Bundesbank in Dilemma As German Mark Declines

THE German deutsche mark, which hit a 20-month low against the dollar this week, is getting mixed reviews in Germany.

It has put a smile on the face of German exporters, who expect the downward trend to make their products more price-competitive. The prospect of higher earnings for exporters - the backbone of German industry - also has breathed new life into the German stock market.

This week the DAX, the index for the Frankfurt stock exchange, climbed up around the 1,700 barrier, a level crossed briefly in March.

But the Bundesbank, Germany's central bank, is not happy about the mark's decline. A staunch defender of the German currency, traditionally the anchor in Europe, the bank is concerned that foreign investors could abandon the mark.

The mark's downward trend puts the Bundesbank in a dilemma over its interest-rate policy.

The central bank gradually has been reducing its interest rates, a help to an economy in its worst recession since World War II. Although the bank took a pause from this course last month, economists were hoping for further interest-rate reductions on July 1 or July 15, the next scheduled meetings of the central bank council.

But the mark now has put the trend in interest rates in doubt. As the mark decreases in value, the price of imported goods for Germans rises, fueling inflation. This is the Bundesbank's No. 1 enemy. Its only tool to fight inflation - and prop up the mark - is high interest rates.

Klaus Friedrich, chief economist for Dresdner Bank in Frankfurt, says he hopes that the Bundesbank will not "chicken out" and abandon its step-by-step cut in interest rates. "I don't think they have reason to," he says.

Mr. Friedrich points out that the mark's decline has been "entirely predicted and desirable and so far not [done] in an excessive manner." He says the reason for the decline has more to do with the strength of the dollar, based on economic recovery in the United States and the expectation that US interest rates have hit bottom and can only go up.

The fact that the mark is now hovering around 1.7 to the dollar "doesn't scare me at all," Friedrich says. He predicts that the mark will sink further to 1.8 by the end of the year, an exchange rate which he terms "good for the economy."

WHILE agreeing that the strengthening of the dollar goes a long way in explaining the mark's weakness, Peter Pietsch, economist at Commerzbank, says it is only half of the equation.

The other half is the German economy, he says, "which is still quite weak." Of course, he adds, "it's simple to find additional reasons" such as Bonn's deficit-heavy fiscal policy.

In an editorial Tuesday, the centrist newspaper Der Tagesspiegel of Berlin commented: "Among foreign investors, the impression is gaining the upper hand that the Bonn government no longer has any control of state finances."

According to forecasts by the German Finance Ministry, the federal deficit will reach a record DM 67.6 billion (US$42 billion) in 1993, compared with an original forecast of DM 43 billion. Finance Minister Theo Waigel is planning cuts of more than DM 20 billion to bridge the gap - cuts that include the sacred cow of social services.

The Bundesbank is pressing Bonn to be a more aggressive cost cutter, instead of choosing the easier route of tax-and-fee increases which it has so far followed. It used its June report, released this week, to point out how government borrowing had fueled money-supply growth - the main reason the Bundesbank was forced to cease its interest-rate cuts last month.

The weaker mark, however, is a welcome relief to Germany's neighbors, since it gives them more room to maneuver their interest rates. On Monday, for instance, the Bank of France cut its key short-term interest rates below German levels - without waiting for the Germans to move first.

The new situation led Jacques Delors, president of the European Commission, to comment that the European Community was no longer bound to "one single dominant currency."

You've read  of  free articles. Subscribe to continue.
QR Code to Bundesbank in Dilemma As German Mark Declines
Read this article in
QR Code to Subscription page
Start your subscription today