THE 1948 GERMAN CURRENCY AND ECONOMIC REFORM: LESSONS FOR EUROPEAN MONETARY POLICY.

• Author: Schnabl, Gunther

Twenty years after the introduction of the euro, the European Monetary Union (EMU) is at its crossroads. Following the outbreak of the European financial and debt crisis in 2008, the European Central Bank (ECB) took comprehensive measures to stabilize the common currency. Interest rates were cut to and below zero and several asset purchase programs have inflated the ECB balance sheet (Riet 2018). Within the European System of Central Banks, large imbalances have emerged via the TARGET2 payments system, which can be seen as quasi-unconditional credit in favor of the southern euro area countries (Sinn 2018).

While the ECB terminated its asset purchase program at the end of 2018 and is expected to increase interest rates in late 2019, financial instability is reemerging. Growing uncertainty about the fiscal discipline of the Italian government has triggered a significant increase in risk premiums on Italian government bonds. In particular, in Italy and Greece, but also in Germany, bad loans and assets remain stuck in the banking systems. In the face of the upcoming downswing, European banks do not seem ready for new financial turmoil.

In this fragile environment, the future path of the EMU is uncertain. To enhance the stability of the EMU, a group of German and French economists has called for a common euro area budget, for a strengthening of the European Stability Mechanism as lender of last resort for euro area countries and banks, as well as for a common European deposit insurance scheme (Benassy-Quere et al. 2018). In response, 154 German economists have warned against transforming the EMU into what they call a "liablity union," which systematically undermines market principles and wealth (Mayer et al. 2018).

In 2018, a French-German initative to introduce a common euro area budget faced strong opposition from a group of northern European countries as well as from Italy, symbolizing the political deadlock concerning reforms of the EMU. This article explains the different views on the institutional setting of monetary policymaking in Europe from a historical perspective. It begins with a description of the economic and monetary order in postwar Germany. It then discusses the positive implications for the European integration process and the economic consequences of the transformation of postwar German monetary order. The final section offers some economic policy recommendations.

The Role of Germany's 1948 Currency and Economic Reform in Germany's Recovery

The currency reform in the three western occupation zones of Germany on June 20, 1948, formed the basis for West Germany's impressive postwar recovery (Buchheim 1998). Until then, monopolization, central planning, price controls, and the state-led allocation of goods had determined the living conditions of Germans. The turnaround came due to the fortunate coincidence of three factors: (1) the U.S. occupying forces under General Lucius Clay believed in market principles and pushed toward the resolution of cartels (Ritschl 2016); (2) Walter Eucken (1952) and Franz Bohm (1950) had developed the academic foundations for a liberal economic and legal system; and (3) in 1947, Ludwig Erhard, an advocate ofa liberal economic order, took over the leadership of the Special Office for Money and Credit (Sonderstelle Geld und Kredit), which was preparing the currency reform.

The reform was initated by the U.S. Congress, which aimed to reduce the economic burden on the starving German population. The first step was to eliminate the overhang of money that had been created by financing the war by printing fiat money. As money was in excessive supply, it disturbed the efficient use of resources. Most goods were rationed and only available on a certificate of entitlement that limited production. The overhang of money undermined the acceptance of the Reichsmark as a means of payment and store of value. A rapid economic recovery was to be expected, as the industrial plants had survived the war largely without serious damage (Ritschl 2005).

The Bank Deutscher Lander was founded in March 1948 as the predecessor of Deutsche Bundesbank (Buchheim 1998). The new Deutsche Mark (DM) banknotes were printed in the United States. On June 20, 1948, the population received 40 DM per capita. Companies and tradesmen received 60 DM per employee. Cash and bank deposits were exchanged at a ratio of 100 Reichsmark to 6.5 DM; debt at a ratio of 100:10; and wages, prices, and rents at a ratio of 1:1. Thus, the owners of physical assets such as goods, companies, and real estate gained while savers lost. A recompensation scheme (Lastenausgleich) provided only partial compensation (see Hughes 1999).

After drastic hardships of the prewar, war, and postwar periods, the currency reform became one of the "most striking positive collective experiences of the Germans." (1) While on June 19, 1948, many shops were still closed--allegedly due to being sold out or due to illness--from June 20 the shelves suddenly filled. The high demand quickly caused production to rise to prewar levels (Erhard 1958: 13-15). (2) On the basis of the "Law Governing the Principles of Planning and Price Policy after the Currency Reform" of June 24, 1948, price controls were successively relaxed and wage freezes were lifted.

The large enterprises pushed for price controls and restrictions to market access. Erhard (1958: 101) vehemently opposed them: "Any fragmentation of the national economy into vested interests cannot therefore be allowed." Erhard (1958: 136) regarded it as risky if entrepreneurs moved from personal responsibility to the socialization of risks. He saw cartels as detrimental for small and medium enterprises, which were not able to build cartels (Erhard 1958: 137-38). In his view, cartels would ultimately have to be paid by people with a lower standard of living. In 1958, the "Law against Restraints on Competition" came into force, which prohibited cartels and subjected mergers to the approval of the cartel office. (3)

Eucken (1952), one of the most prominent representatives of German ordoliberalism, (4) formulated eight constitutive principles of a market economy, which were implemented in large parts of the economy: (5)

1. The primacy of monetary policy was applied: "All efforts to make a competitive order a reality are pointless unless a certain level of monetary stability can be ensured. Monetary policy thus has primacy for the competitive order." (Eucken 1952: 256). The DM issued by the independent Deutsche Bundesbank formed a stable backbone for the economy.

2. The stable currency in combination with free prices ensured that prices provided reliable information about the scarcity of goods and consumer preferences. (6) Therefore, the production structure was able to adapt to demand. Erhard (1958: 28) placed the consumer at the center of his economic policy: "The customer became king again; a buyers' market began!" (7)

3. The markets were open. New companies could enter at any time, unprofitable companies had to leave the market. Monopoly supervision prevented excessive market power. Consumers benefitted from competition in the form of lower prices and thereby higher real wages.

4. In contrast to Soviet-occupied East Germany, private ownership of means of production was predominant, which was seen as an important prerequisite for an efficient allocation of resources. Only those who can privatize the profits will strive for the greatest possible efficiency.

5. Due to freedom of contract, excluding contracts that would build monopolistic power, everyone was free to organize his economic activities according to his strengths.

6. The liability principle guaranteed that profits could be retained, but also that losses had to be borne by the individual. Only if people can be made liable for their actions (it was assumed) will they act economically responsibly.

7. According to Eucken, economic policy should be constant and forward-looking. He was very cautious in using state interventions and defended market principles against interest groups.

8. Thus, as demanded by Eucken (1952) in his eighth principle, all seven principles were to be jointly fulfilled in broad areas of the West German economy.

   Even though sectors such as banking, insurance, transport, and many public monopolies remained excluded from free competition (Rhonheimer 2017), the free market economy could unfold its potential in an impressive way. (8) Figure 1 shows the real growth rates of the Federal Republic of Germany since 1950, which between 1950 and 1990 refer to West Germany and since 1991 to unified Germany. While the economy was still idle in 1948, growth accelerated rapidly. Machinery ran smoothly, wages rose faster than prices, and unemployment fell steadily. While 1.3 million unemployed were registered in 1949 (Erhard 1958: 90), full employment was reached in 1962 with 0.7 percent unemployment (Figure 2).

   Germany was surprised by an economic miracle that stood in fundamental contrast to the economically and politically fragile interwar period. The notion of "Wirtschaftswunder" emerged. Erhard, who was minister of economic affairs from 1949 to 1963 and chancellor from 1963 to 1966, embodied the new prosperity with his thick cigars. Erhard's (1958) book Prosperity through Competition makes one aware that the market economy was anything but a self-runner and had to be constantly defended: "The danger of limitation of competition threatens constantly from many sides. One of the most important tasks ... is, therefore, to secure free competition" (Erhard 1958: 2).

   The programs of the political parties only slowly adapted to the evident economic success of the currency and economic reform. The Ahlen program of the Christian Democratic Union (CDU) of 1947, which aimed at overcoming capitalism and socialism, still had many elements also found in the East German socialist planning economy. Only in 1949 did the CDU turn to the market economy in the...