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Festering U.S.-German row could hurt world economy

By Erik Kirschbaum

BERLIN, Sept 25 (Reuters) - Friction with the United States over German Chancellor Gerhard Schroeder's "hell no we won't go" attitude to war on Iraq could ruffle the world economy if Berlin and Washington fail to patch up their pivotal relationship.

The public spat between the United States and its normally cooperative ally has chilled the climate among the big economic powers ahead of Friday's meeting of Group of Seven (G7) finance ministers in Washington, adding an element of uncertainty for markets already rattled by war fears and weak global growth.

The animosity lingering since Schroeder was narrowly re-elected on Sunday after campaigning against U.S. policy on Iraq recalls a major row between West Germany and the United States 15 years ago that was seen as a contributing factor to the "Black Monday" stock market crash of October 19, 1987.

That dispute, between Treasury Secretary James Baker and Finance Minister Gerhard Stoltenberg, was specifically about G7 economic policy and so more obviously unsettling for financial markets than the present argument over attacking Baghdad.

But some analysts fear the "poison" top American officials say has seeped into relations with Germany could spread to hamper cooperation on pressing economic issues as well.

"Political tension between Germany and the United States is about the last thing markets need now," said Ulla Kochwasser, senior economist at Mizuho Corporate Bank in Frankfurt.

"It's an additional burden to the other woes markets are facing," she added. "The German-U.S. ties are very deep both politically and economically. The strains are most unhelpful."

EXPORT FEARS

An outspoken attack by Baker on high West German interest rates on Sunday, October 18, 1987, persuaded investors that G7 economic coordination was breaking down and triggered a 23 percent drop in U.S. share prices the next day.

Analysts stress that this week's slide in stock markets to five-and-a-half year lows is down to factors unrelated to U.S. President George W. Bush feeling insulted by being supposedly likened to Adolf Hitler by one of Schroeder's ministers.

But fears the row could hurt the economy surfaced on Wednesday when a major business association warned that the big German automobile industry was vulnerable to it.

"We urgently have to repair relations with America," said Klaus Braeunig of the BDI. "Every seventh job in Germany is dependent on the car industry. We want our American friends to keep buying German cars and not be upset by all this. We need to tell America we want to continue with this close cooperation."

Other analysts agreed the traditionally close ties, built around America's protection of West Germany during the Cold War, had been soured by Schroeder's campaign and worry an escalation of the rift could cause severe damage down the road.

"Both governments are behaving poorly and making a lot of mistakes," said Adolf Rosenstock, chief European economist at Nomura International in London.

"The important question is will these tensions lead to a bigger dispute if both sides don't come to their senses and keep their mouths shut. If policy decisions are to be made based on these tensions, it would be a very big problem and cause trouble in financial markets. It's time for them to put out the fire."

"POISONED" RELATIONS

Defense Secretary Donald Rumsfeld said on Monday ties had been "poisoned" by Schroeder's campaign and U.S. officials have said the chancellor faces a long, uphill road back to favour.

Bush repaid Schroeder with a snub -- not sending the usual congratulations on his win. The president was reported even to have declined to take a post-election phone call from Berlin.

Rumsfeld, in Warsaw for a NATO meeting, rebuffed attempts by German counterpart Peter Struck to set up a meeting to patch over their differences. Struck was quoted by German television saying he had no plans to get on his knees to talk to Rumsfeld.

Schroeder, who says attacking Iraq could destabilise the region, has now replaced the minister who still denies likening Bush to Hitler and also the parliamentary leader of his Social Democrats, who drew a similar comparison with a Roman emperor.

But memories linger of Schroeder's own campaign speeches -- including a memorable vow that Germany would "not click its heels" and follow the United States into war with Iraq.

"What Schroeder said during the campaign was quite blunt," a senior German diplomat told Reuters. "Yet the reality is German- American relations have been deteriorating since 1991 after unification. The Cold War defence bond isn't there any more."