Although Germany has lost her way occasionally over the last century she’s been in pretty good economic shape for some decades now. Possibly a little too good if you listen to some other members of the EU, particularly the likes of Greece, Italy and Spain, who grumble about the huge German trade surpluses and their tight control over the value of the Euro via the EU Central Bank.

Those nations relied for decades upon devaluation of their money as a key economic tool and since it has gone they’ve struggled to impose upon themselves the sort of economic discipline the Germans are famous for.

But you can hardly blame the Germans for their paranoia about the value of money. Twice in the last hundred years they have suffered terrible bouts of inflation that wrecked their economy.

Let’s make paper machie out of it!

The most well-known of these is the hyperinflation that hit Germany just after World War I had ended. So much money was printed by the government that children played with it in various ways.

To be worn only once

But there actually was a second period of inflation that is not as well known, mainly because it was not quite as bad, the government kept a lid on the pressures it created, and it was soon put in the background by World War II.

All of this is documented in an article first published in 1978, The German Non-Miracle, which looked at what Germany did to re-start it’s economy after WWII ended. It should be a valuable lesson as to how the world today gets out of our locked down economies.

Germany faced a similar problem to what we have now: it had suffered a supply shock, courtesy of having almost all its industries and businesses smashed in the war.

The advantage we have is to have not suffered physical destruction.

But the problem of re-starting the economy is similar.

Governments the world over are doing what they usually do – applying Keynesian solutions by printing vast quantities of new money and regulating the hell out of everything.

But Keynesian economics is really designed to deal with demand shock recessions like the Great Depression, where money seems to just vanish out of the economy and demand shrinks. In that situation having the government push money into the economy via a central bank, and to a lesser extent by increased spending, is a workable solution within boundaries (all economic theories have boundaries).

The Keynesian approach has proved itself for things like the 1987 Stock Market crash, the Asian crisis of the late 90’s and, to a lesser extent, the GFC of 2008-09. But even with that last one there were signs that it had reached its limits. Economic growth barely recovered at all, despite all the trillions thrown around by governments. That likely had a lot to do with the fact that most Western economies were already heavily indebted both publicly and privately. People were simply leery of taking on more debt to “recover”, even when it was being given to them cheap, or for free (i.e. no interest).

It should also be noted that – very much against Keynes own advice – when economic growth resumed, most governments did not get around to paying down all that debt from they’d created. Keynes’s basic lesson was that you don’t try and balance the budget during a recession, you let it go into deficit but when the economy improves you run surpluses and pay it down. New Zealand was one of the few nations that did that after the GFC, and Michael Cullen(L) and Bill Birch(N) did the same in an earlier period, although I think Cullen went overboard, running huge surpluses even after the debt was largely paid down. All that did was increase private debt.

But Keynesian economics has also failed at times, most notably with the smaller recessions of the 1960’s and 1970’s, when no amount of stimulation seemed to work. In fact we got “stagflation”, inflation while an economy was moribund or even in recession; something that Keynesian theory said could not happen.

This lesson had actually been learned by the Germans via their inflationary periods; sometimes just throwing money at the economy doesn’t work:

Under the Third Reich, the German government had financed a colossal industrial build-up to accommodate the designs of the Nazi war machine. The tremendous industrial expansion was paid for with rampant monetary expansion. All the screws of the Nazi State had to be tightened to their breaking point to suppress the resultant inflation; the guns of the Gestapo turned on black marketeers and others who sought to evade the officially posted prices of goods and services. The result of the effective price controls under Fascism was the explosion of liquidity after Fascism.

And that explosion of liquidity meant inflation after 1945 – lots of it. Worse, to combat this the Allied governments in charge of West Germany also went for controls:

Government policy fluctuated among the vengeance of the French, the reformist zeal of the British (Labourites), and the bewilderment of the Americans. About the only consensus to be found anywhere was to rely on economic controls.
…
In an effort to forestall the inevitable realignment of money and prices, the Allied commanders of France, Britain, and the United States slapped on an extensive control network that fixed wages and prices at preinflation (1936) levels.
…
The victors attempted to administer the economy through a patchwork assortment of price regulations, allocation details, and rationing.

Setting prices back a decade might have sounded smart but the actual price of resources had moved on:

The economically obvious occurred: goods disappeared from legal markets and were sold illegally at prices far above the official prices. Severe misallocation of resources took place
…
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.
…
In the fall of 1946 the mechanism had reached bankruptcy, the officially rationed food allotment being under 1,500 calories per person per day.

Clearly things could not go on like this, so a debate began inside Germany itself, rather than with the Allied controllers. The debate settled down into two predominant schools of thought: the Social Democrats and the “Freiburg School.”

The major SPD [Social Democrats] economic ideologue was Dr. Kreyssig, who in June 1948 told the 18th Bizonal Economic Council that, since the society had been under control for such a long period, any decontrol or currency reform would be ineffectual. To Dr. Kreyssig’s mind, not only would recovery not follow, but collapse was inevitable if prices were set free; the only course for the German economy was one of strong central direction. Another SPD spokesman was Herr Schoettle, who joined the argument against free markets by claiming that the task of reconstruction was too big for individual enterprise alone—massive State involvement was imperative if Germany was to recover.

And all of this would also be primed with lots of credit:

Not surprisingly, the Social Democrats favored an aggressive fiscal and monetary expansion policy and the “full employment” policies that had gained political popularity elsewhere. The SPD was joined in this expansionary position by the labor unions, the British authorities, most German manufacturing interests, and, in a slightly more moderate tone, by the Americans.

The Freiburg school – named after the University of Freiburg where a liberal resistance movement to the Nazis had started during the war, safely couched in talk of economic freedom – took a different approach: the Soziate Marktwirtschaft.

The idea of a “socially conscious free market,” as the translation goes, was that totalitarianism is the evil to be most guarded against and that the only way to prevent tyranny is to promote freedom. The theory spread freedom across political and economic lines and espoused a policy of non-control—by either the State or individuals—of individual choice. 

In other words it was philosophy first and the economics flowed from that.

The Freiburg approach was not laissez-faire: government was to be active in promoting competition and protecting free markets from monopoly, public or private. It also allowed for a small degree of wealth redistribution through graduated income taxation and social welfare programs, but it was insistent on keeping tax rates low enough to prevent economic disincentives to productive effort.

So not the cut-throat ruthlessness with which opposition to Keynesians and Central Big Government is always cast. Somewhat to their own surprise the Freiburg school won and although they had a lot of intellectual grunt it seems just as likely that the SDR side lost because the German people were psychologically scarred by the idea of printing money and creating credit, all with massive, central government control. They didn’t need an economics degree to know that was the wrong path because they’d actually been down it and knew it in their gut rather intellectually.

The Freiburgers did not just fight an academic battle. They had a specific plan which you can read in detail at the link but which is summarised below:

  • Create a new currency, with a central monetary authority and held to what would nowadays be called a monetarist perspective.
  • Tight money policies would be pursued to create ‘buyers’ rather than ‘sellers’ markets.
  • Decontrol the economy by eliminating what they called “the strangling devices of economic repression … ‘directing,’ ‘licensing,’ ‘prohibiting,’ and what not.” One exception that should be noted was that rent controls were retained all through the 1950’s.
  • The German people would be allowed to produce. Looking at the destruction around them was a powerful incentive, but they had to be freed from controls to take advantage of that as well as giving incentives to saving, investment, and overtime
  • There would be expenditures on social welfare through transfer payments, and they would be comparable with those of other European nations.
  • However, the State would abstain from further economic intrusions via “full employment” policies, subsidies, and income redistribution.
  •  The government would push steadily and firmly for free(..ish) trade with the rest of Europe since exports would have to be a big part of the recovery. This would take years but it led to the European Commission on Coal and Steel and then to the EEC.

I did have to laugh at this comment about the price controls by the most prominent political member of the Freiburg school, Ludwig Erhard, when they were dumped in June 1948:

“It was strictly laid down by the British and American control authorities that permission had to be obtained before any definite price changes could be made. The Allies never seemed to have thought it possible that someone could have the idea, not to alter price controls, but simply to remove them.”

The effects were dramatic and almost instantaneous, as two non-German observers, Jacques Rueff and Andre Piettre, reported:

“Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display. Shops filled up with goods from one day to the next; the factories began to work. On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food. A day later they thought of nothing but producing them. One day apathy was mirrored on their faces while on the next a whole nation looked hopefully into the future.”

Industrial output increased 50 percent within the year, and national income, which had fallen 20% below that of 1936, was restored to that level in just over a year and continued to climb fast. Unemployment did climb and peaked at 10.4% by 1950, but steadily dropped for the rest of the decade.

Moreover, this approach beat the publicised plans of the proponents of central planning. Their “Long Term Plan of 1948” predicted that by 1952-53 industrial  production would reach 110 percent of the 1936 level and agriculture 100%. Another study done in 1950 by four German research institutes – which supposedly already took account of things like the Marshall Plan, the Korean War and the success of the Freiburg plan to that date – said that five years would be needed by government planners to hit their goals – and would need another $1.5 billion in US aid beyond the Marshall Plan.

Under the Freiburg plan all those targets were met and exceeded: Industrial production in 1952-53 averaged about 150 instead of 110. Net agricultural output was 111 percent of pre-war instead of 100. The overall balance of payments was highly favorable and even the dollar sector was approaching balance.

It should be no surprise that Ludwig Erhard would become Economics Minister in the Adenauer administration from 1949-57 and then Chancellor from 1963-66. Such are the fruits of success for politicians who don’t go down the path of centralised command and control route of their peoples but are willing to stand and argue for individual freedom in all spheres of life.