Thayer Watkins
Silicon Valley
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Currency Conversion for
the Germanies with Unification

It is tempting to say that the West German authorities, in the exuberance of pending unification, did not understand the policy mistake they were making in the matter of the conversion of the East German currency, the Ostmark, into the Deutschemark. But that would not be correct there were many, notably in the Bundesbank, who said the conversion terms were overly generous to the East Germans.

The issue was clouded by several factors. The offician exchange rate between the two currencies before 1990 was one-to-one, but there was very little conversion that took place at that rate. That exchange rate could by no means be considered a market exchange rate. The market exchange rate, the so-called black market exchange rate was from five Ostmark to the Deutschemark to ten to one.

Prices of necessities in socialist countries are often held at artificially low, subsidized levels. Anything other than necessities may be unavailable. A comparison of the costs of the goods that were available in East Germany with the costs of those goods in West Germany made it seem that the Ostmark had equivalent or superior purchasing power to the Deutschemark, but that comes from the limited array of goods available for the comparison and no allowance for the differences in quality of the goods in the two areas. Because of the scarcity of goods other than necessities the East Germans had accumulated the unspendable Ostmarks in savings accounts.

In trade between the two Germanies the effective exchange rate varied from about five Ostmark to the Deutschemark to about 2.5 to one.

When the actual unification conversion had to set political considerations played as important if not more important role than economic and financial reality. Helmut Kohl had promised to support a one-for-one conversion ratio. The formula that was established was, in somewhat simplified form,

The savings, pension and loan conversions were very generous to the East Germans. They were, in effect, a gift to the East Germans from the West Germans. Since a gift was being given it would have been more sensible to make the gift on a per person basis instead of making it proportional to their holdings of East German currency. The real policy mistake was the use of the one-to-one ratio for the conversion of wages and prices in East Germany. This priced East German labor out of the market. East German labor was less than half as productive as West German labor. This made former East German labor market too expensive for West German firms to want to locate facilities in those areas. In the absence of market incentives establishing manufacturing facilities in the former East Germany the central government needed to pay very expensive subsidies. These subsidies amounting to about $100 billion per year go on to this day, and yet the economic depression of the east continues. The Bundesbank had to mesh German monetary policy of the time with the fight against budget and trade deficits. It is no wonder that the head of the Bundesbank, Karl Otto Pohl, called the conversion scheme a disaster.

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