Germany hit by EMU birth pangs

Date: 10/07/1997

WITH less than ten months to go before the final decision on launching the single currency, pre-EMU birth pangs have finally spread to Germany.

The EU's biggest member state has become engulfed in a public debate as intense as it is ludicrous: a storm has arisen over the question of whether economic and monetary union should be allowed to proceed with countries showing an estimated budget deficit slightly above the Maastricht bench-mark of 3.0&percent; of gross domestic product.

Far from being dismissed as economically grotesque, irrelevant to the success of monetary union and contrary to the letter and spirit of the Maastricht Treaty, the issue has led to a massive row between the federal government in Bonn and the Bavarian government in Munich, heightened tensions within Germany's ruling coalition and further weakened Finance Minister Theo Waigel's already shaky political power base.

The discussion which has flared up in recent weeks is so far removed from economic reality and political wisdom that only a look into Germany's post-war psyche and complex political structures can offer some explanation of the driving forces behind it.

In this century, Germans have experienced the collapse of their currency twice within 30 years. The hyper-inflation which followed World War I led to an almost instant destruction of all savings and the sudden and traumatic impoverishment of a large section of the population after decades of virtual price stability.

The experience was repeated, albeit on a lesser scale, after World War II.

Both times, the population ended up with worthless money because their government resorted to the printing presses to finance the enormous cost of disastrous wars.

The creation of today's deutschemark heralded the onset of a new period of monetary stability during which West Germany's currency, under the stewardship of the Bundesbank, became one of the least inflation-prone in the world.

The D-mark, as the currency is labelled in its home country, also served as a catalyst for West Germany's staggering post-war economic and commercial renaissance, which Germans still associate with the name of the former economics minister and later Chancellor Ludwig Erhard.

Practically overnight, Erhard's coup de main decision in 1948 to replace the near-worthless reichsmark with the deutschemark - against, incidentally, the initial wishes of the allied occupation government - filled up empty shops, reinvigorated trade and gave Germans some economic hope amidst the pile of rubble that was their country after the war. With West Germans encouraged to engage in business as opposed to new political adventures, the deutschemark later became a symbol of everything post-war Germany was striving to stand for, while giving millions of German tourists abroad a pleasant feeling of wielding (buying-) power.

Faced with such intense popular sentiment, the German government found no other way to sell the euro to a hostile public than by promising the single currency would be as 'hard' and as stable as the deutschemark.

Over the last few years, the word 'stability' has been used as a magic mantra with which Germany's ruling politicians try to exorcise popular angst about the euro. It became the recurrent theme of thousands of speeches and public utterances by German Chancellor Helmut Kohl, Waigel and other ministers.

To bolster its claim, the German government gave out the line that strict adherence to the Maastricht Treaty's convergence criteria, and in particular to the deficit target of 3.0&percent;, would be the necessary and sufficient condition to ensure that the euro would become the deutschemark's twin in all but name.

Yet the relentless propaganda, unthinkingly relayed by cohorts of economically illiterate journalists, obscured the simple fact that a currency's external worth is ultimately determined by the markets, and its inflationary track record by a complex mix of economic and monetary factors.

The decision to turn the deficit criterion - arguably one of the least suitable of all - into the litmus test for a country's readiness for EMU also ignored the simple statistical fact that April 1998's figures, on which EU chiefs of government will have to base their decision on whether to press ahead with monetary union, are likely to be substantially revised in the following years.

Initially, the absence of economic common sense behind the German government's and, more specifically, Waigel's public position only bothered a few economists.

With Bonn confident that it would easily achieve all the Maastricht Treaty's convergence targets, the highlighting of the 3&percent; bench-mark was seen by many as an expeditious way to pressurise profligate EU partners (looking south) into sensible budgetary austerity, while giving Germany a useful tool to keep unwelcome aspirants out of EMU.

Yet, in an ironic twist of history, it is now Germany itself which - along with France - is desperately struggling to achieve, or at least come close to, the fateful 3.0&percent; this year and next.

Waigel's apparently ill-timed and clumsy manoeuvre to force the Bundesbank to re-evaluate its gold reserves and transfer the proceeds to Bonn (the full story has still to be told) only succeeded in showing its EU partners that Germany would 'fudge' the criteria when push came to shove, while further convincing ordinary citizens that the euro would be a messy business.

Ignoring the option of edging away from his earlier statements about the importance of 3.0&percent;, Waigel, faced with an unprecedented weakening of his prestige, has been stubbornly clinging to his stance in what seems like a desperate attempt to fight off a further erosion of his credibility.

For the embattled finance minister, the stakes are high indeed. Waigel - who is the nominal leader of the Bavarian ruling party, the Christian Socialist Union (CSU) - faces a possible leadership challenge from his arch-rival, the Bavarian Minister-President Edmund Stoiber, at a party conference later this year.

In a manoeuvre interpreted by some either as a reckless bid to bring down the Bonn coalition (and destroy Waigel politically), or as a more limited attempt to outflank vocal Eurosceptics at home, Bavaria's populist ruler has threatened to vote against the switch to the single currency in parliament's upper chamber should Germany's 1997 deficit exceed 3.0&percent;.

Stoiber's pressure, forcefully exerted from the right of the political spectrum, is being mirrored on the left by the Lower-Saxony state Governor Gerhard Schröder, an ambitious SPD baron playing on the public's euro-fears in a bid to wrench the candidacy for the chancellorship in 1998 away from party leader Oscar Lafontaine.

Yet while the German chancellor has clearly been made uneasy by the pressure being brought to bear on his trusted and loyal finance minister, and the resulting strains within the ruling coalition, few seriously doubt that Kohl's still massive political weight - in conjunction with the momentum the EMU project has now acquired - will be enough to ensure the euro can be launched on time.

Financial markets, usually the most nervous of observers, have remained remarkably steady in their belief in the project.

Kohl has now clearly subordinated all other domestic, foreign or European policy considerations to the unbroken push for EMU. In this aim, the chancellor can count on the strong and growing support of German big business and banking interests.

Less than 18 months before the final switch to the euro, fears that an EMU postponement might lead to a massive re-evaluation of the deutschemark and plunge Germany - and ultimately Europe - into a new recession are being taken seriously enough to deter a growing number of financial decision-makers from even considering such an option.