GERMANY IS embarking upon one of the boldest experiments of the modern era -- the rapid and total transition of an Eastern bloc nation from communism to capitalism. Today that transformation begins in earnest with the "Big Swap," the phasing out of the East German Ost-mark and the introduction of the Deutsche mark as the currency of both countries.

In the university libraries of the Western world today, there are hundreds of books about economies shifting from capitalism to communism, but no one has ever written a blueprint for making a transition the other way. As a result the economic changes now occurring in East Germany are not merely the first steps toward unification with the West; they are a potential role model for other Soviet bloc countries attempting to make a similar transition.

There has been no economic union in the modern era with such highly divergent starting points in terms of both wealth and social organization. Although East Germany had the most efficient industry in the Soviet bloc, four decades of communism have left East Germans with an average income less than a third of that enjoyed by their prosperous bourgeois cousins across the Wall. As a result of this huge gap, the cost of rebuilding the East bloc economies could produce a redirection of global capital flows in the 1990s as great as those produced by Reaganomics in the 1980s or the OPEC oil shocks of the 1970s. Indeed, German unification constitutes the greatest leveraged buyout in history.

The currency union effective today will instantaneously transform East Germany into a de facto economic colony of Bonn. Previously the East German government derived most of its revenues from state-owned monopoly enterprises made uncompetitive by the opening of the border and the elimination of the Ost-mark. Moreover, the overnight disappearance of the East German mark -- billions of now worthless banknotes are to be dumped in abandoned mine shafts -- means that the East Berlin government no longer has a central bank to purchase its debt. As a result, the East German government retains nominal autonomy, but it cannot spend without obtaining funds from West Germany. Strong incentives have thus been created for both countries to complete the process of political as well as economic union as quickly as possible.

Financial markets have already registered their concern about the risks of rapid unification, driving German long-term interest rates to 9 percent -- an extraordinary premium over the still low West German inflation rate of 2.5 percent. The apprehension of the German bond market is not surprising. As a result of the deterioration which occurred under communism, rebuilding the East German economy will require massive investment.

Private analysts estimate that upgrading the public infrastructure alone will require $400-500 billion. The cost of developing internationally competitive manufacturing and service industries could easily exceed that sum. Social services and unemployment insurance must also be expanded to narrow the living standard gap with the West and discourage emigration as East German factories slash their labor forces this autumn.

As a result, West Germany's normally conservative fiscal and monetary policies are likely to suffer unaccustomed strain. Nearly 37 percent of East Germany's 9.7 million workers are now employed in manufacturing and at least half those jobs will be eliminated. Although there should be offsetting employment gains in construction, services and the creation of small-businesses, the unemployment rate could rise to 20 percent during the next 12 months and remain above 10 percent three years from today. High East German unemployment will help to contain inflationary pressures this year, but rapidly increasing social spending could push the unified German government budget deficit as high as 125 billion D-marks in 1991 -- more than five times the level of last year's West German budget deficit.

Aid for the Soviet economy will place another large claim on German resources. Because of history and geography, West Germany already has numerous commercial and financial ties with the Soviet Union. But as a consequence of unification, there will be no other Western country with a greater vested interest in the Soviet Union's political stability and economic modernization.

The unified Germany will play host to over 350,000 Soviet troops for at least two more years. East German industry has traditionally had large markets in the Soviet Union and the Bonn government has said that it will honor a variety of East German trade agreements for raw-materials imports from the Soviet Union. Hence it is not surprising that Chancellor Kohl has taken the lead in assisting Gorbachev, sending emergency food shipments to Moscow and last week announcing a 5-billion-mark government-guaranteed loan. At the upcoming Houston G-7 summit, the chancellor will encourage the major industrial nations to launch a multibillion-dollar Marshall plan for the Soviet economy. Indeed, future historians will probably argue that the Iron Curtain fell in 1989 because Soviet economic decay forced Gorbachev to dramatic actions that would encourage large-scale Western economic aid to ensure his survival. How will Germany react to these new economic burdens? It is first important to note that there are few countries better equipped to assume them than West Germany. Although inflexible labor laws have given it regional pockets of high unemployment, West Germany's real per-capita income is now $23,000 -- 10 percent higher than the United States'. The Germans also have such a high savings rate that their current account surplus with the rest of the world was a remarkable $60 billion in 1989. As a result of these excess savings, Germany may be able to finance much of the East's reconstruction from domestic funds and not become an external borrower, as the United States did during the 1980s.

Simply giving the East German worker the training and management needed to match the far higher productivity of his West German neighbors -- and the wages to match their buying power -- will give a healthy boost to the growth rate of a unified Germany. Such rapid economic expansion will, in turn, produce a surge of tax receipts once East Germany replaces its previous fiscal dependence upon state ownership of industry with a formal tax system. Indeed, one of the great employment opportunities in East Germany today is tax collection. Under the communist system, there were only about 800 tax collectors, whereas fiscal experts believe a capitalist East German economy will require nearly 26,000.

Finally, West Germany has a better grasp of the challenges posed by shock economic reform programs than many other industrial nations because it experienced one after World War II. The introduction of the D-mark and the elimination of price controls in 1948 is widely considered to have been one of the most successful economic liberalization programs in modern history.

Ironically, though, the problem with these favorable historical comparisons is that the unified Germany of 1990 will be a democracy, whereas West Germany in 1948 was not. It was the Allied military authorities acting on the advice of academic economists who announced West Germany's currency and price reforms in 1948, not elected politicians. Many Germans complained that the reforms reduced the value of their savings and permitted businesses to increase their profit margins excessively, but they could not stop them because Germany was under military rule.

In 1990, by contrast, East Germany is being introduced to both a market economy and democracy simultaneously. As factories close and unemployment rises, the East Germans may demand even greater income subsidies and economic security guarantees than the West German government has so far offered. Since the East Germans will be given the right to vote in the upcoming German federal election, it will be difficult for Bonn to ignore all of their demands.

The unification treaty will also introduce all of West Germany's restrictive labor laws and work practices into the Eastern economy next year -- thus increasing the risk of unemployment remaining at high levels after 1991. Such a rapid introduction of current German labor law means that East German will not have the labor market flexibility which permitted West Germany to enjoy full employment while absorbing millions of refugees during the 1950s. In fact, some German businessmen are already suggesting that they regard Czechoslovakia as a potentially more attractive location for some labor-intensive industries because it has many of the same cultural characteristics as East Germany while retaining the exchange rate autonomy necessary to keep its workers' price competitive. And what does all this mean for the rest of the world? The economic costs of rebuilding East Germany in the early 1990s, and Eastern Europe later in the decade, are likely to be the third great financial shock in the world economy since the end of the Vietnam War. The first shock was OPEC's decision to quadruple oil prices in 1973-74. The second was the Reagan economic program of the early 1980s. Both events set in motion upheavals in global capital flows, currency values and trade patterns which dominated the world's economy for nearly a decade.

In the 1980s Reaganomics turned the United States into the world economy's borrower and spender of last resort -- while Germany and Japan emerged as the great lenders. Although Germany did not play as direct a role in financing America's external deficits as Japan, it was possible for British companies to purchase nearly $100 billion of U.S. assets during the late 1980s because of London's ability to attract funds from Frankfurt. Now, as German excess savings are diverted from Paris, London and New York to rebuilding the East, interest rates are likely to rise around the world, not just in Germany.

The magnitude of the upward pressure on world interest rates will depend upon how Germany decides to finance unification. Will she raise taxes or increase her public borrowing? Will the Bundesbank attempt to restrain inflationary pressures by increasing interest rates? Or will there be a major revaluation of the D-mark comparable to the large rise which occurred in the U.S. dollar during the Reagan years?

At the moment a further rise in German interest rates in 1990 and 1991 seems the most likely outcome. Kohl is promising the German people that he will not raise taxes in order to pay for the costs of unification. And the European monetary system will prevent Germany from letting the D-mark appreciate as dramatically and indiscriminately as the dollar did under the Reagan administration. What remains to be seen, though, is whether Western leaders, including President Bush (who last week backed away from his similar pledge) will ask Kohl to rescind his tax pledge in order to lessen upward pressure on world interest rates.

Of more enduring potential consequence for the rest of the world are the vast new economic opportunities that the liberation of Eastern Europe will provide for Germany in the long term. Indeed, it would not be an overstatement to suggest that the European economy of 2010 may have more in common with the European economy of 1910 than any period in between.

In the decade before the outbreak of the first World War, Imperial Germany was the largest trading partner of Eastern Europe and a formidable industrial rival of both Britain and the United States. British journalists then wrote articles about the rise of German economic power which bear a striking resemblance to those now being written by American journalists about Japan. {See box.}

It is not difficult to imagine a unified Germany re-emerging as the dominant country in a new European trading and financial bloc stretching from Moscow to Lisbon. Before unification, West Germany had 62 million people and a GNP of $1.2 trillion, 30 percent greater than France's. After unification, Germany will have a population of 78 million and a potential GNP of $1.6 trillion once East German incomes converge with the West.

The prospect of Germany regaining its pre-1914 economic and political stature has so frightened other Europeans that many want to accelerate the movement towards European federalism in order to contain it. While 20th-century events make such sentiments unavoidable, they overlook a critical historical difference between Germany in 1870 and Germany in 1990. When Bismarck used Prussian military power to unify Germany 120 years ago, the birthrate of continental Europe was as high as it is in the Third World today. As a result, Germany's population grew from 40 million in 1870 to 50 million in the early 1890s and 68 million by the outbreak of World War I in 1914. Meanwhile, the Austro-Hungarian Empire had a population of 50 million people, giving the two great German-speaking empires a combined population larger than the United States.

But the Germany of today has far less demographic energy. Before the fall of the Berlin Wall, demographers were projecting that West Germany's declining birthrate would cause her population to shrink from 62 million to 50 million in the early 21st century. Since East Germany's birthrate is only modestly higher than the West's, the unified Germany may have a population in the year 2025 only about as high as West Germany has today unless there is a major change in the birthrate or a significant increase in emigration from Poland, Romania or other European countries with high birthrates.

A society characterized by such rapid aging and depopulation is unlikely to be as aggressive as Germany in the early 20th century. On the contrary, the birthrate of Europe is now so low that future historians may look back upon the fall of the Iron Curtain as not merely the end of the East-West struggle but as the start of a much greater historical realignment that revived the North-South conflicts which dominated European foreign affairs before the Industrial Revolution.

North Africa and the Middle East now constitute a demographic time bomb. In 1950, their combined population was one-third of Western Europe's. Today Western Europe has 358 million people, Eastern Europe has 138 million people and the Islamic periphery of Africa and the Middle East has 278 million. If current birthrates persist, the population of the Islamic periphery will exceed Western Europe's by 2001 and all of non-Soviet Europe's by 2015.

The political instability which could result from such rapid population expansion suggests that the great threat to European security in the 21st century is far more likely to come from the southern shores of the Mediterranean and the Middle East than from a unified Germany enjoying one of the world's highest living standards and the other economic achievements which militarism denied it in this century.

David Hale is chief economist of Kemper Financial Services in Chicago.