EMU gives Germans the jitters

Date: 06/02/1997

WITH 700 days to go until they are due to drop the deutschemark for the euro, the Germans are getting cold feet.

Granted, their toes have been chilly for a long time. Helmut Kohl's blind love affair with the single currency idea has never been shared by German voters, even though they have consistently invited him back to the chancellery.

The reasons for their scepticism are not terribly sophisticated. Whatever politicians say, German fears are not really about the independence of the European Central Bank (ECB) or a harking back to the inflation of the Weimar Republic. They are simpler than that.

“People have gone to Italy, Spain and even France for their holidays for the past 30 years and they have always swapped a strong deutschemark for the weak lira, peseta and franc,” says Thomas Mayer, an economist at Goldman Sachs investment bank in Frankfurt.

“Now the government is asking them to merge their mark with these currencies, which they feel have always been falling. If you mix a good wine with a bad one, the good one is inevitably watered down. That is their perception, and who can really fault it?”

Having said that, Germans are not a homogenous mass and neither are the country's movers and shakers.

Bankers, and particularly those closeted in the Bundesbank's headquarters on the outskirts of Frankfurt, lie awake at night thinking of 'stability' and the independence of the ECB. For them, letting Italy and Spain into the euro-zone from day one would be an act of folly which would undermine the credibility of the new currency, stoke up inflation and push up interest rates.

For the same reasons, they like to overreact to French notions of a political counterweight to the powers of the ECB. This is all the more absurd given that the French are only talking about the European equivalent of an institution which already exists happily in Germany - the Konjunkturrat - which groups together federal and regional authorities to assess the economic outlook and coordinate their budgetary stances in a non-binding manner.

The seemingly endless round of misleading and over-the-top comments coming out of Bonn and Frankfurt about the need to maintain the independence of the ECB - which has never been under threat - finally provoked a response, with Kohl's predecessor Helmut Schmidt accusing Finance Minister Theo Waigel and Bundesbank President Hans Tietmeyer of unwittingly panicking the German people.

While the bankers take an ultra-cautious stance, German heavy industry - which has long suffered from the strength of the deutschemark against not only the dollar but also the lira - is rather more pragmatic.

Locking Italy into a fixed, and preferably uncompetitive, exchange rate would take some of the heat off manufacturers. No longer would Volkswagen feel the need (allegedly, of course) to instruct its Italian dealers to stop selling cheap cars to bargain-hunting German citizens.

Simply qualifying for EMU will be more touch-and-go for Germany than was previously thought.

While the government is now expecting to get the deficit just below the qualification target of 3&percent; of gross domestic product this year, private-sector forecasters are predicting something closer to 3.3&percent;. Hitting 2.9&percent;, as Waigel anticipates, will take a little finessing.

However, the budgetary book-cooking demonstrated by his French and Italian counterparts has shown that lopping a half-point off the deficit is perfectly possible with one-off measures.

And despite its holier-than-thou attitude towards Rome and Paris, the German government itself knows how to give the books a quick fry-up.

The solidarity surcharge, a tax invented to finance reunification, was meant to be cut from January 1997 but will now be reduced a year later. As a result, coincidentally of course, the effects of this reduced revenue on the federal budget will fall into 1998 - one year too late to be taken into account in the EMU qualification assessment carried out by the European Commission and the European Monetary Institute.

It is the longer-term budgetary measures which have upset Germans - the kind of structural reforms which the Italians have simply not addressed in their headlong rush towards monetary union.

At the same time as having to get used to the idea of joining a single currency bloc with reckless Mediterraneans, Germans are also coming to terms with hard home truths: unemployment is still rising, the tax system is a shambolic welfare state for the middle classes and state pensions will be unaffordable as the population greys.

Grasping these nettles has caused unprecedented ructions within the ruling CDU-FDP coalition and even evoked the previously unthinkable political mortality of Helmut Kohl.

Dealing with a pensions time bomb which is not due to go off until 2030 is hardly necessary for EMU candidates but, to the credit of the German government, it is tackling the issue as head-on as it can.

It was Labour Minister Norbert Blüm, Kohl's long-time ally and the only man to have served in all his cabinets, who unveiled the pensions reform plan which lit a fuse under the coalition a fortnight ago.

Under his proposal, the state pension would be cut from 70&percent; of average net wages now to 64&percent; in 2030. Wage-earners' pension contributions, which rose to 20&percent; this year, would go up to 23&percent; over the same period and value added tax would increase by 2&percent; to finance a 'family fund' to pay for more peripheral parts of the social security system into the next century.

The reform plan caused a political storm and was disowned by fellow Christian Democrats and even Kohl himself, much to the annoyance of Blüm. The opposition Social Democrats, who have been languishing ever since a euro-sceptical campaign failed in state elections last year, found a theme - generational equity. The young claim that it would favour existing pensioners while they would have to pay the extra VAT and receive smaller pensions.

“It has a lovely symmetry to it,” says a retiring German economist. “Germans feel they will be paying higher contributions and extra taxes to receive a smaller pension in a weaker currency.”

As if this were not enough, Waigel has proposed a long-overdue overhaul of Germany's Byzantine tax system to eliminate as many as 70 allowances for such vital economic activities as driving to work.

The reforms are intended to reduce the higher rates of tax and make the whole system more transparent. The top marginal rate of tax will fall from 53&percent; to 39&percent; and a myriad of tax breaks will go, leading to a net gain for most Germans.

At the moment, all the social contributions paid by wage-earners and their employers amount to 42&percent; of salaries, with tax on top of that. Needless to say, this makes employers wary before they hire. The government's aim in the long-term is to get this contribution rate below 40&percent;.

However, ordinary people see things differently. For example, those working on Sundays or nights to supplement their income in a tax-efficient way are going to see their bonuses fully taxed. As their allowances disappear, they feel that the consequent reductions in basic tax rates will not compensate them.

Suddenly, the formerly immortal Kohl looks shaky.

The SPD has been careful in the area of tax but has made hay on the pensions issue, while Kohl has taken the unusual step of trying to stifle public debate.

Gerhard Schröder, the popular and populist state premier of Lower Saxony, could still emerge from the shadows. An opinion poll published last week showed that while SPD leader Oskar Lafontaine would lose to Kohl in an election due to be held in the autumn of next year, Schröder would see him off with a ten-point victory.

More than anyone else, Kohl has been the driving force behind EMU. His replacement - or even the prospect of it - by a sceptic such as Schröder would change the whole monetary union landscape.