found that the war’s end did not immediately end the misery. In West Germany, the Allies and their occupational forces kept the Nazi policies in place.

In fact, conditions got at first worse after May 1945, rather than better. Currency flooded the economy and became nearly worthless. There were widespread shortages of retail goods. David Henderson describes the result:

Barter was very inefficient compared with straight purchase of goods and services for money. German economist Walter Eucken wrote that barter and self-­sufficiency were incompatible with an extensive division of labor and that the economic system had been “reduced to a primitive condition.” The numbers bear him out. In March 1948 bizonal production was only 51 percent of its level in 1936.

The reports used the word ‘bizonal’ to reflect that these were aggregate numbers for both West Germany and East Germany - the Soviet occupational zone and the combined British, French, and U.S. zone.

A complex technological economy cannot survive if its trading mechanisms are reduced to barter and black market tactics. Many observers expected that Germany would sink permanently into a ‘third world’ category.

Indeed, some among the western Allies wanted precisely that: Henry Morgenthau, the U.S. Secretary of the Treasury, argued that all Germany should be turned into farmland, with no industrial capabilities whatsoever.

Thomas Hazlett describes the ongoing deterioration of the German economy in the first postwar months:

The stupendous gap between the legal and illegal prices grew to such proportions that a general collapse of the currency ensued. People resorted to barter, and German cities typically saw a mass exodus on weekends as city-dwellers flocked to the countryside to trade with the farmers in kind. As the German economist Walter Eucken summed up: “The failure of money and the central administration of the economy has led to increasing self-sufficiency of economic units and to the emergence of a system of barter, two things incompatible with an extensive division of labor. The economic system is reduced to a primitive condition.”

A turning point was the election of Konrad Adenauer, Germany’s first postwar chancellor, in 1949. He convinced the western Allies to allow the Germans to form their own economic policies and make an effort to rebuild.

This was the Stunde Null for West Germany - the ‘zero hour’ when history experienced a gigantic ‘reset’ and there was a chance to begin again from the rubble of wartime devastation.

In East Germany, sadly, things did not go well under the Soviet socialist dictatorship. The economy continued to crumble, creating an ever-widening gap between East Germany and West Germany.

But the economics were merely one aspect of a larger difference: West Germany respected personal liberty: the freedoms of the press, of speech, of religious belief, of the political process, etc.

Economic freedom - the observance of property rights and of the free market - were inseparably tied to the other liberties. Because East Germany denied the right to personal expression, it denied rights of people to freely buy and sell.

Adenauer’s appointee, Ludwig Erhard, carried out policies of deregulation and lower taxes. Government control over wages and prices was greatly reduced, and retailers were allowed to compete by offering lower prices to consumers.

Instead of sinking into the swamp of ‘third world’ or ‘developing world’ countries - most which never ‘develop’ - West Germany revitalized both its political liberty and its free market. Personal freedom, in terms of deregulation and lower taxes, led to prosperity.

This was the Wirtschaftswunder - the ‘economic miracle’ - which was no violation of nature’s laws, but rather the predictable and replicable result of economic principles. Free markets and low rates of taxation are inextricably intertwined with those personal freedoms which both the Nazis and the Soviets so harshly oppressed.