$Unique_ID{COW04071} $Pretitle{373} $Title{Federal Republic of Germany (West Germany) Chapter 4C. Money and Banking} $Subtitle{} $Author{Darrel R. Eglin} $Affiliation{HQ, Department of the Army} $Subject{west percent germany banks billion exports countries foreign credit german} $Date{1982} $Log{} Country: Federal Republic of Germany (West Germany) Book: Federal Republic of Germany, A Country Study Author: Darrel R. Eglin Affiliation: HQ, Department of the Army Date: 1982 Chapter 4C. Money and Banking The country's financial system was large, modern, and intricate. Besides banking, the system included several stock exchanges, many insurance companies (including those for reinsurance), and securities markets handling a variety of financial instruments, both domestic and foreign. In addition the system was closely linked to international financial centers with few restrictions on flows of funds in either direction. Currency The deutsche mark, West Germany's currency unit, was introduced during the currency reform of 1948. In September 1949 its value was DM4.20 per US $1, but West Germany, like most European countries in the aftermath of World War II, maintained extensive foreign exchange controls. As the economy and exports expanded, controls were removed in 1958, and since then the deutsche mark has remained freely convertible. At times a few restrictions were placed on certain kinds of transactions, largely to avoid the movement of funds by currency speculators that affected West Germany's money supply and inflation. Many factors affect the internal and external purchasing power of a currency. West German officials succeeded in maintaining price stability within the country better than most other industrial nations. Expanding exports kept the balance of payments under control at a time when many industrial countries were experiencing less success. As a result the value of the deutsche mark was appreciated several times in terms of the United States dollar, the key currency in the international monetary system before the 1970s. In 1971 the dollar was devalued, and convertibility into gold was officially abandoned. In 1973 the dollar was again devalued, and West Germany stopped using the dollar for the central exchange rate, using instead the market basket of currencies developed by the International Monetary Fund called special drawing rights. Meanwhile in 1972 EC members set up a European system of controlled currencies called the snake. Other European countries outside the EC subsequently joined. At first fixed parities between the participants' currencies were attempted, but when these proved impossible, limited fluctuations were permitted above and below the fixed parities while each participant allowed its currency to float against all other currencies outside of the snake. Several members dropped out early. A better system was needed, but it was a long time in coming. In March 1979 the European Monetary System (EMS) came into being after long negotiations, encompassing all EC members except Britain. A basket of participating currencies, called the European Currency Unit (ECU) was calculated against which each member set an exchange rate. Market foreign exchange rates could fluctuate 2.25 percent (6 percent for Italy) above or below that rate before central banks intervened by buying or selling currencies to stay within the prescribed limits. The participating members had no obligation vis-a-vis currencies outside the system where foreign currency markets essentially established the exchange rates. In October 1981 the basic exchange rate of several countries against the ECU had to be adjusted because of differing inflation rates and other monetary developments. West Germany appreciated the value of its currency in the EMS by 5.5 percent. The purpose of the snake and the EMS was to restore some order to exchange rates after the breakdown of the system that had existed since World War II. In the 1970s large liquid sums were available to speculators to shift around to take advantage of small discrepancies in rates between currencies. These shifting, large sums threatened domestic currency stability and affected exchange rates-and therefore export prices-in many countries. The broader the system the better for all concerned, but it meant subjugating some control over domestic policies to international developments, which some countries refused to do. The snake and EMS were limited efforts by a group of countries that were close foreign trade partners. West Germany participated in these efforts partly for its own interest and partly to support the EC concept. In the early 1980s the United States dollar remained the most important currency in international trade, helped in part by the requirement of many crude oil exporters that payment be in dollars. The deutsche mark also remained a very important international currency, which other countries used for currency reserves and as a safe investment. The exchange rate between the two currencies was important to West Germany. In 1980-81 the deutsche mark began to drop in value vis-a-vis the dollar for several reasons. At the end of 1979 the market exchange rate was DM1.71 per US $1 compared with DM2.37 per US $1 in June 1981, a decline of 28 percent. The lower value of the deutsche mark was expected to help West Germany exports. West German monetary authorities, however, were confronted with an outflow of funds that required action opposite to that needed by the domestic West German economy. Banking Banking was the most important part of the financial system. Public, cooperative, and private credit institutions competed in West Germany, and many also conducted business abroad. In 1981 there were more than 5,350 banks with over 44,660 branch offices. In addition the federal postal service operated postal savings banks, which in 1979 had 18 million depositors and DM23 billion of deposits, and there were some 148 private installment credit institutions for consumer loans. Among the seventeen banks with special functions was the publicly owned Reconstruction Loan Corporation (Kreditanstalt fur Wiederaufbau) originally created to handle the Marshall Plan aid for West Germany. In the 1980s it continued long-term loans for domestic development. It also provided long-term credits for exports and handled West German aid to developing countries. It received its funds primarily by bond issues and from the federal government. Other public credit institutions provided special services in industrial, agricultural, and mortgage loans. In 1981 the main banking organizations included 246 commercial banks, 599 savings banks, twelve central savings institutions Landesbanken), thirty-eight private mortgage banks, and 4,225 credit cooperatives. The mortgage banks acquired funds from the sale of long-term bonds, receipts of which financed long-term credits particularly for housing and government projects. The mortgage banks, most of which were owned by the large commercial banks, were a major source of long-term credit. The credit cooperatives had an extensive network of offices and in 1980 accounted for 11 percent of banking business. They were particularly active in lending to individuals but also were important sources of credit to housing and other businesses, including the self-employed. Cooperatives' share of the country's banking business increased rapidly, more than doubling from 1960 to 1980. Savings banks, usually municipally owned, had a large network of branches, which facilitated rapid growth over the past thirty years. Most savings banks were small, but a few were quite large. In 1980 savings banks accounted for 22 percent of banking business, being an important credit source throughout the economy and the main source for individuals seeking loans. The twelve Landesbanken were the regional clearing and reserve institutions for the savings banks, which along with the state government usually owned the Landesbanken. By 1981 some of the Landesbanken had extended their activities into all phases of commercial banking including operating offices abroad. A couple of the Landesbanken were among the largest credit institutions in the country. In 1980 Landesbanken accounted for 16 percent of banking business. They were an important credit source for governments, particularly at the state and local level. The 246 privately owned commercial banks had 6,140 branch offices and accounted for 24 percent of the banking business. They provided customers with a full range of services and extended credit throughout the economy, particularly to corporations. The three largest commercial banks remained the Deutsche Bank, Dresdner Bank, and Commerzbank, which along with a few other large banks provided the bulk of credit to large corporations. The commercial banks had close links with and considerable influence in industry (see Industry and Banks, ch. 6). Many of the commercial banks had branches and subsidiaries abroad. Foreign governments and businesses as well as international institutions issued deutsche mark bonds through West German banks, and the commercial banks participated in many loans abroad. In 1981 West German banks held about DM4.8 billion of Poland's debt, for example. Banking activity expanded rapidly. The amount of credits extended by West German credit institutions to nonbanks (governments, businesses, and individuals) rose from DM544 billion in 1970 to DM1,543 billion in 1980, while total business increased from DM818 billion to DM2,351 billion for the same years. Considerable competition existed as the various kinds of banks attempted to increase their share of the market. The credit cooperatives, savings banks, and the Landesbanken had substantially expanded their shares at the expense of commercial banks over three decades. By 1981 the competition, fluctuating interest rates, and poor judgment had greatly reduced the profits of most banks and pushed some into precarious positions. By the 1970s several changes in banking laws had been made, and broader reform had been discussed for many years. Draft changes emerged in 1981 only to be scrapped. One object was to include foreign operations in the reporting data of West German banks because some had developed foreign subsidiaries to avoid the closer supervision exercised by West German authorities. Commercial banks feared the proposals would weaken their competitive position internationally. Intense lobbying by the various banking groups sought favorable definitions of equity because loans could not exceed eighteen times equity capital. The reform, when it comes, could have considerable influence on the structure of banking. Although actual supervision of credit institutions is the responsibility of a federal office, control of credit and monetary policy is lodged with the central bank, the Deutsche Bundesbank, headquartered in Frankfurt but with regional administrations in each of the states (Landeszentralbanken). The present form of the central bank dates from 1957 after a reorganization of the former central bank. The government owns the stock of Deutsche Bundesbank and appoints its directors, but the central bank is legally, and often in practice, independent. The central bank has the exclusive right of note issue, but its main function is the promotion and enforcement of a monetary policy that will ensure economic stability. To this end it has various means at its disposal to regulate the availability of credit and the liquidity of the credit system. The central bank has the power to vary the rediscount rate on commercial paper presented to it and to set limits on the amount of such paper it will discount. The central bank controls the minimum legal reserve requirements that financial institutions must maintain against deposits. By varying the reserve requirements, the central bank can directly influence the supply of liquid funds in the credit system. The central bank also manages the country's foreign currency reserves, buys and sells in foreign currency markets to protect the deutsche mark, and exercises some controls over the movement of funds in and out of the country. In 1981 Deutsche Bundesbank's intervention in foreign exchange markets produced a rare and fortuitously high profit (because of accidental exchange rate movements) expected to be DM10 to DM15 billion, most of which the federal government intended to use to help reduce the 1982 budget deficit. The central bank is legally required to support the economic policy of the federal government. All too frequently this obligation conflicted with its other main responsibility-to preserve the stability of the currency. In many instances the central bank exhibited its independence by giving priority to maintaining the stability of the currency, in its broad sense, rather than supporting government policy. For example, in 1981 federal officials desired an easing of credit to lower interest rates, but the central bank restricted credit and kept interest rates high most of the year because of the adverse effects lower interest rates would have on internal inflation and the balance of payments. In mid-1981 the head of the central bank publicly responded to government pressure by implying that control of budget expenditures to fit conditions was essential to an economic policy. Since the 1950s monetary policy has been a major instrument in managing the economy. It generally has tended toward conservatism, leaning toward price stability and stable exchange rates if there was a trade-off in terms of growth or unemployment. Central bank officials have had a variety of tools, however, that have permitted fine adjustments, which they have employed to minimize adverse developments during the course of a year. Bank officials also have had greater discretionary powers since 1973 when West Germany ceased supporting the United States dollar-deutsche mark exchange rate to the degree required in the early 1970s. Since 1974 the central bank has published annual goals for the money supply and other monetary indicators for the coming year to help influence policies and expectations of banks and businesses. The dilemma of monetary policy was vividly demonstrated in 1980-81 when demand was weakening, the deficit on the current account of the balance of payments was increasing, and high interest rates in other countries were attracting funds from West Germany. If monetary policy was relaxed to expand credit and stimulate domestic demand, capital outflows would exert downward pressure on the exchange rate, which would increase import prices and cause further deterioration in the current account balance. The other extreme-that of keeping domestic interest rates high to encourage an inflow of foreign funds to ease pressure on the exchange rate and to finance the current account deficit-would have a depressive effect on domestic business activity and employment. In 1980 officials selected a middle course to avoid the harshest effects of either extreme with adjustments during the year. By the beginning of 1981, however, external considerations gained importance and domestic interest rates were pushed up, and an informal agreement was arranged with leading commercial banks to halt temporarily long-term loans to foreigners. By the fall of 1981 monetary policy began to relax, and domestic interest rates started to fall as export orders picked up and balance of payments pressures eased. At the beginning of 1982 business activity was increasing, and the expectation was for modest, real economic growth of perhaps 1 percent, although unemployment had reached its highest level since 1953, and prices continued to move up. Monetary policy, along with other government policy measures, achieved remarkable success over three decades. Exchange rates remained relatively stable, given the sharp changes in international developments. The general trend of the external value of the deutsche mark was upward. The consumer price index increased an average of 1.8 percent a year between 1950 and 1960, 2.6 percent a year between 1960 and 1970, and 6.2 percent a year between 1970 and 1974. The yearly increases in the cost of living index were 6 percent in 1975, 4.3 percent in 1976, 3.7 percent in 1977, 2.7 percent in 1978, 4.1 percent in 1979, and 5.5 percent in 1980. Since 1979 external sources of inflation, partly related to crude oil price increases, have overshadowed those from internal sources. In 1981 prices continued to increase; in September the annual rate reached 6.5 percent, and the average for the year was expected to be above the figure for 1980. Nonetheless West Germany's rate of inflation remained near the lowest among the industrialized nations. Foreign Trade West Germany was the world's second largest exporter and importer in terms of value. In 1980 the country exported 23 percent of GNP, the proportion having remained stable since the mid-1970s. Few industrialized countries were as dependent on foreign trade. In 1979 the ratio of exports to GNP was 8 percent for the United States, 10 percent for Japan, 17 percent for France, 23 percent for Britain, 43 percent for the Netherlands, and 51 percent for Belgium. Because it possessed few natural resources and limited agricultural capacity, West Germany also needed many imported goods. In foreign trade, West Germany followed the country's general economic philosophy that competition and free markets provided the best allocation of resources. Few subsidies or other distortions promoted exports, and a liberal trade policy was applied to imports, although the small agricultural sector was protected for social reasons (see Agricultural Policy, ch. 5). In spite of this West Germany was the world's largest importer of agricultural products. Many West German businesses had to face strong international competition whether they produced for export or the domestic market. The result was that the economy was vulnerable to disturbances throughout the world. West Germany was a founding member of the EC, one goal of which was a common market among members. In 1981 trade among the nine members was duty-free. A common external tariff applied to each member's trade outside of EC. Under the common external tariff, most raw materials had low rates or were duty-free. The exception was agricultural products to which variable levies were applied to equalize the prices of imports with those of commodities produced within the EC. The common external tariff applied duties generally in the range of 5 to 17 percent on manufactured goods, although some processed foods carried substantially higher duties. EC organizations participated in the General Agreement on Tariffs and Trade (GATT) and arranged trade treaties with other trade groups. A treaty with most European countries outside the EC provided for a phased free trade area in industrial goods during the 1980s; free trade had existed for many industrial products since 1977. West Germany applied most-favored-nation treatment to all countries and extended preferential treatment to a number of countries under EC treaties or other schemes. Exports Exports increased from DM8.4 billion in 1950 to DM350.4 billion (US $193 billion) in 1980, an annual average increase of 13.2 percent (in current prices). The ratio of exports to GNP was 8 percent in 1950, 16 percent in 1960, 18 percent in 1970, and 23 percent in 1980. Nearly one in four jobs depended on sales abroad. The growth of exports had been primarily in manufactured goods (which probably accounted for nearly 95 percent in 1980)-especially machinery and equipment. In 1980 machinery and equipment alone amounted to 44 percent of total exports (see table 17, Appendix). Other manufactured goods contributed an additional 30 percent, and chemicals 13 percent. Most of the remaining exports were such items as beer, processed foods, tobacco products, and fuel-related products that were surplus to domestic needs. In 1980 over three-quarters of all exports went to free world industrialized countries. The EC members alone were the markets for 48 percent of exports. France, the Netherlands, Italy, Belgium, and Luxembourg were the largest buyers in order of rank in 1980 (see table 18, Appendix). Although the United States imported about US $11 billion from West Germany in 1980, its share was only 6 percent. West Germany had made an effort to market its manufactures in developing countries. Twelve percent of exports in 1980 went to non-oil exporters and 7 percent to members of the Organization of Petroleum Exporting Countries (OPEC), primarily in the Middle East. Although exports to communist countries, largely the Soviet Union and its East European allies, had expanded considerably and had become particularly important for segments of industry as a result of policies during the 1970s, the communist countries bought only 5 percent of total exports in 1980 (see Industry and East-West Trade, ch. 6). Exchange of goods with East Germany was considered internal trade and not recorded in foreign trade data. The trade was handled under a bilateral clearing arrangement using a special unit of account instead of either country's currency. A special interest-free swing credit equivalent to about DM850 million a year permitted a surplus of West German exports for many years. By 1980 East German purchases from West Germany amounted to the equivalent of more than US $2 billion annually, about 2 percent of total exports. West German exports historically were helped by lower prices but relatively less affected by higher prices. The numerous appreciations of the deutsche mark had a smaller impact on foreign sales, for example, than economists had expected. Buyers were willing to pay the price for West German advanced technology and quality control, deliveries as scheduled, and the availability of after-sales service and parts. Business conditions, particularly in Western Europe and the United States, however, strongly affected West German exports. Exports of machinery, materials used in construction, and chemicals were particularly sensitive to the rise and fall of investment spending in other industrialized countries. Economists attributed part of the West German recessions of 1975 and 1980 to the decline of exports caused by the impact of large crude oil price increases on investments in most industrialized countries. Imports The rising price of crude oil and other energy sources has made fuel the country's largest import category. In 1980 energy imports accounted for DM77 billion, 23 percent of total imports. Although coal was imported, natural gas and crude oil (and some refined products), primarily from Britain, Norway, members of OPEC, and the Soviet Union, were the main imported energy sources. Petroleum prices increased 46 percent in 1980. The net oil import bill was nearly DM45 billion in spite of a 10 percent decrease in volume. West Germany, like many other countries finding it difficult to meet rising energy costs, was developing domestic sources while conserving to reduce imports. Although West Germany was a leading exporter of machinery and equipment, such imports accounted for 19 percent of total imports in 1980 (see table 17, Appendix). West German industry did not attempt to produce all types of machinery but tended to specialize, relying on imports to meet the remainder of total requirements. About 30 percent of imports were various manufactures that included a wide range of consumer goods and substantial amounts of metals and semifinished materials. Prices of metals and raw semifinished materials rose 14 percent in 1980, contributing to the increase of domestic prices. Agricultural products, including some processed foods, were nearly one-fifth of total imports. Imports in 1980 increased only 2 percent in volume but 17 percent in value, amounting to the equivalent of US $187.7 billion. Western Europe was the main source of imports. Members of the EC supplied 46 percent of total imports in 1980. The Netherlands was the largest source of imports followed by France and Italy (see table 18, Appendix). American exports to West Germany amounted to US $14.1 billion in 1980, accounting for nearly 8 percent of imports. OPEC accounted for 11 percent of imports, and other developing countries an additional 11 percent. Communist countries, primarily the Soviet Union and Eastern Europe, supplied 5 percent of imports. East Germany supplied mainly textiles, petroleum products, food and other agricultural commodities, and machinery under the clearing arrangement. Imports from East Germany amounted to the equivalent of only about US $2 billion, because many of its commodities were difficult to sell in West Germany. Balance of Payments Since the 1950s West Germany has relied on a substantial excess of exports over imports to balance international payments. The trade balance increased for more than two decades until 1979 when it began declining, mostly because of increasing prices for imports (see table 19, Appendix). Other items in the current account balance continued to increase in 1979 and 1980, creating the first deficits in fourteen years. The result was pressure on the external value of the deutsche mark and a need for an inflow of capital while high interest rates, particularly in the United States, were attracting funds out of West Germany. West Germany's current account contained many entries. Although the country's defense expenditures were similar in magnitude to those of its partners in the North Atlantic Treaty Organization (NATO), most defense costs were in domestic currency because few troops were outside of the country. Foreign troops stationed in West Germany, however, required considerable supplies and spent money amounting to the equivalent of nearly US $6 billion in 1980. The federal government made official transfers for various purposes, including payments to the EC and continuing payments to Jews who had suffered losses during the Hitler era. Foreign workers in West Germany continued to send remittances home, although the sums declined from the peak of DM8.2 billion in 1973 to DM6.9 billion in 1980. Net income from foreign investments was small because foreign investments in West Germany were nearly as high as West German investments abroad (see Industry and The World Economy, ch. 6). Net payments for transportation had improved by 1980 but had been negative throughout the 1970s. The passion of West Germans for foreign travel caused a major and increasing outflow of funds that, along with remittances, required an expanding trade surplus to finance it. In 1980 total tourist spending abroad was about US $21 billion (more than twice what American tourists spent), while West Germany's net outflow for tourism amounted to over US $14 billion. The government took no measures to restrict foreign travel, although the balance of payments had become a major concern by 1980. The current account balance is an alarm signal for many in West Germany. When the balance began to deteriorate in 1979, the alarm bells rang in the form of media coverage. The situation was not nearly as desperate as that which many countries faced, but monthly developments were widely reported. The current account balance went from a positive DM18.4 billion in 1978 to an outflow of DM9.6 billion in 1979, and DM29.1 billion (2 percent of GNP) in 1980. Available statistics for 1981 indicated a probable rise in exports and a smaller current account deficit for the year. The net capital movements financed only a small part of the current account deficit in 1980. Banks sharply reduced imports of capital, and private funds flowed out because of interest differentials and the declining value of the deutsche mark. Toward the end of 1980 foreign long-term lending and portfolio investment by banks became substantial. In December the central bank obtained the agreement of the leading banks to halt long-term lending abroad until April 1982. Government borrowing became significant for the first time in more than a decade. Direct borrowing by the government occurred largely in Saudi Arabia and the United States. About half of official borrowing abroad was handled by banks. Nearly all of the current account deficit was financed by reducing the reserves of the central bank. At the beginning of 1981 the gross external assets of the Deutsche Bundesbank amounted to DM82 billion, the net value of which was DM67.5 billion. The 1980-81 recession was troublesome for the West German economy and the population because of the interaction of several factors. Demographic forces were expanding the working-age population while pressures on industry tended toward capital-intensive measures. The business cycle interacted with this longer trend, and both were intensified by price increases for oil and other raw materials. The terms of trade deteriorated for West Germany while high interest rates abroad attracted funds. Economic policy, of which monetary policy was the primary instrument for managing the economy, was severely constrained by the balance of payments to respond to diminishing domestic demand. By early 1982 the economy appeared to be recovering, although unemployment could remain a problem. Many economists believed the West German economy was strong and that its competitiveness had been aided by the decline of the deutsche mark, but the reaction of labor unions in 1982 may play an important role for the country's future. * * * Literature on the West German economy is extensive but often narrowly focused. The Political Economy of Germany in the Twentieth Century by Karl Hardach presents a comprehensive survey of events and developments up to 1970. Managing the German Economy by Jack H. Knott conveys some of the political aspects and techniques of budget formation and economic management at various levels of government. The Organisation for Economic Co-operation and Development publishes an annual economic survey, Germany, which reviews recent developments and policies and includes up-to-date key statistics in English. West German official statistical publications are numerous, current, and often in English or with English keys to the tables. The annual Statistisches Jahrbuch and the monthly reports, in four separate series, of the Deutsche Bundesbank provide a wide variety of statistics on various aspects of the economy. (For further information see Bibliography.)