Three Men Who Resolved an Economic Crisis

by Jim Powell

President Obama seems frustrated because he has "tried everything" to revive the economy and still it's in a slump. But as the following cases suggest, he hasn't tried the kind of policies that work.

Germany was a pile of rubble after World War II. Millions of people were homeless, and there was massive unemployment.

A German economist named Ludwig Erhard, who had worked in the anti-Nazi underground, was increasingly critical of economic controls that Hitler had originated and the Allies continued to enforce. Erhard was named economics minister on the Allies' Economic Council, a key policymaking position.

Jim Powell, a fellow at the Cato Institute, is author of FDR's Folly and Wilson's War (Crown Forum, 2003 and 2005, respectively).
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On Sunday, June 20, 1948, Erhard went on the radio and announced that there would be a new currency and for every 10 depreciated Reichsmarks that were handed in, people would receive one new Deutschmark. Erhard recognized that people wouldn't use the new currency unless goods were available. He explained that by holding prices below market levels, price controls simultaneously encouraged consumers to demand more and entrepreneurs to produce less, causing shortages. U.S. commander Gen. Lucius Clay reportedly remarked to Erhard, "My advisers tell me you're making a terrible mistake abolishing price controls." Erhard replied, "Don't listen to them, General. My advisers tell me the same thing."

Overnight, goods that had been hidden away, awaiting barter opportunities, appeared on store shelves. Germans began to spend the new currency. Soaring prices sent a vital signal to entrepreneurs that they could make money by increasing production, and soon prices came down. Erhard abolished exchange controls to make trade easier. Finally, Erhard began cutting taxes so that businesses would have more money for hiring and consumers would have more money for spending.

West German industrial output and wages more than doubled. West Germany became the world's second-leading exporter, after the United States. The biggest success was the Volkswagen.

West Germany's peaceful prosperity eliminated discontent that had led people to support fascist and Nazi rulers. West German Chancellor Konrad Adenauer and French President Charles de Gaulle became friends, ending Europe's deadliest political rivalry.

Two decades ago, Estonia was part of the Soviet Union — a small territory on the Baltic Sea about the size of Connecticut. In 1988, during the "Singing Revolution," as many as 300,000 people gathered in Tallinn, the capital, to defy their Soviet rulers, sing patriotic songs and talk publicly about independence. Soviet leaders recognized that if they tried to suppress all this, there would be a bloodbath. They lost their nerve as the Soviet Union approached an economic collapse.

Estonia gained independence and faced the daunting challenge of turning a stagnant, government-run economy into a market economy. A bearded 32-year-old history teacher named Mart Laar emerged as prime minister in 1992. He promoted privatization, free trade, a flat tax and sound money.

Without continued subsidies, government-run enterprises went bankrupt, many people lost their jobs, and there were angry protests. However, cutting subsidies made it possible to cut spending and bring down inflation. Mr. Laar simplified and cut taxes, making it easier for entrepreneurs to start new businesses. He abolished trade restrictions, enabling businesses as well as individuals to shop the world for the best and cheapest goods. Estonia became a very attractive place to invest, and capital flowed in to finance new businesses. Mr. Laar's government couldn't afford much help for the unemployed, but this created strong incentives to make the fastest possible transition.

Estonia became known as the "Baltic Tiger," and other nations — even Russia — adopted some of its policies. Mr. Laar was awarded the Cato Institute's Milton Friedman Prize for Advancing Liberty.

The "Great Inflation" of the 1970s began in the 1960s when President Johnson established his Great Society domestic spending programs — including two of the biggest federal entitlements — at the same time he escalated the Vietnam War. Subsequently, President Nixon, anxious to win the 1972 election, pressured Federal Reserve Chairman Arthur F. Burns to inflate the money supply so unemployment would come down. Unfortunately, both unemployment and prices went up.

Inflation and unemployment plagued all three presidents who served during the 1970s. The last of them, Jimmy Carter, appointed Paul Volker as Fed chairman. Mr. Volcker understood how inflation could impoverish people. But anti-inflation policies are often undermined by a president who reacts to the pain (higher unemployment) that tends to come before the gain (lower inflation). Mr. Carter couldn't hold out, and inflation doomed his bid for another term.

President Reagan shared Mr. Volcker's belief that inflation must be stopped. Biographer Lou Cannon reported, "Three days after his inauguration, Reagan startled the Secret Service by walking out the front door of the White House and down Pennsylvania Avenue to the Treasury Building, where he lunched with Volcker."

Reagan was steadfast in his support for Mr. Volcker's anti-inflation policies. Inflation was vanquished, Reagan persuaded Congress to cut marginal income tax rates 25 percent, he abolished price controls on oil and gas, and a great economic boom began. Because of all the criticism Mr. Volcker faced, he probably couldn't have succeeded without Reagan's support.

We can resolve an economic crisis with a good plan and courageous action.