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FOR RELEASE ON DELIVERY
FRIDAY, FEBRUARY 8, 1985
11:00 A.M. (5:00 A.M. EST)

FREE MARKETS IN THE WORLD TODAY

Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
on the occasion of receiving the
Ludwig-Erhard-Preis fuer Wirtschaftspublizistik
Bonn, Germany
February 8, 1985

FREE MARKETS IN THE WORLD TODAY
Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
on the occasion of receiving the
Ludwig-Erhard-Preis fuer Wirtschaftspublizistik
Bonn, Germany
February 8, 1985

When a prize is awarded in the name of Ludwig Erhard —
honor that I deeply appreciate —

a signal

it seems fitting to turn our thoughts to

the role that Erhard's heritage of ideas and achievements plays in the world
today.

Erhard was concerned with the application of the concept of freedom

to the economic affairs of his and all countries.

Today, as in Erhard's days,

freedom and how it is respected and applied in economic affairs is a dominant
issue.

Today, freedom advances in some countries and some economic sectors.

It may be retreating in others.

My remarks will be addressed, first, to these

broad tides in the world's affairs, and, second, to the particular progress
that some of Erhard's principles are making in my country today, under the
unprepossessing title of "deregulation."

I understand the best translation

into German to be "Deregulation."
Erhard took his historic decision to cut German prices loose from
controls in 1948 in the most adverse climate of opinion imaginable.

In

Germany, few could then visualize economic activity uncontrolled by the state
and perhaps even by cartels.

Among Americans, some residual belief in markets

-2
had survived the skepticism of the New Deal period and the war.

But the

German economy, in its postwar paralysis, surely must have seemed the least
promising place to apply the principles of free prices, competition and
incentives.

The fact that today

Erhard's solution seems so obvious shows

how much the climate of world opinion has changed.
It was in good part by the example of the German miracle that the
world, and particularly the United States, became motivated to rediscover the
role of markets, of money, and of multilateral trade.

It was a predominantly

free-market world that produced, after World War II, one of the strongest surges
of economic growth in modem history.
But Ludwig Erhard's principles did not prevail consistently.

The

role of government, both as a user of resources and a manipulator of markets,
advanced in many countries.

At times it seemed that a doctrine enunciated

by an earlier German economist, Adolf Wagner, was being validated.

He argued

that the share of the state in economic life was destined to increase secularly.
Thus the social purposes of the market economy, which were to be achieved
through free competition and equal opportunity for all, often were preempted
by government action seeking to achieve them by "dirigiste" means.
demands on the economy often produced inflation.

Excessive

Erhard's dictum that the

working of a socially oriented market economy requires moderation on the part
of all participants -- government, labor, and business —
unheeded.

frequently went

The responsiveness of the market mechanism and its ability to

reallocate resources and overcome unemployment often was blunted by govern­
ment restrictions.

International trade, which had been one of the main success

stories of the postwar period, was increasingly placed in jeopardy by

-3

protectionism.

Profit, which should be a driving force in a market economy,

at times became a dirty word.
The verdict is still outstanding whether such departures from
Erhard's principles will prove aberrations or rather symbols of a trend.
I derive some confidence, however, from increasing worldwide recognition of
the role of the market price as a steering mechanism.

At the level of

theoretical economics, price is widely accepted as the mainspring of
economic decision making.

The use of econometric methods, backed by

computers, makes possible more complete —
analysis than was possible in Erhard's day.

though hardly infallible
For countries whose economic

policies have gone astray and that are experiencing foreign debt problems,
a return to the principle of market prices is the standard prescription.
As administered by the International Monetary Fund, it means to get back
to market-based, i.e., uncontrolled and unsubsidized prices for producers
and consumers, to positive real interest rates, to realistic exchange rates.
Even in some socialist economies, market prices and, in a small way, sometimes
even profit have begun to play a role.
Perhaps the most dramatic expression of the market principle today
can be found in the area of international finance.

International borrowing

and lending increasingly take place in a true world capital market.

National

markets are becoming part of the world financial market, as barriers like
withholding taxes and regulatory restraints are beginning to yield.

It is in

this general area that, for the United States today, markets are asserting
themselves as regulation retreats.

I would like to say a few words about

this process, which I believe is very much in the spirit of Ludwig Erhard.

-

4-

Before focusing on the financial field, however, which for me is a natural
topic, I would like to point out that the process of deregulation has gone
forward in much broader areas.
One such area has been the oil and natural gas industry.

Both were

the object of regulation long before the oil shocks of the 1970's, in a mis­
guided effort to stimulate domestic production and benefit consumers.

Under

the impact of the oil shocks, both oil and natural gas were further subjected
to very detailed discriminatory price controls.

It is this congeries of

controls that gradually has been relaxed since 1978, with benefits to consumers.
Decontrol is by no means complete, but significant steps toward free-market
pricing for these commodities that have been subject to such tremendous price
upheavals is a real victory for the market principle.
Transportation also has been deregulated in the United States.

For

the railroads, which were the first industry to be regulated at the federal
level (1887), the new trend may have come too late.

But deregulation of air­

lines and trucks since 1978 has been another victory for free markets.

Air

fares and trucking services have been priced more economically, traffic patterns
have become more efficient.

Some lines have been unable to compete under the

new conditions, since protection of uneconomical service had been one of the
principal results of regulation.

But new lines have come into existence, and

while some localities have lost service, a larger number appear to have gained.^

1.

Roger G. Noll and Bruce M. Owen, The Political Economy of Deregulation.
Washington, D.C.: American Enterprise Institute for Public Policy Research,
1983, pp. 121-29, 140-50.

5

-

The telephone service has been subjected to a more competitive
regime.

Under the earlier highly regulated system, the long-distance

service subsidized local service, with resultant inefficiencies.

Under

these anticompetitive conditions (the industry in the United States is
privately owned), entry for newcomers both into the transmission and the
equipment end of the business was difficult.

Today, competition has become

the rule.
In the financial field, deregulation is going forward apace,
though it is by no means complete.

Interest ceilings on bank and thrift

deposits previously controlled under Regulation Q have been virtually
eliminated. This is a matter of great importance for the functioning of
mortgage markets given the tendency of volatile market rates to exceed
regulatory ceilings from time to time.

Periodic financial crunches, that

occurred as thrift institutions were disintermediated, came largely to an
end, although problems by no means disappeared altogether.
savers increasingly received positive real returns.

As a corollary,

It should be noted

that controls over deposit and lending rates were abolished in Germany at
a much earlier date, although it is not clear to what extent they are now
determined by the free play of market forces.

Fixed commission rates for

securities transactions on U.S. stock exchanges have been ended.
commissions have been negotiable.
the United Kingdom.

Since 1975,

A similar movement is now in process in

The effect, in the United States, has been to squeeze

out inefficient brokerage firms.

On the negative side, the cost of securities

transactions to the small individual investor has approximately doubled.

-6Today, broader powers for U.S. banks are being proposed, allowing
them to engage in securities, insurance, and real estate, all subject to
specific limitations.

If this legislation passes, it would end existing narrow

restrictions on what American banks can do.

In Germany, of course, the country

of "universal banks," these limitations have been largely absent, although
the "universal" or "department store" principle does not seem to be without
its critics.

The main benefit from the proposed new activities in the United

States is likely to be intensified competition in the areas opened up to bank
entry.
Reducing geographic limitations on American banks is also under con­
sideration.

At present, banks are not allowed to establish branches outside

the state of their head office.

This, too, incidentally, is a kind of regula­

tion I believe is not present in Germany.

Among the benefits anticipated

would be greater competition and efficiency.

Also, a broader deposit base

would become available to banks that today find their access to deposits
constrained and must, therefore, rely more heavily on volatile purchased funds.
Whether or not these legislative intentions bear fruit, the market
today is in effect overcoming many regulatory restrictions.
ways of operating nationwide in more limited forms.

Banks have found

"Nonbank banks" are

springing up, i.e., institutions that, by surrendering either the power to
accept demand deposits or to make commercial loans, can circumvent geographic
restrictions while in other respects performing normal banking functions.
They have made some inroads in.the securities and real estate business.

Mean­

while, firms in those and other industries have found means of entering major
parts of the banking business.

Regulatory divisions, in other words, are

being undermined from both sides.

-

7-

The free-market principle is making its most dramatic progress in
international finance.

National capital markets, as I noted earlier, are

becoming internationally integrated.
growing for many years.

The role of the Euromarkets has been

The development of this market is a textbook example

of the response of finance to domestic regulation.

In the case of American

banks it has been principally the freedom from reserve requirements and
Federal Deposit Insurance Corporation insurance premia that has caused funds
to move into the Euromarket.

The segmentation of the world capital market

into national compartments is being overcome.

Floating exchange rates are

no longer a serious obstacle to international flows of capital.
swaps, properly used, reduce exchange risks.

Currency

Interest-rate swaps reduce market

imperfections that give different borrowers unequal access to various types of
money.

Under the impact of these opportunities for innovative finance, regu­

latory and tax obstacles to the free international flow of funds also have
been reduced.

Large banks participating in international lending and,

recently all too frequently, in rescheduling operations, have learned to cope
and live with different national regulatory, accounting, and tax situations,
in a common effort to maintain the international flow of capital.

An inter­

national banking community has developed.

Safety
Free markets imply risks.

It is appropriate that these fall to the

extent possible on those who as entrepreneurs and shareholders have claims to
profits.

But failure of a bank,when it occurs, has wide repercussions on

other sectors.

Regulation to enhance bank safety, therefore, is not inconsistent

with market principles.

In the United States, enhanced safety is being pursued

8by mandatory increases in banks' capital relative to their assets.
view, further increases of this sort are needed.
to improve the deposit insurance system.

In my

Proposals are afoot also

Fuller disclosure of international

exposure has been mandated in order to enhance the discipline of the market.
In Germany, banks with foreign subsidiaries have been strengthened by consolida­
tion of their accounts.
A balance between market freedom and safety is necessary in the
financial system.

Recent moves in the United States have been mainly in the

direction of freer markets, but the safety factor is simultaneously being
enhanced.

Further progress in both directions is needed.

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