Options for Europe – Part 22

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[PRIOR MATERIAL HERE FOR CHAPTER 1]

Next stop – “L’Europe se fera par la monnaie ou ne se fera pas” – the European Monetary System (EMS)

[PRIOR MATERIAL HERE FOR THIS SECTION]

While Schmidt was increasingly seeking a ‘European’ solution to Germany’s economic difficulties, the simmering conflict between the German government and the Bundesbank continued. The popularity of German politicians in the Post World War II period was influenced by both how stable the domestic inflation rate was and how low the unemployment rate was. Increases in either led to social discord. The Bundesbank Act focused the Bank on the former goal but at the expense of the latter, given that inflation was controlled by restricting total spending in the economy. When Willy Brandt began the Keynesian era, and Helmut Schmidt followed, the conflict between government and bank was never far from the surface. The government was more interested in currency stability in the world foreign exchange markets while the Bank was more focused on domestic price stability (Hetzel, 2002: 12) and the two ambitions were not necessarily consistent at all times. Hetzel cites Johnson (1998: 70) who said a Bundesbank official considered this struggle to be “a Glaubenskrieg (religious war) of Wagnerian proportions.”

The European ambitions of Schmidt inflamed these tensions within the Germany economic policy circles. While the stagflation that followed the first oil crisis had consolidated the Bundesbank’s domestic price stability priorities as the Federal government reduced its embrace of Keynesian expansion and all but abandoned low unemployment rates as an objective, the move to increased economic and monetary integration within Europe was seen by the Bundesbank as a threat to their independence (Hetzel, 1998). As we will see, the Bundesbank exploited the vagaries of the plan for the introduction of the European Monetary System (EMS) and firmly defined their place in a European monetary system on their own terms. This strategy was important for what was to come post Maastricht. But first we should briefly trace the stages towards that the creation of the EMS.

Schmidt and Giscard d’Estaing, who both came to office in 1974 at a time the global economy was in chaos as a result of the oil crisis, stagflation and on-going currency speculation. For the first time, the Germand found a French ally who was willing to push the ‘European’ issue. With Deutsche Mark appreciating strongly against the US dollar in 1977 and early 1978, the strains on the depleted ‘snake’ were immense. Schmidt and Giscard d’Estaing, met in early 1978 to develop a joint strategy and unveiled their plan for a renewed attempt to introduce a European Monetary System at the European Council summit in Copenhagen on April 7 and 8. The proposal became reality at the European Council meeting in Bremen on July 6-7, 1979, when the leaders decided to push ahead with the creation of a European Monetary System along the lines laid out in Copenhagen. In its ‘Conclusions’ (European Council, 1978a: 17), the European Council argued that the “serious disruptions of the world economy, especially since the end of 1973” required Europe to take a “common approach … to achieve … a considerably higher rate of economic growth and thus reduce the level of unemployment by fighting inflation” (17). This would be achieved by “establishing a greater degree of monetary stability” among other things (p.17) which would require “the creation of a closer monetary cooperation” (p.18). In effect they wanted to bolster the ‘snake’ which they confirmed would “remain fully intact” (p.18).

Annex IV of the Council conclusions outlined the proposed design of the EMS, which would be “at least as strict as the ‘snake'” (p.20). Interventions to stabilise currencies within the snake would “be in the currencies of participating countries” and changes “in central rates” would be mutually agreed in advance. This represented a change to the existing ‘snake’, which allowed individual nations to alter their own parities. The EMS would define the European currency unit (ECU), which was effectively the same as the previously created European unit of Account (EUA). The ECU would thus be the benchmark value against gold against which other currencies would be paired. It would also be “used as a means of settlement between the EEC monetary authorities” (p.20). The ECU would reflect a basket of European currencies and each participating central bank would subscribe 20 per cent of their US dollar and gold reserves to establishing the initial pooled ECU fund.

The French, particularly, wanted the ECU to be “at the center of the system” (European Council, 1978a: Annex, 5) because they assessed it would reduce the importance of the Deutsche Mark, while Germany acceded because it would mean the Bundesbank would not bear all the responsibility of maintain parities in the face of on-going upward pressure on the Deutsche Mark (Piodi, 2012). The compromise was that when two currencies were in danger of breaching the limits of the allowable bi-lateral fluctuations (plus or minus 2.25 per cent) both nations would intervene. In a formal sense, there was symmetry in the proposed system. When, for example, the French Franc reached the lower band of its parity against the Deutsche Mark the latter would have reached the upper band of its agreed parity against the Franc. This would mean that both the Bundesbank and the Banque de France would have to sell Deutsche Marks and buy Francs in the foreign exchange markets simultaneously. In theory, there would be less pressure on any one currency to adjust and less monetary disturbance in the respective economies. The EMS should be seen as a formal linking of the various Member State currencies and, in that sense, was a very limited development. In reality, the adjustment process was not symmetric because the liquidity effects of the respective interventions were quite different.

For nation with a depreciating currency against the Deutsche Mark, it either had to have Mark-reserves or access funds through the so-called ‘very short-term financing’ (VSTF) arrangement. Some interventions were made using US dollars but mostly bi-lateral intervention was the norm early on in the arrangement (Ungerer et al., 1983). VSTF calls were recorded as a debt that had to be paid back in foreign currencies within 45 days. To ensure solvency, therefore, nations facing depreciating currencies had to effectively increase their interest rates or devalue. For Germany, however, while it had to sell its own currency and acquire, say French Francs, to push its parity down below the upper limit against the Franc, the accounting rules of the system meant that gave the Bundesbank a VSTF credit and this was debited against the Banque de France, in the same way as the French intervention. But the important point was that this placed no pressure on the Bundesbank to alter its interest rates. In other words, just as the adjustment under the Bretton Woods system always fell on the nations with balance of payments deficits (weaker currencies) and required them to reduce domestic growth and increase unemployment in order to ease the downward pressure on their currencies, the same asymmetric biases were built into the EMS.

Piodi (2012: 38) notes that the European Parliament gave the Bremen proposal “a cool reception” and emphasised that the establishment of a ECU fund “is not sufficient for the success of the European Monetary System” as a path to full economic and monetary union unless it is accompanied by common economic policy is agreed and the convergent economic policies of the Member States eliminated. This concern repeats itself throughout the several decades of debate in Europe about the viability of the economic and monetary union and was also ignored, as we will see, in the final chapter that began at Maastricht in 1991.

On December 5, 1978, the European Council met in Brussels and agreed to set up the European Monetary System (EMS) along the lines outlined at the Bremen summit (European Council, 1978b). It won’t surprise the reader to learn that the system eventually found itself in crisis and instead of abandoning the almost impossible idea of tying these disparate European economies together into a functioning fixed-exchange rate currency zone, the European political leaders began the rocky road to Maastricht with a compromised EMS and the creation of the Delors Committee. But first, we have to tell the story.

The EMS in practice

The EMS came into operation on March 13, 1979 despite it being agreed at the December Brussels Council Meeting that it would start on January 1, 1979 (European Council, 1978b).

[TO BE CONTINUED]

[WE ARE MOVING THEN TOWARDS THE DELORS REPORT IN THE LATE 1980s AND THE TREATY OF MAASTRICHT – THINGS WILL FLOW MORE QUICKLY AFTER THAT – I HOPE!]

Additional references

This list will be progressively compiled.

Beyer, A., Gaspar, V., Gerberding, C. and Issing, O. (2009) ‘Opting out of the Great Inflation, German Monetary Policy After The Breakdown of Bretton Woods’, ECB Working Paper Series No. 1020. http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1020.pdf

Deutsche Bundesbank (1978) Monthly Report of the Deutsche Bundesbank, February.

Gesetz über die Deutsche Bundesbank (Bundesbank Act), http://www.iuscomp.org/gla/statutes/BBankG.htm

Fabra, P. (1976) ‘Après la reprise et avant les élections I. – “Modell Deutschland”‘, Le Monde, July 6, 1976.

Llewellyn, J. (1983) ‘Resource Prices and Macroeconomic Policies: Lessons from Two Oil Price Shocks’, OECD Economics and Statistics Department Working Papers, Organisation for Economic Co-operation and Development.
http://www.oecd.org/eco/outlook/35552323.pdf

Schmidt, H. (1974) ‘Regierungserklärung von Bundeskanzler Helmut Schmidt vom 17. Mai 1974’.
http://www.hdg.de/lemo/html/dokumente/NeueHerausforderungen_redeRegierungserklaerungSchmidt1975/index.html

Siervert, O. (2003) ‘Vom Keynesianismus zu Angebotspolitik’, in SACHVERSTÄNDIGENRAT zur Begutachtung der gesamtwirtschaftlichen Entwicklung, Statistiches Bundesamt, Wiesbaden, 33-46.
http://www.sachverstaendigenrat-wirtschaft.de/fileadmin/dateiablage/Sonstiges/Tagungsband.pdf