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.