THE WEST GERMAN ECONOMY: EARLY RECOVERY A MIXED BLESSING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700040025-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 13
• Document Creation Date: December 20, 2016
• Document Release Date: March 30, 2006
• Sequence Number: 25
• Publication Date: October 1, 1972
• Content Type: IM

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Confidential
DIRECTORATE OF
INTELLIGENCE
The West German Economy: Early Recovery A Mixed Blessing
Confidential
ER IM 72-142
October 1972
Intelligence Men7orandum
Copy No.
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CONFIDENTIAI,
CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
October 1972
INTELLIGENCE MEMORANDUM
THE WEST GERMAN ECONOMY:
EARLY RECOVERY A MIXED BLESSING
Summary
1. After stagnating in 1971, West Germany's economy is again on
an upswing. Continuing buoyant private consumption, some easing of
restrictive monetary policies, and a high level of construction made possible
by an unpredictably mild winter all combined to prevent an expected drastic
decline in business activity and a correspondingly large rise in unemployment
in the early months of this year. These factors, together with an improved
economic climate following the December Smithsonian monetary agreement,
as well as gradually improving profit margins in the wake of moderating
wage demands, have now largely dispelled the gloom in the business
community.
2. Some soft spots still remain, but leading indicators suggest the
economy will expand at a steady, though not spectacular, pace through
the year's end. Industry's order books are slowly filling, profit margins are
improving, investment is picking up, and unemployme.~t -which failed to
rise as much as feared during the slowdown -has leveled off. Lingering
uncertainties on the international monetary scene, heightened anew by last
June's ;~terling float, could still affect recovery. But the introduction of
controls over capital inflows has strengthened Bonn's monetary defenses,
and in any case, the increasing strength of domestic demand reduces the
economy's vulnerability to foreign iniiuences.
3. Inflation is the economy's Achilles' heel. Inflationary pressures
have again accelerated, aggravated in part by Bonn's inability to halt the
rapid rise in public spending, and the August cost of living index was up
anear-record 5.7% over a year ago. Given the almost pathological fear of
Note: This memorandum was prepared by the Office of Economic Research
and coordinated within the Directorate of Intelligence.
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inflation, especially among the older generation of 'Germans whose savings
were wiped out twice in a lifetime by runaway prices, the cost of living
index probably will be one of the key political barometers during the next
few months.
Background
4. 17~e 1971 slowdown, precip:~ated by $onn's deliberate
anti-inflationary policies, was aggravated by growing uncertainties in the
international monetary system. With domestic investment and foreign
demand flagging, gross national product (GNp) in constant prices declined
steadily from its first quarter high (see Figure 1). For the full year, tl~e
real growth rate was 2.7%, do .rn from 5., % in 1970 and 8.0% in 1969.
Industrial production increased even more slowly - lea:., than 2%, comi;ared
with 6% and 13% in the two previous years. While production cutbacks
led to some layoffs, employers more typically sought to maintain their work
forces by reducing the workweek. Unemployment (seasonal).y adjusted) rose
gradually throughout last year, reaching about 230,000 in the ;ast quarter -
up from 150,000 in 1970 -but was still less than 1 ?Jo of the total labor
force.
5. Moderated wage increa~;;s, reduced overtime, anc' lowered prices
of imported raw materials and semi?flnished goods gradually ased industry's
cost pressures during the year. Reflecting these rlAvelopments, as well as
weakening domestic and foreign dema~id, industrial producer prices, which
]lad risen sharply since 1968, began to level off by mid-1971. With consumer
spending rem~iining strong, however, retail prices continued to climb, and
the cost of living index rose a rPCOrd 5.9% by the end of the year.
6. Concerned primarily about the intolerably high rate of inflation,
Bonn maintained its restrictive policies in an effort to break the wage-price
spiral. At the same time, Karl Schiller, then Minister for Economics and
Finance, prepared a contingency, pump-priming budget to be activated if
a recession threatened to develop. A recession would be politically just as
damaging to the Social Democratic/Free Democratic coalition as excessive
inflation. Monetary policy also remained tight, as the Bundesbank pressed
hard to reduce the banking liquidity, which had becn swollen by massive
capital inflows before the May Deutschemark float. Amid gathering signs
of the slowdown, '~iowever, the Bundesbank eased its policies slightly toward
the year's end.
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West Germany: Selected Economic Indicators
(Seasonally Adjusted)
uNP, Quarterly Figures at Annual Rates
Billion 1962 Dnutschomarks
1909 70
~Estinw(ed.
Cost of Living
tssz=too
300 ..__---..._..___.
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7. Business confidence, already flagging in the face of declining
orders, shrinking profit margins, and the prospect of increased corporate
tai:es, was badly shaken by the international moneta crisis
by the float
Pessimism deepened as businessmen
oun t etr concern schoed in dire commentary by bankers and in forecasts
of highly respected economic research institutes which uniformly predicted
an accelerated downturn in the first half of 1972.
8. These fears proved premature. Unusually favorable weather in late
1971 permitted an unseasonably high level of construction which prevented
a drastic decline in business activity and a large increase in unemployment.
Building investment increased an unusually high I S% during the winter
months. At the same time, private consumption rose about 4%, largely as
a result of rising demand for automobiles and other consumer durables.
These factors, together with the reduction in the de facto appreciation of
the Deutscl:amazk and the return to fixed parities following the December
>rnithsonian monetary agreement, as well as gradually improving profit
margins in the wake of moderating wage demands, brought about an upturn
in business expectations.*
The Economy Picks Up
9. In the first three montha of 1972, real GNP grew 3.7% over the
preceding quarter. To be sure, this good showing was influenced by such
exogenous factors as the favorable winter weather and the catch-up in
production in the important metal working industries that had been hard
hit by strikes in late 1971. Nevertheless, the continued rise in GNP through
the first half ~f 1972 (2.2% over the corresponding 1971 period) and the
renewed increase in orders booked by industry suggest that the improvement
is more basic and that recovery is under way.
10. Businessmen appazently believe that prospects are looking up. Thy
rise in domestic orders for machinery and equipment prcvides tangible
evidence of an improved investment climate. Growing inventories and rising
orders for raw materials and semi-finished goods also indicate improved
buai:tess confidence. Contrary to eazlier fears, investment in machinery and
equ nment during the first half of 1972 appears to have reached the level
" By mid-December 1971, the float had produced a de facto revaluation of the
Deutschemark in excess of 12%. As a result of the Smithsonian currency realignment,
the revaluation was reduced to an average 6%a'1?o relative to all ether currencies.
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of a year ago and well above *he second half of 1971. Because strike-delayed
orders and the reduction of the investment tax early this year ;tndoubtedly
contributed to this favorable development, however, it is probably too early
to speak of a sharp upward trend in investment activity.
11. Foreign orders have increased significantly, quieting widespread
fears that a revalued Deutschemark would price German goods out of foreign
markets. Early in the year, the normal order flow probably was increased
by orders previously delayed as importers hoped that the currency
realignment would reduce the extraordinarily ]sigh Deutschemark
appreciation during the float. More recently, cyclical factors have become
more important as the rate of economic growth in most of West Germany's
principal trading partners has accelerated, increasing their aggregate import
demand.
The Labor Market Becomes Firmer
12. The cyclical rise in unemployment -substantially smaller than
during the 1966-67 recession - has ~ virtually halted. While overall
employmE~ t has not as yet begun to increase, the number of workers on
reduced work shifts has declined drastically. On a seasonally adjusted basis,
unemployment iii July 1972 was about 300,000, or 1.1% of th.~ labor force,
and reported job vacancies numbered more than 500,000. At the same time,
the foreign labor force exceeded 2.3 million, up 7% from the year before.
13. Union wage demands, which were scaled down significantly last
fall under the threat of an impending recession and increasing
u..^.employme,it, have not ,moderated further this year, but neither have they
incteas:,?d. Gross hourly wages (seasonally adjusted) during the first half of
1972 were up 10% over the corresponding period in 1971. The comparable
increase for 1971 over 1970 was more than 14%.
Inflationary Pressures Remain Strong,
14. Declining cost pressures have not slowed the price rise, because
businessmen are apparently intent on widening profit margins that had
shrunk substantially during the earlier period of rapidly rising cents. The
seasonally adjusted rise in the cost of living index did decline briefly to
a 4% annual rate in tl~e first quarter of this year. Since then, however,
it has accelerated, and, this August, living costs were 5.7% higher than a
year ago. Wholesale prices, more immediat?ly affected by import
competition (especially the reduction in the Deutschemark price of imports
following last December's revaluation), have remained steadier.
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The Foreign Sector
I5. Despite two Deutschemark revaluations during the past three
years, West Germany's foreign economic position remains Europe's
strofigest, and its foreign exchange reserves the world's largest. Export
grovrth slowed substantially in the second half of 1971 (as was to be
expected in view of the decline in foreign orders during the prolonged period
of uncertainty regarding the international .monetary system in 1971). In
the first half of 1972, however, exports grew 7.4%, and the trade surplus
(f.o.b./c.i.f.) reached 8.4 billion Deutschemarks ($2.6 billion) up 22%
from the corresponding 1971 period (see Figure 2). Reflecting the impact
of the Deutschemark float and subsequent revaluation, the trade surplus
in terms of US dollars increased a whopping 37%. Nevertheless, with rapidly
rising deficits in services (14rgely German tourist expei~ditu;es abroad) and
transfer payments (foreign workers' remittances), :he current account was
approximately in balance. It had shown a small surr:us ($160 million) during
the first Half of 197! .
16. Reflecting the impact of the Caslt Deposit Law (Bardepotgesetz),
activated this spring to discourage the inflow of short-term funds generated
by the interest rate differential between the West German and foreign (now
primarily ~u~~odollar) money markets, the short-term capital account showed
a new outflow of $2.1 billion in the first half of the year. But this was
more than offset by a not inflow of $3.3 billion in long-term capital. West
German and foreign money managers si;nply s~vitched into bonds to
circumvent the Cash Deposit legislation. Limited controls over the sale of
fixed interest rate sec!irities to foreigners were introduced in late Juno (over
the strong opposition of Schiller, then Minister for Ecenc~mics and Finance)
to plug this gap in West Germany's monetary defenses. The Bundesbank's
gold and foreign exchange reserves, swollen by extensive p~.irchases of US
dollars in defense of the Smithsonian monetary agreement during the
]nir!i-crisis set off by the June float of the British pound, stood at $25.5
billion on 31 August 1972, up from $17 billion at tl~e end of last year.
The Near-Term Outlook
17. Mast observers believe that economic expansion will pick up
during the coming months but wi!1 remain within the bounds of available
production capacity and labor reserves. Business has upped its investment
plans, and that means rising expenditures for machinery, equipment, and
inventories. With a firming labor market promi~;ng added income and greater
job security, polls show that cons~~mers expect to increase their purchases -
especially of uarables, including cars, refrigerators, and color television
receivers. Finally, the accelerating cyclical upswing in the U:.ited States and
other major West Germa~i trading partners promises brisker foreign demand
for German products.
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Figure 2
West Germany: Major Components ~f the Balance of Paymernts
Net Short-Term Capital
Net Long-Term Capital
Net Services and Unilataral Transfers
Million US $
1999 70 71 7? ~~~- -1989 r0 71 72
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18. The prospect for containing inflation is far less promising. There
is little if any hope of reducing the cost of living increase to the
government-targeted 3% annual rate in the foreseeable future, The upturn
came unexpectedly early, upsetting Schiller's anti-inflationary game plan.
Instead of falling to a 3% annual rate, a low rate by world standards, the
cost of living was rising at more than 5% - in marked contrast to the
1% increase that prevailed in the fall of 1967 when the economy began
to pull out of its last recession. Still, there are at least two vital differences
between then and now that could affect the government's chances for
inflation control. In 1967, the tJeu~~schemark was seriously undervalued,
and excessive foreign demand - a~ well as massive inflows of speculative
funds anticipating revaluation -significantly contribut?d to inflationa.
pressures. Since then, the lieutschemark has been revalued on the average
about 20% relative to t;te currencies of the country's principal trading
partners. The resulting ;harp rise in the foreign exchange cost of German
products should in tirte serve as a brake on foreign demand. Moreover,
strengthened control ~;ver the domestic money supply has enhanced the
Bundesbank's ability to fight inflation through monetary policy.
21. Government expenditures have in :act been rising rapidly - as
they did under previous administrations -but the rise probably is more
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the ~ftect than the cause of inflation. In the attempt to dampen inflationary
pressures, proposed budgetary expenditures have repeatedly been scaled
down, forcing the postponement of politically important social
infrastructure projects. In fact, persistent budgetary strictures have
prevented Brandt from implementing many of the socirneconomic reforms
that provided the basis for his 1969 platform. With non-discretionary and
defense spending accounting for the major share of federal outlays, the
government has very little scope for employing expenditure policy as an
anti-inflationary instrument. Nor has the revenue side of the budget offered
a more viable alternative. Schiller recommended a temporary and refundable
income tax surcharge in early 1970 to cool off private demand, but even
that faced strong oppostio?;i in the Bundestag. It was enacted only after
much delay -and by then it was tco late to do much good. Given the
downtrend in the economy during most of last year, further tax increases
would have entailed the politically unacceptable risk of precipitating a
recession. While there is now general agreement that some tax increase will
becomt unavoidable, if only to reduce the rising federal deficit, the
upcoming elections rule out any action along this line pending the formation
of a new government.
And Some Important Non-Issues
23. Foreign economic and monetary policy are not likely to produce
significant partisan fireworks. Brandt and Barzel are widely agreed in their
views on West Germany's role in the European Community (EC) and on
Wast German-US economic relations. Both men support further progress
toward EC monetary union, provided parallel progress is ensured toward
coordinating or harmonizing economic f~olicies generally. Both back tre EC's
Common Agricultural Policy and, under strong pressure from the well
organized and highly vocal German farm bloc, both defend high support
prices for key agricultural products. At the same time, they strongly
advocate an outward-looking orientation for the EC and favor the
institutionalization of an E~~ dialo;;ue with the United States to resolve
outstanding economic issues.
9
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n e question of international monetary reform,
both men share the EC view that Special Drawing Rights (SDRG) should
increasingly supplant the dollar as the principal reserve medium, and both
can be expected to resist French demands for a substantial increase in the
price of gold and an en.~+anced role for gold in the international monetary
system. Keenly aware of the continued impor~ance of US support, both
men would work hard to mediate US-EC differences.
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