German Reunification And The Triumph Of Politics

Author:Mr Ian Stewart

This month marks the 25th anniversary of the reunification of Germany. Integrating two vastly different economies was a hugely risky venture. West Germany was a global powerhouse while East Germany was an economic weakling, wracked by poor productivity and unprepared for the introduction of a market system.

One of the main decisions facing West German politicians was the choice of official exchange rate between the West German Deutschmark (DM) and the East German Ost-Mark.

On the face of it the decision was straightforward. The DM was one of the world's strongest currencies, an anchor of stability and a symbol of West Germany's post-war economic miracle. The Ost-Mark was the currency of a failed state and an enfeebled economy. The market reached its own verdict and in the winter of 1989-90 the Ost-Mark was trading at seven to one DM.

This exchange rate destroyed East Germans' spending power in Western shops and set up huge incentives for the citizens of East Germany to seek work in the West. With the opening of the border, tens of thousands migrated westwards. The shift in population undermined East Germany's economy and placed huge pressure on West Germany's welfare system.

This set the scene for an epic battle between politicians and policymakers over the choice of an official exchange rate for the Ost-Mark.

The policymakers, in the form of West Germany's Bundesbank, wanted the Ost-Mark to trade close to a market exchange rate. It argued that a weak Ost-Mark was would help offset the effects of poor productivity and would help East German industry cope with reunification. The Bundesbank warned that an artificially high exchange rate would force up costs in the East and inflict more damage on its economy.

West Germany's Chancellor, Helmut Kohl, disagreed. He wanted a one to one exchange rate believing it would provide stability, preserve the spending power of East Germans and stem the flow of migrants. With elections looming in the East, a one to one exchange rate would also go down well with the new citizens of the Federal Republic.

Chancellor Kohl brushed aside the warnings of the Bundesbank and in the summer of 1990 the DM was...

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