Options for Europe – Part 28

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]

[NEW MATERIAL TODAY]

The EMS ‘second life’ marked by increasing Franco-German acrimony as they march together towards Maastricht

[REWRITTEN FROM FRIDAY WITH ONE NEW PARAGRAPH – THE SECOND]

At the end of 1986 and into 1987, there were major speculative attacks on the European currencies, which were unrelated to tensions within Europe and reflected a weakening US dollar. Whatever the cause of the instability, the EEC Economic and Finance Ministers agreed to realign the currencies on January 12, 1987 because the central banks could not hold the existing parities in the face of the speculative capital flows. There was a general concern that the German domination of the EMS was forcing unwanted realignments on the EMS and was stifling the growth prospects (Tsoukalis, 1989) There was neither stability nor growth!

In 1986, the famous French cohabitiation began, with the socialist Mitterand as President appointing the right-wing neo-Gaullist Jacques Chirac as his Prime Minister. The latter, who as the majority holder in the Assembly, was given oversight of the domestic economy, didn’t waste any time in picking up the deregulation and privatisation agenda from the previous regime. Chirac wanted to be France’s Margaret Thatcher. Chirac appointed Édouard Balladur as the Minister of Economy, Finance, and Privatisation, the last responsibility reflecting the penetration that the neo-liberal ideology had made into the affairs of the state. Balladur spearheaded the revival of the neo-liberal agenda, selling off public companies and abolishing the wealth tax as part of the much-vaunted, but never to materialise, ‘trickle down’ growth strategy. He was also the vanguard for France’s now very pro-European stance.

Balladur pressured the ECOFIN members about the need to usurp the Bundesbank’s deflationary policy bias. This concern led the Ministers to call upon the Committee of Central Bank Governors to formulate a plan to improve the intervention mechanisms within the EMS. The result was a meeting of the Governors in Basel on September 8, 1987 which sent a plan for strengthening the EMS to the Economics and Finance Ministers (Committee of Central Bank Governors, 1987). The day before, the ‘Alternates’ to the EEC Monetary Committee met to review the document that would be considered by the Governors. At that meeting, the Bundesbank representative stressed that it “could not accept rules that weaken its stability oriented policies” and that it was up to the other EMS countries “to work further towards greater stability so as to have other strong currencies in the system which could acquire reserve status and thereby reduce the relative role of the Deutsche Mark” (Monetary Committee of the European Economic Communities, 1987: 1). A rather ‘Marie Antoinette’ sort of denial of what was happening to say the least.

[NEW MATERIAL TODAY]

Richter (1999: 3) notes that “To experts on German affairs it must have been clear from the beginning that the Bundesbank would not yield to political pressure and that no Bonn government in its right mind would get the idea of changing Section 3 of the BBG” (the BBG being the Bundesbankgesetz or Bundesbank Act).

What became known as the Basel/Nyborg Agrement was based on the recognition that large-scale intervention in the currency markets was not sufficient to maintain currency stability and that, both increased cooperation (meaning: more symmetrical intervention burdens) was required. The French, supported by the Belgians and Italians, demanded that bi-lateral obligations on currency market intervention be enforced (Renard, 1987). The Dutch and German representatives wanted to avoid being forced to expand the supply of their own currencies to defend the weak currencies because they feared this would be inflationary. The same old same old.

The Bundesbank won! The bankers, recognising that investment funds were now more mobile, not to mention the ideological preference to abandon capital controls, agreed to allow currencies to move more freely within the set bounds and to expand the flexibility of the VSTF capacity to allow intervention in situations where the lower limits of a parity were threatened (BIS, 1988: 196). The Germans argued that nations should abandon capital controls and rely more on interest rate differentials to manage the currency parities, which would reduce the need to call on the VSTF. The ‘easy credit’ implied by the VSTF was repugnant to the Germans (Gros and Thygesen, 1992). The agreement reached was intended to result in less frequent currency realignments (BIS, 1988: 196). The Governors’ proposal was signed off at a meeting of the European Council in Nyborg on September 12, 1987.

But Édouard Balladur was just getting started on the French government’s new anti-Bundesbank strategy and on January 8, 1988 he released his famous memorandum –Mémorandum sur la construction monétaire européenne – for discussion among the ECOFIN Ministers (Balladur, 1988). He realised immediately that without capital controls, the French economy would be more sensitive to the deflationary stance of the Bundesbank and that France would have to continue use higher interest rates to maintain the Franc parity. French politics, let alone national pride, would not tolerate that reality.

These developments were being reinforced by statements coming from the Banque de France. Deputy-Governor of the Banque de France, Philippe Lagayette wrote in 1988 that while the EMS had been a success (stablising inflation) it was not well geared to handle growth (“le Système monétaire européen a, en quelque sorte, un problème de croissance. Tel qu’il est construit, il était bien adapté aux périodes où la priorité était de faire reculer l’inflation; il est moins bien adapté lorsque la politique économique a des objectifs plus complexes que la seule baisse du niveau de l’inflation”, Lagayette, 1988: 444). He proposed three major changes: make the intervention system more symmetric; broaden the EEC membership, and develop the use of the ECU as a European currency (“rendre le système plus symétrique, l’étendre à un plus grand nombre d’Etats membres de la Communauté, développer l’usage de l’ECU”, Lagayette, 1988: 444). He specifically said that the external surpluses of Germany were a source of tension for the weaker currencies and there was no adjustment mechanism to correct the imbalances (“Ces excédents sont parfois des facteurs de tension et le Système monétaire ne comporte pas de mécanisme ou de force de rappel qui pousse à leur correction”, Lagayette, 1988: 445).

The point was that there was a corrective mechanism in place which amounted to the Bundesbank holding its line and forcing all the adjustment onto France and the other weaker nations. What Lagayette was saying was that the French were dissatisfied with the German dominance. In recognising that the trade imbalances were problematic for the EMS, Lagayette said that the values of the European currencies could not be set by the economic situation of the nation with the largest external surplus (“la monnaie de l’Europe ne pourra être déterminée par la situation économique du pays le plus excédentaire”, Lagayette, 1988: 445). He called for a return to the vision in the Werner Report, and the logical necessity of a single currency and a European Central Bank, all code for reducing the power of Germany.

Balladur, once again, promoted the French concern about the EMS on the grounds that the intervention criteria forced the nation with the weaker currency to assume the adjustment burden. The stronger currency nation (aka Germany) could do nothing and avoid the domestic costs associated with the intervention. Balladur indicated French support fro a common European currency, a strategy designed to eliminate the Deutsche Mark forever. What the French thought would happen if they succeeded in gaining a common currency and European Central Bank replacing the Bundesbank is another matter. They clearly found out in 2008!

Italian government Finance Minister Giuliano Amato responded, supportively in February 1998, with his own memorandum accusing the Germans of stifling growth and operating with an undervalued currency. The Italians upped the ante and “threatened to invoke escape clauses in the process capital liberalization … as well as implement various protective domestic regulations” if the asymmetries were not eliminted (Moravcsik, 1998: 433). While the two memoranda were strident in their attacks on the system they failed to outline a process towards economic and monetary union. Piodi (2012: 51) said they were “vague when it came to the solutions for achieving monetary union”.

The Germans, were very sensitive to the growing anti-Germany sentiment. They saw the ‘European Project’ in terms of restoring the nation’s place in Europe, whereas the French saw it from the perspective of stopping Germany invading them again. In 1995, former German Chancellor, Helmut Schmidt reflected on the accusations of German bullying or intimidation in relation to the evolution of the economic and monetary union and the reactions of leading German policy makers to these accusations. He said that “the creation of the monetary union is in the first instance eminently a task for foreign policy” (“Die Schaffung der Währungsunion ist in erster Hinsicht eine eminent außenpolitische Aufgabe” Schmidt, 1995). He noted that over the last 125 years Germany had conducted three wars with France. He said that without a full economic and monetary union, the Deutsche Mark and the German financial institutions would dominate Europe, which would spark increased fear and envy against Germany and lead, for the third time in the C20th, to a coalition of almost all other European nations against Germany (“Diese Dominanz Deutschlands löste zwangsläufig bei allen Nachbarn Angst und Neid aus und bewöge sie zu einer gegen Deutschland gerichteten Gemeinsamkeit. Zum dritten Mal wäre eine Koalition fast aller anderen europäischen Staaten gegen Deutschland zu befürchten”).

In this context, the German Foreign Office took the diplomatic decision to push for the union to quell the on-going criticism of the ugly German, which threatened to derail the progress that the nation had made in restoring its image in the Post World War II period. Two separate memorandums were issued in early 1988. The first was issued by the Helmut Kohl’s Foreign Minister, Hans-Dietrich Genscher (Gensher, 1988).

[NEXT STEP HANNOVER EC MEETING]

[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.

Balladur, E. (1988) ‘Mémorandum sur la construction monétaire européenne’, ECU Newsletter, No. 3 Brussels March 1988.

Bank of International Settlements (1988) 58th Annual Report, Basle.

Gensher, H.D. (1988) ‘Memorandum für die Schaffung eines Europäischen Währungsraumes und einer Europäischen Zentralbank’, press article, Deutsche Bundesbank, March 1, 1988.

Gros, D. and Thygesen, N. (1992) European Monetary Integration, London, Longman.

Moravcsik, A. (1998) The Choice for Europe: Social Purpose and State Power from Messina to Maastricht, Ithaca, Cornell University Press.

Renard, F. (1987) ‘M. Balladur veut accélérer la construction de l’Europe monétaire’, Le Monde, January 8, 1987.

Richter, R. (1999) ‘European Monetary Union: Initial Situation, Alternatives, Prospects – in the light of Modern institutional Economics’, Economic Series No. 9908, University of Saarland, May.

Schmidt, H. (1995) ‘Deutsches Störfeuer gegen Europa’, Die Zeit, No 40, 29 September 1995.
http://www.zeit.de/1995/40/Deutsches_Stoerfeuer_gegen_Europa

Tsoukalis, L. (1989) ‘The Political Economy of the European Monetary System’, in Guerrieri, P. and Padoan, P. (eds.) The political economy of the European integration: states, markets and institutions, New York, Harvester Wheatsheaf, 58-84.

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.