German Reunification: Role of Financial Institutes

German Reunification: Role of Financial Institutes

 

Sang Bong Park (Ph.D., Prof., Myongji University)

 

1. Monetary Union (July 1, 1990)

 

Financial aspects of the German reunification cannot be explained in simple economic terms. In 1989, Chancellor Kohl’s administration was determined to achieve its national goal of reunification, even at the rather high cost of sacrificing West Germany’s economy. Therefore, as it would again during the European currency unification, the Deutschmark had to carry the actual burdens of a politically-made decision when currency was unified in Germany to prevent the East Germans from leaving the country. “If the Deutschmark doesn’t come to us, we will go to the Deutschmark” was a popular saying in Germany at the time.

 

Germany monetary union meant introducing West Germany’s Deutschemark to replace the East German Mark as the official currency of East Germany, and the most important issue at hand was to decide what exchange rate to apply. East German Marks were exchanged at a rate of 1:1 for the first 4,000 marks in cash, pensions, wages, savings for the first 6,000 marks. Most financial experts opposed this on the grounds that the government was making an economic decision on political grounds. Karl Otto Poehl criticized this decision as a catastrophe and resigned from his then-post as the President of the Bundesbank. Simple disregard for the market exchange rate of 8:1 forced Eastern German companies to lose competitiveness overnight. This forced many corporations to file for bankruptcy, and unemployment rate skyrocketed.

 

East Germans, suddenly in possession of the Deutschemark, become busy buying up West German products. This gave rise to a short boom in West German economy; however, the interest rate had to be kept a high level (9.5% in 1992) to maintain a check on inflation. In effect, West German government’s finances had to support the spike in East Germany’s standard of living, and for the next 20 years, West Germany’s financial burden came up to approximately 1.6 trillion Euro.

 

2. Establishment of Financial Infrastructure

 

Along with the German reunification, The Frankfurter banks absorbed East Germany’s central bank functions, and most East German companies automatically become debtors to Westbanks. Additionally, private West German banks set up branches in East Germany, which allowed for prompt establishment of financial infrastructure in East Germany. However, it also gave rise to a structure where West Germany took full control over East Germany’s industries and its financial world.

 

3. Foreign Liabilities

 

In order to bear the cost of German reunification, the German government borrowed funds from foreign sources. Debt per capita rose from the 20% of the GNP in late 1960’s and 30% in late 1970’s to 65% in late 1990’s. When compared with other advanced nations’ debt ratios (72% in Japan, 62% in the US, 100% in Belgium, etc.), such numbers do not seem alarming; however, the problem was the size and the rate of growth of such national debt. The rapid rise in national debt increased the government’s interest burdens and put tremendous pressure on government finances. The biggest creditors, domestic banks, supplied half of Germany’s net liabilities from 1990 to 1996, and foreign loans supplied 40%. Foreign loans of Government rose from 1.2 trillion in 1990, to 1.8 trillion in 1993, and to 2 trillion Deutschmark in 1995.

IUED