Trade, Transfers, and Monetary Overhangs

  • Lester D. Taylor


In this chapter, we turn to questions involving international trade and the transfer of wealth from one country to another or from one region within a country to another. The focus, initially, will be on the emergence of trade between two previously closed monetary economies and the factors which influence the exchange rate established between their respective currencies. Following this, we will turn to transfer questions involving ‘monetary overhangs’ and how they are related to the conservation laws imposed by the pool of fluid capital. Two examples will be considered, the first the ‘capital levy’ proposed by Schumpeter for Austria at the end of WWI, the second the reunification of Germany in 1990 following collapse of the Berlin Wall.


Exchange Rate Real Income Monetary Union Ownership Share Money Stock 
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  1. 1.
    Schumpeter’s specific focus was Austria, but the problem he was concerned with is a very general one and, as we shall see in a moment, can be identified with the ‘monetary overhangs’ that plagued the Eastern European economies in 1989 and 1990.Google Scholar
  2. 2.
    For a chronicle and detailed analysis of Schumpeter’s ill-fated attempt to effect the capital levy, see Stolper (1994, Chapters 14–19).Google Scholar
  3. 3.
    The fact that the war debt in Austria was internal made a capital levy, in principle, feasible. The levy was to have been paid in either money or bonds. In the case of payment in bonds, the bonds would obviously have ceased to exist once they were received by the Treasury. In the case of payment in money, the money was to have been used to repay government loans from commercial banks as well as the central bank.Google Scholar
  4. 4.
    This is an obvious stylization of how income was received in the communist command economies, for much of income was received in kind in the form of nomnarket prices for housing, food, public transportation and free medical care, etc.Google Scholar
  5. 5.
    In East Germany, homes could be owned, as could small craft-type businesses, and there were small amounts of privately owned life insurances policies in force at the time of the monetary union with West Germany. Also, states cannot completely eliminate the values placed on privately createdGoogle Scholar
  6. 6.
    I am assuming at this point that there are no assets to be held in D2 except for money and goods. A different conclusion could emerge if, at the time of the currency merger, D2 residents were also to acquire property rights in D2’s produced means of production. This will be discussed below.Google Scholar
  7. 7.
    Since goods produced in D2 would almost certainly be less desirable than goods produced in DI, it might seem that inflation could be contained by price decreases for D2 goods. This would not be the case, however, so long as the windfall to D2 residents leads to a net increase for the newly combined economies in the desire to consume, for a now larger pool of purchasing power is coming up against the same amount of goods. Prices of D2 goods may very well decrease, but any decreases will necessarily be more than offset by price increases in DI. Also, it should be noted that it is implicitly being assumed that the economy of D l is operating at full capacity. If this should not be the case, then some of the increased demand for D l goods could be accommodated by an increase in utilization with little or no inflation. I am grateful to Dieter Elixtnann for pointing this out.Google Scholar
  8. 8.
    This is with respect to the consumption by D2 residents of DI goods, and accordingly does not take into account the much lower prices of non-traded goods in D2. In terms of purchasing-power parity, therefore, the ‘market’ exchange rate will understate the real purchasing power of the pre-merger D2 mark. The implications of this will be discussed below.Google Scholar
  9. 9.
    Although illustrative numbers for total income in the two economies have not been provided, total income will always be of the same order of magnitude as the value of the pool of fluid capital. The numbers in the text are accordingly derived using 250b and 28b as the total incomes for the two economies in conjunction with the populations of 64m and 16m.Google Scholar
  10. 10.
    This 8.2% inflation in goods prices is in addition to that triggered by the increase in real value of the D2 marks held as an asset which is caused by the pegging of the two currencies at par. The analysis assumes that D2 goods continue to be desirable at pre-merger prices. If this were not so, then the inflation in D1 goods would be greater than 8.2%, in which case the decrease in real incomes in DI would be even larger.Google Scholar
  11. 11.
    Moreover, for the real-world circumstances in question, this problem is compounded by the fact that D2’s productive structure was highly geared to external markets which, for the most part, ceased to exist.Google Scholar
  12. 12.
    Reference here is to people rather than to geography. Presumably, what is meant by parity in the long run is that the distribution of real income reflects ability rather than former place of residence in D l orD2.Google Scholar
  13. 13.
    As discussed at length by Sinn and Sinn (Chapter 5), the conversion of price and wage contracts at par was actually a two-edged sword. For although (per the earlier discussion) it raised the real wage in the East relative to the West, it also increased the wage costs of Eastern production to the point where a rapid inflation of nominal Eastern wages towards parity with nominal Western wages would make Eastern manufactures unsalable. In the event, this is what occurred, resulting in massive Eastern unemployment.Google Scholar
  14. 14.
    The point of reference (as determined by the Deutsche Bundesbank) for the ‘proper’ amount of liquidity was the ratio of M3 to GDP which prevailed in the FRG at the time of monetary union. The appropriate conversion rate accordingly became extremely sensitive to the assumption that was to be made concerning potential output in the GDR as a proportion of potential output in the FRG. In the event, it was assumed that GDR potential output was 9.5% of FRG potential output. The conversion rates chosen implied a resulting increase in the M3 money stock of 12% and a remaining monetary overhang for the combined economies of about 5%. For a detailed discussion, see Hasse (1993). Cf, also, Sinn and Sinn (1992, Chapter 3).Google Scholar
  15. 15.
    Sinn and Sinn cite evidence that the two marks were essentially at par in terms of purchasing-power parity and therefore that par was the proper conversion rate. See Sinn and Sinn (1992, especially Chapter 3).Google Scholar
  16. 16.
    See Sinn and Sinn (1992, Chapter 4).Google Scholar
  17. 17.
    The actual details of the initial transfer and auction of ownership rights are not key to present purposes. What is important is that property rights in the East’s produced means of production become available to holders of ostmarks so that some form of portfolio adjustment could occur.Google Scholar
  18. 18.
    See Sinn and Sinn ( 1992, p. 66 ). I am assuming in all of this that sufficient market mentality would have existed for the East German population to meaningfully participate in the auctions of ownership shares. Obviously, this may not have been a valid assumption.Google Scholar
  19. 19.
    What is at issue here is whether the real value of the stock of produced means of production, as measured by the prospective yields of these assets from the sale of marketable goods and services, is less than the nominal stock of savings, as represented in the holdings of ostmarks. There are many ways in which this might come about, including capital consumption and a production structure that is poorly adapted to produce the goods that will be demanded through the free exercise of tastes and preferences. The end result, in one form or another, has to be a reduction in the stock of ostmarks, so that the real stock of money is in accord with the stock of fluid capital.Google Scholar
  20. 20.
    It is assumed that the ostmarks received by the Treuhand from the initial auction of ownership rights would have been neutralized, so that the monetary overhang was not simply transferred from individuals to the Treuhand. As will be discussed in a moment, the best form of neutralization would have been transfer of the ostmarks to a bank for ‘reconstruction and development’.Google Scholar
  21. 21.
    Obstacle Removal’ (from the Obstacle Removal Law) represents investment in retrofitting and upgrading of existing plant. There is a neat French word, bricolage - “a cobbling together of contraptions from whatever is available” - which is even more expressive. [The descriptive phrase is Patricia Churchland’s, as quoted in Lewin (1992, p. I64).]Google Scholar
  22. 22.
    There are several ways that the money thus collected could have been made available for financing investment. Two obvious ones are that the funds could have been transferred to a newly created bank for ‘reconstruction and development’, or the Treuhand itself could have functioned as a financial intermediary.Google Scholar
  23. 23.
    It is to be emphasized that removing the monetary overhang by conversion at less than par caused no destruction of the pool of fluid capital, but only the claims on the pool that these ostmarks represented. The claims that were destroyed were transferred to those who were subsequently able to purchase ownership shares in East German businesses at prices lower than would have been the case if all ostmarks had been converted at par.Google Scholar
  24. 24.
    I do not mean to imply that Eastern savings would have been sufficient to finance all of the investment that was needed in the East. Obviously, this would have been far from the case. Nevertheless, Eastern savings could have made an important contribution and would have relieved some of the pressure on Western savings.Google Scholar
  25. 25.
    It is not clear, however, how much of the turn in the capital account reflects (I) purely short-term financial capital movements because of the relatively higher German interest rates; (2) the finance of imported goods and services; or (3) real investment in German industry (whether in the East or the West is immaterial). (I) and (3) would be consistent with a higher exchange rate, but not (2). The higher exchange rate of the DM with the dollar in the early 1990s was, in my opinion, a consequence of U.S. domestic and international policies.Google Scholar

Copyright information

© Springer Science+Business Media New York 2000

Authors and Affiliations

  • Lester D. Taylor
    • 1
  1. 1.University of ArizonaWilsonUSA

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