Why do German folk dance in lederhosen?

It is only a Bavarian (Southern part of Germany) tradition. Why exactly they do that...Well, I don't know. It's traditional and I guess it it something like walzer or foxtrott, but developed in this special region. Just some dance.

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The dance you're probably referring to is the Schuhplattler, a traditional folk dance from Bavaria and Austria. The origins of this dance are found in an early courtship display (Balztanz). Such a dance was described in 1050 by a monk in the knightly poem Ruodlieb, in which he described a dance with similar moves to the Schuhplatter.

The homeland of the Schuhplattler dance is the alpine region of Europe in Bavaria (Germany) and Austria. In days gone by young men wished to impress marriageable young ladies with their dancing prowess. Initially the style was free without rules. Performed usually in a 3/4 time, one would carry out a series of jumps and hip movements to the time of the music.

Characteristically the dancers will rhythmically strike their thighs, knees and soles of the feet, and stamp with the feet. Nowadays the dance is usually performed out of tradition, maintaining the older customs, and as part of the activities of Trachtenvereine (that is, societies which maintain traditional dress, songs and culture of earlier days). Hence the wearing of traditional Lederhosen.

Source: Wikipedia