Germany's Growing Economic Woes Roil The Currency Markets

Notwithstanding the dollar's recent ascent, the most significant development in currency markets seems to be the sudden decline of the German mark. Because it reflects growing German economic malaise, and Germany is the linchpin of West European economies, the mark's drop may well be a harbinger of slowing demand for U. S. exports.

The mark's reversal has been dramatic. After hitting new heights in mid-February, it has plunged 18% against the dollar, even though short-term German interest rates are 300 basis points higher than U. S. rates. It has also fallen 11% against the Japanese yen and weakened against other European currencies.

Behind this fall from grace, says economist Carol A. Cantore of Manufacturers Hanover Trust Co., is the realization that restructuring the east German economy will be a long, hard process. Instead of sparking an economic miracle, monetary union has dissipated east Germany's comparative advantage of cheap skilled labor. And the sudden availability of Western products has hurt demand for its own inferior consumer goods.

The result has been a 60% drop in east German industrial production, combined with soaring unemployment and inflation. At the same time, the west German boom fueled by the federal government's decision to subsidize east Germany's sagging economy is finally starting to fade. Huge tax increases slated to take effect in July to help pay for economic union are already stirring public unrest and weakening the power of Chancellor Helmut Kohl's Christian Democratic Union party. Germany's soaring current-account balance has suddenly slipped into deficit. And inflationary pressures are heating up in the face of rising wage demands, the falling mark, and pending tax hikes.

Looking ahead, economist William Sterling of Merrill Lynch & Co. expects growth in west Germany to slow from 4.6% in 1990 to 2.7% this year and 2.2% in 1992, as the effects of tight money and higher taxes finally brake the economy. At the same time, he expects inflation to rise to 4% or higher.

All of this, says Sterling, spells continued downward pressure on the mark, particularly since the U. S. economy is expected to perk up and inflation is expected to ease in coming quarters. But the wild card, says Carol Cantore, will be the impact of a German slowdown on Europe's demand for U. S. goods. "Western Europe," she notes, "is the only major area with which the U. S. enjoys a trade surplus, and deterioration there could undermine one of the key props of the anticipated U. S. recovery."