INTELLIGENCE MEMORANDUM THE WEST GERMAN ECONOMY ON THE EVE OF THE NIXON-BRANDT MEETING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001700020092-7
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 13
• Document Creation Date: December 22, 2016
• Document Release Date: March 2, 2010
• Sequence Number: 92
• Publication Date: December 1, 1971
• Content Type: IM

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Confidential
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
The Wert German Economy
on the Eve of the Nixon Brandt Meeting
Confidential
ER IM 71-239 25X1
December 1971
Copy No N2 82
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WARNING
This document contains information affecting the national
defense of the United States, within the meaning of Title
18, sections 79" and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
Va1:.d from a.fa.alk
raanpra4l.0 and
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
December 1971
INTELLIGENCE MEMORANDUM
THE WEST GERMAN ECONOMY ON THE EVE
OF THE NIXON-BRANDT MEETING
Conclusions
I. The immediate impact of the 18 December currency realignment
on the German economy will be a psychological boost to business
confidence resulting from settlement of the international monetary crisis.
The December settlement means a somewhat smaller average appreciation
of the deutschemark than had already occurred on the market. It provided
for a somewhat higher dollar-deutschemark rate than had been anticipated,
but it reduced the deutschemark revaluation vis-a-vis the currencies of the
major European countries, which account for two-thirds of German exports.
On the average the deutschemark will appreciate 6%-7% relative to all other
currencies.
2. The West German economy, basically the strongest in Europe,
currently is experiencing a marked slowdown -- precipitated by the
government's anti-inflationary policies - together with an intolerably high
rate of price increase. Business confidence has been eroded by Digging
domestic and foreign sales and fears of the adverse effects of the
deutschemark revaluation Unemployment remains a minor problem thus
far but is rising.
3. The key consideration affecting the short-term economic outlook
is the timing of a change to an expansionary monetary and fiscal policy.
Although sensitive to the danger of recession, the government is unwilling
to reverse its restr;ctive policies until inflation has been brought under
control. In the absence of reflationary measures, real gross national product
(GNP) in 1972 probably will grow no more than 1%.
Note: This memorandum was prepared by the Office of Economic Research
and coordinated within the Directorate of Intelligence.
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Discussion
4. At the end of 1971, West Germany is beginning to exhibit
symptoms of the economic malaise so aptly described as "stagflation."
Although real GNP has declined since early spring, the surge of inflation
continues. The overall level of business activity remains high, but order
backlogs are dwindling. Despite some moderation of wage pressures and
price declines for industrial producer goods, inflation has accelerated. The
cost of living in October 1971 was a record 6% higher than a year earlier,
an increase alarming to those who recall the runaway inflation in the 1920s
and late I 940s. The reestablishment of fixed exchange rates and elimination
of the uncertainty that dominated international trade and finance through
most of 1971 should provide some stimulus. Business and labor are
increasingly worried about a recession in 1972. Looking ahead to the
election campaign in 1973, however, government leaders still see inflation
as their principal concern.
Production and Investment
5. The growth of real GNP in 1971 is expected to be no more than
2% to 3%, substantially less than the 8.0% and 5.4% achieved in 1969 and
1970. Indeed, the aggregate output of goods and services has declined during
the year. By the third quarter, GNP was 2% below the first quarter's level,
primarily because of declines in exports and gross fixed asset formation
(see Figure 1). Underlying the decline in GNP was a marked slowdown
in industrial growth - especially in the capital goods sector, which accounts
for 40% of output and 60% of exports of manufactures. The overall in-tease
in industrial production in 1971 probably will be no more than 2% - far
less than the 13% attained during the 1969 boom and even the 6% gain
in 1970.
6. Demand pressures have eased noticeably throughout the economy.
Investment in new plant and equipment has dropped off sharply. Industrial
investment plans reportedly were radically revised downward, apparently
because of shrinking profits and the business community's growing
pessimism regarding the near-term outlook. Heightening concern among
businessmen over the effects of the new US economic policy and over
government plans to raise corporate taxes and increase labor participation
in management have contributed to the worsening investment climate.
7. Rapidly rising production costs have cut deeply into profit
margins, reducing firms' ability to finance investment from retained earnings.
At the same time, borrowing costs remain high, and businessmen are having
difficuity refinancing the large volume of short-term debts incurred in the
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West Germany: Selected Economic Indicators Figure 1
Billion Deutschemarks
550
Quarterly Figures at Annual Riles
XS\
525 Gross National Product
(1962 market prices)
500
475
0
1 II III IV 1 11 III IV I II III IV
1969 1970 1971
700 054
500
I II III IV
1969
Index (1962-100)
250 r
260
s.~
1 1 I I I I I I
I II III IV I II III IV
1970 1971
L;ilnsumer Prices
100 L I 1 I I I I I I I I I I
I II III IV I II III IV I II Ill IV
1969 1970 1971
Note: Figures are seasonally adjusted.
5177.15 17-7I
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past few years with cheaper, longer-term credits. Profits have been squeezed
further because German export industries have had to absorb at least part
of the cost increase for foreign buyers resulting from the deutschemark's
revaluation since May.
8. Although many German producers have cut their prices to remain
competitive in foreign markets, export growth has declined. Slack foreign
demand and the investment slump have forced some industries to curtail
production and employment. The resulting psychological impact -- which
is out of proportion to the actual wage loss - has put a damper on consumer
buying. In recent months there has been a pronounced slowing of the growth
of retail sales, the economy's most buoyant factor since mid-1970.
9. The value of new orders placed with manufacturing industries has
remained below sales since May, and in recent months has actually declined.
The decline - especially sharp for capital goods -- is attributable primarily
to the worsening investment climate. Exports orders also have fallen off.
It is too early to tell whether this reflects a deteriorating competitive
position attribut::1ik to the deutschemark's appreciation during 1971 or to
the concentration of export orders early this year, when foreign customers
widely anticipated revaluation. The adverse impact of shrinking order books
on business confidence is aggravated by the fact that manufacturing capacity
expanded more than 20% during the recent boom. Utilization of plant
capacity in October was down to 85%, approximately the level in the fall
of 1966 at the onset of Germany's worst postwar recession.
Tho Labor Situation
10. The labor market is beginning to develop some slack as a result
of the gradual business slowdown. Total employment has declined slightly
since early summer, more as a result of attrition than layoffs. Officially
registered job vacancies show a larger decline, auguring a further reduction
in labor demand. Unemployment, however, is still only a minor problem.
Although the number of unemployed in October 1971 was up sharply from
a year earlier, it approximated only 0.8% of total wage and salary workers.
11. Employment cutbacks have occurred primarily in
manufacturing - particularly in the machine building, electronics, and iron
and steel industries, where shorter work weeks are becoming more
widespread. Employment in trade and other service activities, however, was
still expanding in late summer. This has cushioned layoffs in industry and
also explains in part the continuing, if much reduced, increase in
employment of foreign nationals.
12. Growing slack in the labor market is dampening new wage
increases. The rapid growth in hourly earnings in 1971 is traceable largely
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to pay hikes granted in 1969-70, when labor's bargaining power was stronger
and management was able to compensate for higher labor costs by raising
prices. But wage increases are slowing down: hourly earnings in the third
quarter of 1971 were only 12% above those a year earlier, compared with
a 16%% rise between the corresponding periods of 1969 and 1970. Recently
negotiated wage settlements have provided for increases in basic rates
averaging 8% to 9%. Although these still somev.hat exceed the government's
guidelines, they are substantially below the 12% to 14% settlements not
uncommon at the boom's height in 1969. Cutbacks in overtime are also
reducing the growth in average hourly earnings.
Price Trends
13. Price movements have been mixed since mid-1971. Price rises for
industrial producer goods have come to a virtual halt, as expected early
in a cyclical downswing, but cost of living increases have accelerated.
Cost-push pressures have moderated in many industries. The increase in labor
costs has slowed down and, because of the appreciation of the
deutschemark, the cost of imported raw materials has declined. At the same
time, with both domestic and foreign demand easing (particularly for capital
goods), competition has forced producers to absorb cost increases.
14. As eisewhere in similar circumstances, cost-push pressures appear
to be moderating less in services than in industry. The prices of most
services, especially repairs and rentals, are still rising very rapidly and remain
the major factor in the growing cost of living.
15. Because of continuing inflationary pressures, the government thus
far has not expressed undue concern over the gathering signs of economic
slowdown. In fact, it has deliberately followed deflationary policies,
including the float and budetary curbs postponing reform programs crucial
to labor's continued support. In a speech before the Federal Employers
Union on 7 December, Economics and Finance Minister Schiller reaffirmed
the government's determination to reduce inflation to acceptable levels. He
emphasized that the government's freedom to stimulate the steadily
weakening economy depends on labor and management following
responsible wage and price policies. Bonn believes that contractual wage
increases should be held to no more than 6%, approximately in line with
anticipated increases in labor productivity. If this result can be achieved,
the government will feel free to use contingency funds to stimulate
economic activity.
The Foreign Sector
16. West Germany's foreign economic position is the strongest in
Europe, and its foreign exchange reserves are the world's largest. Despite
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the 9.3`% revaluation of the deutschemark in October 1969, export growth
was rapid throughout 1970 and only recently has begun to level off.* The
value of imports has grown somewhat less rapidly than that of exports,
reflecting their lowered cost (in terms of deutschemarks) since the
deutschemark's appreciation and, in recent months, the decline in aggregate
domestic demand. The trade surplus averaged roughly $4 billion annually
in 1967-70 and probably will approximate that amount in 1971 (see
Figure 2).
17. The trade surplus, however, has been increasingly offset by a
rapidly increasing deficit in services and transfer payments. Reflecting the
prosperity of the past few years, German.to? rist expenditures abroad have
soared, and foreign workers' remittances have climbed at an unprecedented
pace. As a result, the current account surplus declined from nearly $2 billion
in 1969 to less than $700 million in 1970, and a further decline is likely
in 1971.
18. In the late 1960s, West Germany became a major net exporter
of long-term capital. Net long-term capital exports reached a record high
of some $6 billion in 1969. As the Bundesbank imposed increasingly
restrictive monetary policies in 1970, the domestic capital market tightened
severely, cutting the net outflow of long-term funds to $1 billion. In the
first nine months of 1971, West Germany experienced a net long-term
capital inflow of more than $1 billion because of a further decline in German
long-term lending abroad and increased placement of foreign long-term funds
in West Germany. The latter flows undoubtedly were motivated to some
extent by the desire to profit from deutschemark revaluation, a dollar
devaluation, or both.
19. Short-term capital inflows have been highly disruptive in the past
few years, largely vitiating the Bundesbank's attempts to restrain inflation
through restrictive monetary policies. The large increases in German interest
rates relative to those in other major money markets inevitably attracted
large inflows of short-term capital. These inflows assumed massive
proportions once speculation way rife that the deutschemark would be
revalued or other major currencies devalued. A flood of short-term funds
poured into West Germany during the period preceding the 1969
parliamentary election. The 9.3% revaluation of the deutschemark that
followed the election briefly reversed the flow. In 1970, however, West
German short-term interest rates became substantially higher than those in
* The deutschemark was floated in May 1971, resulting in a de facto revaluation
in terms of the US dollar of about 5% at the end of June and 12% in mid-December.
The central rate set at the Washington Group of Ten meeting is 3.2225 deutschemarks
to US $1, or a 13.6% revaluation from the pre-May parity.
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West Germany: Foreign Economic Position
Billion US $
20.0r-
Major Components of the Balance of Payments
Figure 2
I II III IV I II III IV I II III IV
1969 1970 1971
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the US and Eurodollar markets, again attracting a massive inflow of funds.
By the spring of 1971, the flow was augmented by a flood of speculative
funds that led to the floating of the deutschemark in May.
20. West Germany's basic balance of current and long-term capital
transactions has been in deficit since 1968. The overall balance of payments,
however, was in substantial surplus in 1970 and again this year because
of the large net inflows of short-term capital. As a result, Germany's gold
and foreign exchange reserves rose from $8 billion at the beginning of 1969
to more than $17 billion in October 1971.
Problem Areas
21. In the current economic situation, Bonn faces a serious dilemma.
Although monetary and fiscal restraints are still needed to fight inflation,
stimulation of economic activity is increasingly required to forestall a
recession. Proper timing of the transition to expansionary policies and
selection of an appropriate policy mix clearly are crucial. Not desiring to
interfere with market forces, the government has appealed to labor and
management to hold the line on wages and prices. How effective this appeal
will be remains to be seen. Despite the moderation shown in recent wage
settlements, the union leadership seems unwilling to accept the government's
wage guidelines, and the rank and file is becoming more militant.
22. Failure to bring lab-,-- into line would seriously jeopardize the
effort to break the inflationary spiral, prevent the timely intiuduction of
reflationary measures, and add to the government's political difficulties on
the right and the left. The sharp rise in the cost of living has prompted
increasingly strong partisan attack by the opposition Christian Democratic
Union/Christian Social Union. It also threatens to alienate uncommitted
voters where support the government will need in the 1973 elections. In
addition to threatening a full-fledged recession, maintenance of restrictive
fiscal and monetary policies would further delay implementation of
long-promised social and economic reforms - including improved housing,
education, and medical facilities - expected by the Social Democratic Party
(SPD) supporters.
23. Steering a proper course is particularly difficult because, unlike
the situation in previous cyclical downswings such as in 1966-67, the
government cannot count on export growth to compensate for declining
domestic demand. The deutschemark's appreciation since May has impaired
the competitive position of German industry - especially in the US and
French markets, which together take more than 20% of German exports.
In addition, recessionary tendencies are growing in most of Germany's
principal foreign markets. The new parities agreed on at the Washington
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Group of Ten meeting result in an average appreciation of the deutschemark
of 6%-7% relative to all other currencies. With profit margins in many export
industries already narrow, the impact on German exports could be
substantial, although probably not in the next few months.
24. The machine building, automotive, electrical, iron and steel, and
chemical industries are those most affected by revaluation. They are also
the industries currently suffering most from lagging domestic investment
demand. As shown by the following tabulation, all are highly dependent
on exports:
Exports as
a Percent
of Sales
Automotive products
3^
Machine building
35
Chemicals
31
Iron and steel
24
Electrical goods
22
These industries, which employ more than 40% of the industrial labor force,
account for more than 40% of German sales of manufactured products and
for nearly two-thirds of German exports.
Near-Term Prospects
25. The near-term outlook for the West German e;.onomy remains
bleak despite the psychological lift expected from the recent currency
settlement. Business confidence has been badly shaken by rising costs,
declining orders, shrinking profit margins, and the generally unsettled state
of the international monetary system. Widespread press predictions of
impending recession have added to the general feeling of gloom. Labor
militancy presents an increasing problem for management and has
embarrassed the Brandt government. Indeed, unless labor abandons its
opposition to the government's wage guidelines, it is unlikely that
inflationary pressures will abate sufficiently to enable Bonn to implement
its reflationary program soon.
26. The government and the leading economic research institutes
recently predicted that, in the absence of stimulative measures, there would
be a further sharp decline in the growth rate during the first half of 1972,
followed by some recovery toward the end of the year. For 1972 as a
whole, they project real economic growth at no more than 1%. Average
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employment in 1972 is expected to decline by about 1% as a result of
the slowdown, partly at the expense of foreign workers whose contracts
are not renewed. Total unemployment is expected to reach perhaps 1.5%
to 2% of the total number of wage and salary earners - roughly the level
during the 1966-67 recession. These predictions should be little affected
by the 18 December settlement.
27. Slackening domestic demand is expected to result in sharply
reduced growth of imports. It will also encourage West German industry
to intensify its export drive. But the combined influence of revaluation
and of softened demand in Germany's major foreign markets nonetheless
will reduce export growth, perhaps substantially. The decline of import
growth in the next year or so probably will be more pronounced, however,
and consequently the 1972 trade surplus should exceed that of 1971.
28. The economic slowdown currently predicted would be
substantially moderated if greater labor restraint or overriding political
considerations persuaded the government to begin pump-priming operations.
Release of 5 billion deutschemarks ($1.6 billion at the new exchange rate)
in federal and Land government countercyclical reserves and refund of the
5.8 billion deutschemarks ($1.8 billion) in accumulated income tax
surcharges would provide a strong stimulus for the economy.
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