Options for Europe – Part 59

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).

Chapter X The convergence farce – smokescreens, accounting tricks, and denial

The convergence criteria specified under Article 109j(1) relating to inflation, interest rates and exchange rate stability were clear and most of the contending nations were likely to have satisfied them as the deadline approached. The sticking point, however, was the rules under Article 104c and Protocol 5, which related to ‘excessive deficits’. This condition had two components: a fiscal deficit could not exceed 3 per cent of GDP (with qualifications for direction of movement and extraordinary circumstances) and the gross public debt to GDP ratio should not exceed 60 per cent, again with the qualification that the ratio, if above that threshold, was falling in a satisfactory manner.

The excessive deficit criterion were clearly tripping a number of nations up, including Germany. In 1997, France, Germany and Spain has deficits above the 3 per cent and could not really appeal to the special circumstances clauses as a way out. Further, the public debt ratios in Germany and Spain were above the 60 per cent threshold and had been increasing since 1995. By contrast, although Italy’s public debt ratio was well in excess of the criteria it had been falling. Further, Belgium was in this category too and presented Germany with a major tactical headache – it could not isolate Italy without pleading some special case for Belgium, which, of-course, it attempted without success.

On May 2-3, 1998 the special European Council meeting in Brussels sealed the starting date for Stage III. A week before the meeting, German Finance Minister Theo Waigel upped the ante by demanding that the Council agree to a ‘stability declaration’. While his Stability Pact proposal in 1995 was concentrated constraining fiscal deficits, the ‘stability declaration’ targetted public debt. Germany anticipated that Italy would, by hook or by crook, meet the deficit requirements of the convergence criteria. But even with creative account, it knew Italy would not be able to meet the debt limits in time.

Italy was a major headached for the Germans. In 2012, the German newspaper, Der Spiegel obtained a number of previously secret German government documents via a freedom of information process, which reveal the extent of the German concern over Italy’s entry into the EMU. The documents reveal that the German government clearly understood the deficiencies of the proposed EMU before they entered it with the other ten nations. The documents “prove what was only assumed until now: Italy should never have been accepted into the common currency zone” (Der Spiegel, 2012, Part 1).

Italy’s entry reflected political exigencies “at the expense of economic criteria” (Der Spiegel, 2012, Part 1), which is hardly surprising given that the motivation all along was not ground in sound economics. The only surprising thing is that when the findings of two IGCs converged on Maastricht, the political integration side of the discussion was largely ignored. There was little taste for giving more power to the European Parliament and Germany caved into French demands to focus on economic matters almost exclusively.

Der Spiegel characterised the EMU exercise as “Operation ‘self-deception'” (Der Spiegel, 2012, Part 1). The documents reveal that the German officials and government were aware of the accounting tricks that Italy was engaging (gold sales and special ‘taxes’) to bring the deficit down below the Maastricht thresholds. In early 1997, the Italians announced that they had reached the 3 per cent deficit criterion, defying other known measures of their fiscal position provided by the IMF and the OECD. Theo Waigel’s state secretary, Jürgen Stark accused the Italians of having pressured the Banco d’Italia to manipulate the convergence process.

Who else was ‘cooking the books’ or 3 per cent means 3 per cent … but not always

As 1997 dawned, it was clear that Germany itself might not meet the deficit and public debt thresholds laid out in the convergence criteria. The German government was being attacked within by the opposition SPD about its fiscal position. During the October 1996 federal ‘budget’ debate, Waigel was accused of “lying and deceiving the public” over the state of the nation’s finances (Miller, 1997: 6). SPD leader Gerhard Schröder argued that Stage III should be delayed while Germany sorted out its own economic challenges, which included rising unemployment. Helmut Kohl had a clear political imperative to stitch up the Stage III transition before the 1998 federal election in Germany.

Externally, the German government’s problem was obvious. While the Bundesbank had actually demonstrated some realism about the convergence criteria, with the President Hans Tietmeyer suggesting that “countries should be judged less on the exact numbers and more on what he called the sustainability of their economies” (Andrews, 1997b), the German government had been “Europe’s scolding schoolmarm on fiscal and monetary policy, adamantly insisting that countries should not be allowed to take part in the euro unless they meet exact and nonnegotiable numerical targets on a number of issues, including the size of their government budget deficit” (Andrews, 1997b).

So what to do? The German Finance Minister had anticipated the problem for some months. At the March 17, 1997 meeting of ECOFIN in Brussels, Germany’s convergence program was examined and the European Council “was well aware of the unique challenges and the difficult economic situation currently faced by Germany” (European Council, 1997x). Waigel apparently told the meeting that Germany should be exempted from the 60 per cent public debt condition and said that while “I always said that three means three. I never talked about 60” (Cameron, 1997, 9). That sounded as though Germany was seeking flexibility on the debt criteria only.

But the slippage continued. A month later (April 4-6), at the informal Ecofin meeting in the Dutch seaside town of Noordwijk, as the Finance Ministers waxed lyrical about the nature of the fines that would be imposed on nations with excessive deficits, Waigel demonstrated the hypocracy that still dominated decision making in Europe today and colours the debate relating to the options for the Eurozone. He indicated that Germany was even prepared to be ‘flexible’ about the 3 per cent threshold. The UK Guardian reported that Waigel had told the meeting that that “I have never nailed myself on the cross of 3 percent. When I said in the past ‘3 percent means 3 percent’ I did not necessarily mean 3.0 percent” (Palmer, 1997). How to make sense of that?

It was clear that while Germany hated the idea of Italy joining the EMU, it was so weakened by its own inability to meet the criteria and facing a difficult federal election in 1998, that it would do what it took to push through to Stage III. Waigel’s ‘softening’ at the April Ecofin meeting was in line with Helmut Kohl’s announcement a few days earlier said he would seek re-election in 1998 and that monetary union would proceed on time in 1999. Waigel’s remarks made it clear that there would be no delay in the Stage III transition.

On the domestic front, Germany demonstrated that the accounting tricks were not confined to the nations down ‘south’. While Waigel was publicly railing against France, Italy, and Spain for manipulating their public accounts, he privately crafted his own plan to ‘cook the books’, which looked very similar to those same creative accounting plans deployed by France and Italy. Essentially, Waigel wanted the Bundesbank to revalue their gold reserves at the current market prices rather than at their historical value, and then record the not inconsiderable ‘paper profit’ in favour of the Government’s operating position. This would have wiped of the deficit in that year.

After a public spat with the Bundesbank, who who claimed the plan would compromise their independence, the Government was forced to scrap the plan on June 4, 1997 and bear the public humiliation associated losing out to the bank. Other nations, also reasonably noted that, Germany was “resorting to the very same one-time financial maneuvers that it has loudly denounced in France and Italy” (Andrews, 1997a).

It is ironic that in 2010, Theo Waigel claimed that “Greece fiddled with the numbers, which is quite a nasty trick” (EurActiv, 2010). This was in reference to the secret loan that Goldman Sachs made to the Greek government in 2001, which allowed Greece to manipulate its books and hide the growth of its public debt so as to keep within the EMU rules. The nasty bit was that Goldman produced a transaction of such complexity that Greece “didn’t understand what it was buying and was ill-equipped to judge the risk or costs” (Dunbar and Martinuzzi, 2012).

Politics triumphs amid the economic haze

It was clear though, that the final decision on who would enter the EMU would be political and the convergence criteria were really a smokescreen, a sort of delusional security blanket designed to placate the German public and the conservatives elsewhere that the process was disciplined and sustainable.

The problem was that there was no economic logic anyway, just a set of arbitrary numbers grabbed out of the air, which were then backfilled with a series of spurious ‘economic’ reports, which claimed to prove the legitimacy of these numbers as ‘economic knowledge’. They were never that – they were always just ideological statements about the Monetarist disdain for government activity in what should be, for them, a self-regulating free market devoid of worker protections, with as small a government sector as is required for external defence.

Helmut Kohl’s policy advisor, Joachim Bitterlich indicated that Germany could not exclude Italy from the EMU because “We all shared a certain love for Italy”, given that Italy has been a foundation member of the Community and was seen as a cooperative member relative to the French and the British, both of which had a long history of tension with Germany (Der Spiegel, 2012, Part 1).

Even within this political struggle, the ‘economic’ criteria were being used to undermine the viability of the national economies. The European Monetary Institute Convergence Report was published in March 1998 as part of the process specified under Article 109j of the Maastricht Treaty was (European Monetary Institute, 1998). It assessed that “further substantial consolidation is warranted in most Member States in order to achieve lasting compliance with the fiscal criteria and the … objective of having a budgetary position that is close to balance or in surplus, … from 1999 onwards” (p. 7). While the EMI mentioned several nations, including Germany and France, it claimed that there would need to be substantial fiscal “surpluses in Belgium, Greece and Italy” for “an extended period of time” (p. 7).

There was no discussion about whether this extended austerity was in any way related to what was actually happening in the economy with respect to economic growth or unemployment. The discussion had rendered these important macroeconomic aggregates irrelevant. Public policy was solely being assessed in terms of the arbitrary fiscal criteria that were introduced in Maastricht. It was an extraordinary abandonment of macroeconomic responsibility and the sign of things to come.

The Bundesbank produced it ‘Opinion’ on the state of convergence in the European Union to the Stage III rules in April 1998 and was more explicit than the EMI’s assessment of the situation (Deutsche Bundesbank, 1998). It expressed “serious doubts about the long-term sustainability of the financial position” (“erhebliche Zweifel an der dauerhaften Tragbarkeit der Finanzlage” p. 38) of both Belgium and Italy in relation to their public debt situation. Notwithstanding their recognition of existing austerity plans, the Bundesbank claimed that both nations would have to accept “further substantial binding austerity commitments” (“substantielle Verpflichtungen verbindlich eingegangen werden” p. 39).

The problem for Germany was that if it tried to reject Italy’s membership on the public debt count, then it would have to reject Belgium’s bid. That was impossible. Further, the public debt ratios for both Italy and Belgium had been declining, albeit slowly, while Germany’s ratio, also above the 60 per cent threshold had been rising. Waigel mounted the ‘special case’ appeal relating to the investment the government had made in the reunification effort as a mitigating circumstance. It was convenient for the political elites elsewhere in Europe to accept that because then Italy, Belgium, and later Greece could slip through the net without close scrutiny.

Szász (1999: 226) concluded that “since it felt to be politically awkward to admit Germany and France despite doubts regarding their performance, while at the same time rejecting the participation of other countries, then it was decided the other countries had to be admitted as well.” Which meant the convergence criteria had to be watered down. In effect, they all agreed to fudge the books and bend the rules they had set for themselves, because the rules themselves were impossible to meet while still maintaining anything like politically acceptable unemployment rates.

The upshot was that eleven nations were deemed to have met the convergence criteria and would enter the EMU. Greece would have to wait a few years. The politicians had demonstrated a spectacular capacity to bend their own rules but there were limits if they wanted to retain any semblance of credibility. Greece was at that stage beyond these limits. But not for long!

[NEXT – THE DEAL IS DONE AND GERMANY EXERTS ITS POWER]

[TO BE CONTINUED]

Additional references

This list will be progressively compiled.

Andrews, E.L. (1997a) ‘Germany Set To Revalue Gold Reserve’, New York Times, May 29, 1997. http://www.nytimes.com/1997/05/29/business/germany-set-to-revalue-gold-reserve.html

Andrews, E.L. (1997b) ‘German’s Slick Bookkeeping to Meet Euro Goal Is Scrapped’, New York Times, June 4, 1997. http://www.nytimes.com/1997/06/04/world/germans-slick-bookkeeping-to-meet-euro-goal-is-scrapped.html

Cameron, D.R. (1997) ‘Economic and Monetary Union: Transitional Issues and Third-Stage Dilemmas’, paper presented at European Policy Paper Series, 4. http://aei.pitt.edu/32/1/euecon_monet_union.pdf

European Council (1997x) ‘Press release: 1994th Council meeting – ECOFIN – Brussels’, March 17, 1997. http://europa.eu/rapid/press-release_PRES-97-77_en.htm

Miller, V. (1997) ‘The European Politics of Economic and Monetary Union: Developments in Germany, France, Italy and Spain’, Research Paper 97/36, House of Commons Library, March 19, 1997. http://www.parliament.uk/Templates/BriefingPapers/Pages/BPPdfDownload.aspx?bp-id=rp97-36

Palmer, J. (1997) ‘Bonn softens stance on EMU entry criteria’, The Guardian, April 7, 1997.

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