How Germany devalued the Deutsche Mark to gain the Euro advantage

In popular memory the Deutsche Mark is remembered as a symbol of strength: a hard currency backed by a hawkish central bank and a culture averse to inflation. Yet by the time Germany locked its exchange rate into the euro at 1.95583 marks per euro, the country had quietly engineered something that, in economic effect, looked very much like a devaluation.

There was no dramatic night-time announcement, no single official reduction of the Deutschmark’s parity against its European partners. Instead, over the decade between reunification and the launch of the euro, a combination of policies and economic developments pushed down Germany’s real exchange rate and labour costs relative to its neighbours. When the mark was converted into euros, Germany entered the new currency union with a competitive advantage that would, over the following 10–20 years, transform it from a heavily indebted reunifying state into the principal creditor of the euro area.

This article examines how that process worked, how the mark “slid” in real terms before the euro, and how this translated into a structural advantage that helped Germany rebalance its own finances while much of the rest of Europe fell into debt to Germany.

1. From reunification shock to the “sick man of Europe”

When the Berlin Wall fell and Germany reunified in 1990, the immediate economic story was not one of strength. West Germany absorbed an entire planned economy with obsolete capital stock, low productivity and fragile public finances. Politically, there was pressure to grant East Germans a fast rise in living standards; economically, that carried a large price.

Two decisions in particular shaped what followed:

1. The conversion of East marks into Deutsche Marks at politically generous rates.
   Many East German wages and savings were converted at 1:1 into Deutsche Marks, even though East German productivity was nowhere near Western levels. This gave East Germans purchasing power in a hard currency, but it also priced much of East German industry out of the market almost overnight.
2. Massive fiscal transfers from West to East.
   The federal government financed infrastructure, social benefits and support for Eastern Länder through borrowing and higher taxation. Public debt rose sharply in the 1990s, and Germany’s budget position deteriorated.

The combination led to:

• High unemployment, especially in the East but also in parts of the West exposed to structural change.
• Weak growth relative to other advanced economies.
• Rising public debt, to the point where Germany itself risked failing the fiscal yardsticks that would later underpin the Stability and Growth Pact.

By the mid‑1990s commentators were referring to Germany as “the sick man of Europe”. This is crucial context: the later German “export miracle” and creditor status did not fall from the sky. It was, to a significant extent, a response to the pressures of reunification and the constraints of entering a monetary union without the safety valve of future currency devaluation.

2. The pre‑euro monetary framework: the mark as anchor

Before the euro, most Western European currencies participated in the Exchange Rate Mechanism (ERM) of the European Monetary System. The Deutsche Mark was the de facto anchor. Other currencies set their central rates against the mark and agreed to keep fluctuations within narrow bands. In practice, when tensions arose, it was typically the weaker currencies (the lira, the peseta, the franc, the pound during its brief ERM membership) that had to adjust, not the mark.

Two features of this regime matter for the later story:

• The mark itself was rarely, if ever, formally devalued.
  On the contrary, it was often the currency that others devalued against. The Bundesbank’s tight anti‑inflation stance gave it credibility and attracted capital, tending to keep the mark relatively strong in nominal terms.
• Adjustments happened through others devaluing and through Germany’s domestic cost and price behaviour.
  If German wages and prices grew more slowly than those of its trading partners, Germany would gain competitiveness even without any nominal devaluation of the mark.

This set the stage for what economists call “internal devaluation” – improving competitiveness through domestic wage and price restraint rather than through a one‑off fall in the nominal exchange rate.

3. How the mark “slid” without a formal devaluation

Even though there was no single point at which the Deutsche Mark was officially marked down, several interacting mechanisms made the mark effectively cheaper in real economic terms in the run‑up to the euro.

3.1 Wage restraint and unit labour costs

After reunification, and especially from the mid‑1990s onwards, Germany embarked on a path of wage moderation:

• Collective bargaining became more conservative.
  Employers and unions, under pressure from high unemployment and international competition, agreed to modest nominal wage increases, often below productivity growth.
• Labour market reforms (including the later Hartz reforms) increased flexibility.
  These reforms reduced the bargaining power of insiders, expanded low‑wage “mini‑jobs” and made it easier for firms to hold down labour costs.

The result was that unit labour costs – the cost of labour per unit of output – in Germany barely rose, or even fell, relative to its trading partners. Studies by the European Commission have documented that between the late 1990s and the eve of the global financial crisis, unit labour costs in several southern member states rose by roughly 15–25 per cent relative to Germany. Germany’s cost base was essentially flat; others’ rose steadily.

In terms of competitiveness, that is equivalent to a substantial devaluation: if your prices and wages are 20 per cent lower relative to your neighbours than they would otherwise have been, your real exchange rate has effectively fallen by about that amount.

3.2 Price stability and low inflation

Germany’s culture of monetary stability, embodied in the Bundesbank, also contributed. With wage restraint and subdued domestic demand, inflation in Germany stayed lower than in many partner countries.

A country’s real exchange rate is influenced not only by the nominal exchange rate, but also by relative price levels. If your prices rise more slowly than other countries’, your real exchange rate depreciates even if the nominal exchange rate is unchanged.

Thus, in the years before the euro, Germany’s combination of:

• subdued wage growth, and
• lower inflation

meant that its real effective exchange rate – a weighted average against trading partners, adjusted for price levels – declined. External observers, including the International Monetary Fund, later assessed that by the mid‑2010s Germany’s real effective exchange rate was undervalued by on the order of 10–20 per cent relative to medium‑term economic fundamentals. Much of the groundwork for that undervaluation was laid in the pre‑euro and early euro years through these domestic cost and price dynamics.

3.3 Fiscal squeeze and weak domestic demand

The fiscal cost of reunification was met, in part, through a mix of higher taxes and spending restraint, especially after the mid‑1990s when concerns about meeting Maastricht criteria intensified. Germany ran a comparatively tight fiscal ship given the scale of the reunification shock.

The side effect was weak domestic demand:

• households and firms were cautious,
• unemployment remained high for a prolonged period, and
• consumption and investment growth were subdued.

Weak domestic demand tends to restrain imports and keep a lid on domestic prices and wages. That, again, reinforces the trend towards a lower real exchange rate.

In effect, Germany was engineering an internal adjustment – belt‑tightening, wage restraint, fiscal consolidation – that, over time, made its tradable sector highly competitive, even without any official nominal devaluation of the Deutsche Mark.

3.4 The mark against the dollar and other external currencies

While the key competitiveness story in the euro context is about Germany relative to its European partners, movements against the US dollar and other non‑European currencies also played a role.

Historical exchange‑rate data show that:

• In 1990, one US dollar cost roughly 1.6 Deutsche Marks on average.
• By the mid‑1990s, the mark had strengthened at times, with the dollar buying fewer marks.
• Towards the late 1990s, the dollar strengthened again, and by 1998 one dollar bought closer to 1.7–1.8 marks on average.

From the point of view of German exporters selling into dollar‑priced markets, the latter period amounted to a mild nominal depreciation of the mark against the dollar compared with its mid‑1990s peak. That offered some additional breathing space for German industry on world markets, even as the European focus remained on the upcoming euro.

Taken together – wage restraint, lower inflation, weak domestic demand, and an external environment that at times saw the mark soften against the dollar – the overall effect was a sliding of Germany’s real exchange rate in the years before the euro, without any headline‑grabbing devaluation.

4. Locking in the advantage: 1.95583 marks to the euro

On 1 January 1999, the euro was introduced as a book currency, and national exchange rates within the euro area were irrevocably fixed. For Germany, the rate was:

1 euro = 1.95583 Deutsche Marks

This was not plucked out of thin air. It reflected the existing ERM parities and the composition of the European Currency Unit. But what matters is not the bookkeeping logic; it is what this rate meant relative to Germany’s domestic cost structure and to the cost structures of its partners.

By the late 1990s:

• Germany had held down unit labour costs through a decade of wage moderation and structural reform.
• Several partner countries, especially in Southern Europe, had experienced faster wage and price growth, often linked to credit‑fuelled booms as markets anticipated euro entry and falling interest rates.

When all these economies locked into a single currency at fixed conversion rates, the disparities were frozen into place:

• Germany entered the euro with a relatively low internal price and wage level given the strength of its tradable sector.
• Deficit countries entered with relatively high cost levels and no longer had the ability to devalue their way back to competitiveness.

Subsequent analysis by European institutions suggests that over the first decade of the euro, the real effective exchange rate based on unit labour costs fell for Germany while rising by roughly 15–25 per cent for countries such as Spain, Italy and Greece relative to Germany. In other words, the asymmetry built up in the pre‑euro years was not corrected; it was locked in and then accentuated.

From the perspective of economic outcomes, fixing the exchange rate at 1.95583 marks to the euro after that period of internal devaluation amounted to doing something very similar to a formal devaluation – only this time it was others who found themselves effectively overvalued within the new system.

5. From debtor to creditor: how the advantage translated into gains

The factual record on what followed is stark. Germany, which had entered the euro era burdened by reunification costs and with elevated public debt, became the euro area’s surplus country par excellence.

5.1 Trade balance, growth and employment

At the start of the euro era:

• Around 1999, Germany’s current account – a broad measure of trade and income with the rest of the world – was modestly negative, at about −1.5 to −2 per cent of GDP.

Over the following decade and a half:

• The current account swung from deficit into a large surplus, reaching around +8 per cent of GDP by the mid‑2010s.
• The trade surplus in goods alone was roughly 7½ per cent of GDP at that point.

This is an enormous shift. To a first approximation, it means that Germany was producing far more than it was spending and lending the difference to the rest of the world, much of it within Europe.

Econometric decompositions of growth find that roughly one‑third of Germany’s real GDP growth since the late 1990s can be attributed to net exports – that is, exports minus imports. In a large advanced economy, that is an exceptionally high share.

For employment, the export‑driven upswing was equally crucial. In the early 2000s Germany struggled with double‑digit unemployment; by the 2010s it enjoyed record‑high employment and one of the lowest unemployment rates in the euro area. The tradable sectors – machinery, vehicles, chemicals, precision engineering – were at the heart of this turnaround.

5.2 Sectoral and geographic patterns

The surplus was highly concentrated in manufacturing:

• Germany’s trade surplus in manufactured goods roughly doubled from around 5–6 per cent of GDP to around 10 per cent of GDP over the euro era.
• Key sectors were automobiles, mechanical engineering, chemicals and pharmaceuticals, electrical equipment and high‑quality intermediate goods.

Geographically:

• In the early 2000s, a substantial part of the surplus was with euro area partners, especially those in Southern Europe and the periphery.
• After the global financial crisis, a growing share of the surplus shifted towards non‑euro trading partners, such as the United States and the United Kingdom, and later emerging markets; nevertheless, intra‑European imbalances remained significant.

The common thread is that Germany’s industrial base, supported by a systematically lower cost structure within a fixed‑rate monetary union, was able to capture market share both inside and outside the euro area.

5.3 From trade surpluses to financial claims: the new creditor

Large and persistent current account surpluses are the flip side of capital exports. When a country sells more to the rest of the world than it buys, it necessarily acquires financial claims on foreigners.

For Germany, the numbers again are striking:

• Around the start of the euro, Germany’s net international investment position (NIIP) – the difference between German‑owned foreign assets and foreign‑owned German assets – was close to balance.
• By the mid‑2010s, Germany’s NIIP had risen to around +50 to +60 per cent of GDP.

In simple terms, Germany went from roughly owing as much to the rest of the world as it was owed, to being a very large net creditor. The income from these foreign assets – interest, dividends and profits – showed up as a net primary income surplus of around 1½ to 2 per cent of GDP.

Meanwhile, in many of the deficit countries of the euro area:

• cumulative current account deficits translated into negative net external positions, sometimes on the order of −60 to −100 per cent of GDP;
• a significant share of those external liabilities was held, directly or indirectly, by German and other core‑country banks and investors.

Thus, within a decade or two of joining the euro, the factual pattern is clear: Germany’s public balance sheet had stabilised and its private sector had amassed large foreign claims, while much of the rest of the euro area had accumulated debts – often to investors in Germany and the core.

6. The role of interest rates and safe‑asset premia

Germany’s advantage was not only about trade and capital flows. It was also about the price at which it could borrow.

6.1 The German Bund as benchmark safe asset

Within the euro area, German government bonds – Bunds – became the reference point for safety:

• Investors saw German fiscal policy, institutional strength and export performance as guarantees of solvency.
• In times of stress, capital flowed into Bunds, pushing yields down.

This “safe‑haven” status had two important implications:

1. Lower debt‑service costs for Germany.
   The German state could refinance itself at very low interest rates, even at times when other sovereigns faced punishing borrowing costs. Over time, this eased the burden of the reunification debt and contributed to restoring Germany’s fiscal position.
2. Benchmark effect for the rest of the euro area.
   Before the sovereign‑debt crisis, other euro members often benefitted from spreads that were unrealistically low relative to their fundamentals, in part because markets priced their debt in relation to Bunds. After the crisis, spreads widened starkly – but Bunds retained their privileged status.

In both phases, the existence of a single currency with a single, highly liquid safe asset centred on Germany reinforced the country’s structural advantage.

6.2 Asymmetry of adjustment in the crisis

When the global financial crisis and the subsequent euro‑area sovereign‑debt crisis hit, the underlying asymmetry in competitiveness came to the fore.

Countries with:

• higher unit labour costs,
• weaker tradable sectors, and
• large external debts

were forced into sharp internal adjustment programmes: wage cuts, fiscal consolidation, structural reforms. Without the ability to devalue, they had to pursue their own internal devaluations to restore competitiveness, often under conditions of high unemployment and social strain.

Germany, by contrast:

• already had a strongly competitive export sector;
• benefitted from lower borrowing costs as capital sought safety; and
• could rely on external demand to offset weak domestic spending.

The euro, in other words, amplified a pattern where Germany’s earlier internal devaluation was rewarded, while late‑comers to the devaluation game paid a much higher social and economic price.

7. “Germany devalued the Deutsche Mark”: what the phrase captures – and what it doesn’t

The title of this article – “How Germany devalued the Deutsche Mark to gain the Euro advantage” – is a deliberate simplification. Strictly speaking, there was no one‑off, official devaluation of the Deutsche Mark in the years before the euro. On the contrary, the mark was a relatively strong currency and the anchor of the ERM.

Yet, as a description of the economic substance, the phrase captures something important:

• Through wage restraint, labour‑market reforms, fiscal consolidation and a culture of price stability, Germany ensured that its domestic costs and prices grew much more slowly than those of many of its partners.
• This led to a real depreciation of the mark – not in the sense of the nominal exchange rate falling against other European currencies, but in the sense that German goods and services became cheaper relative to others given the fixed or tightly managed nominal exchange rates.
• When the euro was finally launched, fixing the conversion rate at 1.95583 marks per euro, that real depreciation and cost advantage was effectively locked into the new monetary system.

Economists at international institutions have tried to quantify this. Their bottom line has been that:

• Germany’s real effective exchange rate was undervalued by roughly 10–20 per cent relative to fundamentals during the mid‑2010s;
• Germany’s current account surplus, at around 8 per cent of GDP, was “excessive” in the sense that it exceeded by several percentage points what would be expected based on demographics, productivity and other structural factors.

Those figures are not the result of a single dramatic policy move. They are the outcome of a long sequence of decisions made under the pressure of reunification, the constraints of the ERM and the anticipation of the euro.

8. Counter‑arguments and caveats

Any balanced account must also acknowledge the counter‑arguments and caveats.

8.1 Demographics and saving behaviour

Some German economists argue that:

• Germany’s ageing population naturally leads to high saving and a current account surplus, as the country “saves for retirement”.
• The surplus is not primarily a product of a “devalued” currency, but of structural saving and investment patterns.

There is truth in this: demographics and institutional features of the pension and corporate sectors do play a role. However, when international organisations compare Germany with other ageing societies, they tend to conclude that demographics alone cannot explain such a large and persistent surplus. The competitiveness gains from the earlier internal devaluation and the under‑valuation of the real effective exchange rate still appear to be significant contributors.

8.2 Policy choices in deficit countries

It is also fair to note that:

• Many deficit countries in the euro area chose procyclical fiscal policies in the 2000s,
• tolerated housing and credit booms, and
• allowed domestic price and wage inflation to outstrip productivity gains.

These were their own policy choices, facilitated by the low interest rates and abundant capital made possible by monetary union. In that sense, it is not solely “Germany’s fault” that imbalances accumulated.

Nevertheless, the German policy mix of wage restraint, fiscal tightness and export‑orientation, combined with a fixed exchange rate, meant that adjustment was heavily one‑sided: deficit countries had to bear most of the later painful adjustment, while Germany could rely on external demand and safe‑asset status.

8.3 Limits and risks of the creditor model

Finally, being a large creditor is not an unambiguous blessing:

• German investors and banks suffered losses on some of their foreign claims during the crisis years.
• A large external surplus means that Germany is exporting capital that might otherwise have financed higher productive investment or infrastructure at home.
• Persistent imbalances within the euro area create political tensions, with perceptions of unfairness on both sides.

In that sense, the very success of the German model – built partly on the quiet “devaluation” of the mark before and at the birth of the euro – has also created long‑term strategic questions for Europe as a whole.

9. Conclusion: the euro advantage and its origins

The facts remain that:

• Germany entered the euro era burdened by the fiscal and economic costs of reunification, with high unemployment and concerns about debt sustainability.
• Over the following one to two decades, Germany emerged as the principal creditor of the euro area, with large trade and current account surpluses and a substantial positive net international investment position.

How did this reversal occur?

The answer lies less in a dramatic monetary gesture than in a decade‑long internal devaluation of the Deutsche Mark:

• By holding down wages,
• keeping inflation low,
• pursuing fiscal consolidation despite the costs of reunification, and
• embedding these choices within a fixed‑exchange‑rate system that culminated in the euro at 1.95583 marks per unit,

Germany ensured that, when the single currency arrived, its industry was operating with a cost base out of line with – and more competitive than – many of its partners. The final fixing of the exchange rate transformed that quietly accumulated real depreciation into a structural euro advantage.

Once inside the euro, Germany’s export machine translated this advantage into:

• rising trade surpluses,
• strong export‑led growth,
• high employment,
• creditor status vis‑à‑vis the rest of the world, and
• safe‑haven status for its government debt.

At the same time, much of the rest of Europe, now unable to devalue, saw its earlier credit‑fuelled expansions turn into external debts and painful internal adjustments – often with Germany on the other side of the ledger as a major creditor.

To say that “Germany devalued the Deutsche Mark to gain the Euro advantage” is, therefore, to highlight a deeper truth: the euro was not born into a level playing field. The path Germany followed from the turmoil of reunification to the stability of creditor status ran through a long, understated, but very real depreciation of its competitive position relative to its partners – a depreciation that was completed and made permanent, for a time, at the moment of euro entry.