A weak mark can ease Germany's pain
Sunday 09 February 1997
The shock economic news of the week was undoubtedly the climb in German unemployment in January, with 4.66 million people out of work, equivalent to 12.2 per cent of the workforce. That figure is not seasonally adjusted (see the left-hand graph below), so the underlying trend is not quite so catastrophic. But even allowing for seasonal factors and a change in government compensation for building workers laid off because of bad weather, this news shocked German opinion. Even if you strip out the former East German provinces and just look at the west, unemployment is still nearly 11 per cent - more or less in the same band as France and Italy, and double that of the US. Come to think of it, the figure is pretty nearly double that of the UK.
Looking in from outside, it has been easy to see that German unemployment would rise sharply as companies adjusted to high wage and social security costs with the sort of radical downsizing that took place in the US and UK in the 1980s. But they didn't see it coming. As the head of the federal labour office in Nuremberg said, the rise exceeded his fears "and the estimates of all experts". And of course the Chancellor, Helmut Kohl, acknowledged on Friday that Germany had to change.
But this threatening cloud has a silver lining. In one sense Germany is already changing. Rising unemployment is a sign of commercial restructuring, a sign that German industry is renewing itself. And it is doing so from a base of excellence. Germany remains the world's premier exporter and has been gaining ground in recent months, thanks in part to cost-cutting but also the weaker mark.
This raises the question at the start of this column, a question which applies to Japan as well as Germany, and a question which happens to be at the front of the Group of Seven discussions taking place this weekend.
We'll come back to G7 in a moment. Meanwhile, you see the point about the need to cushion the pain of restructuring. If you are going to have a society operating on a high level of job mobility, you also have to have a high level of insecurity. But to make that socially acceptable you also need a high level of demand, so that people who lose jobs are quickly re-employed. You can, however, operate an economy at a high level of demand without stoking inflation - as the US has shown - because the insecurity helps keep wage rates down.
So the next question is this: how do you achieve a higher level of demand? In the UK and US there is no problem; you just cut interest rates. One of the wonderful things about American and British consumers is that if you put money in their pockets they will go out and spend it. In America, cut rates and they get out their credit cards; here in Britain, cut rates and house prices rise, and people feel secure enough to splurge a bit. But it doesn't work as well in Germany, or for that matter in Japan.
In both Germany and Japan interest rates are very low. But there is no established tradition of borrowing on credit cards in Germany (and not much in Japan), and no link between mortgage rates and consumption. In Germany owner-occupation is much lower than in the UK - most people rent their homes. In Japan, houses tend to stay in families for years. When young couples set up home, it is usually by renting: if they do buy, they are usually helped by the rest of the family and so are not really free to cash in any excess equity.
So cranking up demand depends, particularly in Germany with its large export sector, on cranking up exports. This thesis that Germany needs a weak mark to soften the pain of restructuring was developed last week by Norbert Walter in the International Herald Tribune. Dr Walter, chief economist for Deutsche Bank, is an important figure in German economic thinking. The German establishment is now edging towards accepting that the country has to make radical changes in its taxation system and its labour laws. But it needs breathing space, and Dr Walter argues that the 40 per cent depreciation of the US dollar between 1985 and 1995 could now be encouraged by the central banks and finance ministers meeting at the G7.
It was, after all, the Plaza meeting of the same group (actually then a G5) in 1985 that triggered the fall of the dollar and therefore set the decline in train, while the general exchange rate stability encouraged by the Louvre Accord in 1987 bolted down the dollar. Now, Dr Walter argued, the G7 ought to lean in favour of a strong dollar (and hence weaker mark and presumably, weaker yen) to help German restructuring.
It is a fascinating idea, and I think we will indeed tend to have a strong dollar (and sterling) over the next few years, but not particularly because of any G7 accord. The power of central banks and finance ministers to influence rates is limited, for the weapons are weak. Intervention by central banks can be effective in pushing a currency in the direction it already wants to go, but it is little use when it runs against market sentiment. I would expect some sort of statement, but one welcoming the return to reasonable exchange rates rather than any urging of a still higher dollar. We will get a stronger dollar (and maybe stronger sterling) this year, but because that is the mood of the markets, not because G7 says so.
In any case, while Germany may benefit from the currency shift, it doesn't seem to help Japan. The similarity between the dollar's peak in the 1980s and the yen's 10 years later was spotted by BZW, which produced the chart on the right. BZW's argument is that the yen has further to fall, just as the dollar did, and that is probably right. But one could argue in addition that a falling yen has so far failed to stimulate Japanese exports and so increase domestic demand. The export sector in Japan is not really large enough, relative to the domestic economy, to effect overall demand much. Somehow the Japanese have to be persuaded to spend more of their money, create new businesses, be entrepreneurial, if they want more economic growth.
Looking ahead, it does seem that both the mark and the yen will remain weak for perhaps the next three years. What happens to the mark after that will depend on whether it exists at all when EMU goes ahead. The yen will, I suspect, remain somewhat weak well into the next century.
Meanwhile both countries will go through a restructuring of the tax and benefit systems to bring them much more into line with US and UK practice. In both countries the key to growth will be in service industries and small companies, and the more successful each is in accepting this, the less they will suffer. But there are profound cultural problems for both.
In both cases what has worked in the past no longer works now. In Germany, as Chancellor Kohl now admits, the scale of change is so great that the Germans almost have to change their nature. In the case of Japan, the problem is that structural change has since the war been almost entirely "top down", with large companies being extraordinarily nimble at getting out of declining sectors and into growing ones. But future growth does not lie in large companies, and this will also need a different mindset.
So look this weekend for signs that the world's finance ministers welcome the stronger dollar, for their views do affect markets, and that will help consolidate the dollar's position. Expect, if that happens, sterling to continue to be pulled up with the dollar. It may even be that we will touch the old Dm2.90 rate against the mark, though that would cause ructions in British industry. But the really important things happening are not so much in the currency markets as in the mindsets of the German and Japanese opinion-formers. Both countries start from a much stronger position than Britain (and in a slightly different way, the US) did at the beginning of the 1980s, but in some ways the task they face is much the same.
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