Germany’s Peculiar Role in the Present Euro Fiscal Crisis

April 28, 2010

The Greek debt problems is exacting disproportionate damage to the common currency’s reputation by demonstrating a lack of political cohesion to tackle a problem like this, by confirming that a single monetary policy cannot coexist with sixteen fiscal policies, by generating fears that a Greek default is a matter of when, not if, and by making the defection of either the group’s weakest links or its strongest ones much more plausible.  Greece is a minor player in the tribe, and the crisis would not have snowballed as much as it did without the explicit tough-love role adopted by German Chancellor Merkel.  Irresponsible fiscal management by Greek officials and their deliberate deception in misreporting their budget numbers to the EU make Greece an unsympathetic party in this saga.  However, Germany is not entirely blameless, either.

Germany was a driving force behind the creation of a common European currency.  Although German citizens and the Bundesbank were skeptical and reluctant to give up their beloved Deutschemark and sovereignty over monetary policy, Chancellor Helmut Kohl enthusiastically embraced the idea.  For starters, this was the concession Germany had to pay to secure France’s permission for the unification of West Germany and East Germany in 1990.  Germany was whole again safely ensconced in a broader European currency union.  Nobody twisted Kohl’s arm to cede German monetary policy to a regional central bank.  On the contrary, he thought the arrangement diminished the chance of war in Europe and that building this force for peace outweighed any economic risks from entering a half-baked currency union.  He assumed that political and fiscal unification would in time follow monetary union and did not need to be pre-conditions for the euro.

Elements in Germany, not so much the Chancellor, insisted upon a Stability and Growth Pact to safeguard against the possibility of the whole union being victimized by the fiscal failings of one or two members.  So the SGP would impose very steep penalties on any country in the union found to have exceeded deficit or debt standards.  Early last decade when economic growth floundered and did not revive quickly, Germany itself violated the SGP guidelines.  But they were not alone, and the method for penalizing members involved a vote that Germany was able to prevent by virtue of its size and the clout of other members who were in violation of the rules.  The Stability and Growth Pact rules for enforcement were watered down at the request of Germany and France, such that other criteria like the length of a recession and cyclically adjusted budgetary trends were to be considered as well.  Once the heavyweights like Germany and France had been exempted from taking the medicine, it was obvious to all that SGP penalties would never be enforceable.

The euro has not as performed as well as the mark did against the dollar.  After all, it is a hybrid with some German DNA but also the DNA of economies with historically weaker economic fundamentals than Germany.  Looking at the four decades before the mark retired and joined other national currencies in forming the euro, the dollar/mark relationship posted period averages of DEM 3.99 in the ten years through 1968, 2.9059 in the ten years to 1978, 2.2402 in the ten years to 1988 and 1.6430 in the ten years to 1998.  The mark’s translation value of the euro averaged 1.6931 in the ten years to 2008 and 1.6541 in the entire 11-1/3 years of the euro’s existence.  The mark on average posted gains in ensuing 10-year increments of 37.3% in 1969-78, 29.7% in 1979-88, and 36.3% in 1989-98.  But as a component of the euro, the mark was 3.0% weaker in 1999-2008 than in the prior ten years and off 0.7% since the start of 1999 compared to its mean in 1989-98.

German GDP expanded only 0.9% per annum in the eleven years through 2009, including a drop of 5.0% in that final year.  One can imagine being dissatisfied with such slow activity, but Germany had in fact settled into a much softer path long before giving up the euro.  The Rubicon was crossed when East Germany was annexed in 1990 at an undervalued exchange rate of parity between the D-mark and the East German Ostmark.  That was Kohl’s idea as well, and former Bundesbank President Poehl resigned in protest.  It took nearly two decades for Germany to erase the loss of competitiveness that resulted when East and West Germany reunited.  Since the euro began life in 1999, German CPI inflation has averaged only 1.6% per annum, less than the 2.0% per annum pace of Euroland as a whole.  Weak growth suppressed German inflation to a slower pace than such had been prior to the euro and enabled German competitiveness to crawl gradually upward.

Now Germany wants Euroland’s peripheral economies like Greece to adopt its own standards.  But in fact, German inflation has been more distant from the ECB target of below but close to 2.0% than Euroland as a whole, and German exporters have benefited from excess spending in Euroland’s deficit nations like Spain and Greece just as Chinese exporters benefit from excessive U.S. private spending.

There are two additional peculiarities of Germany’s rigid stance on Greece’s fiscal crisis.  First, the leaders in Berlin seem to be engaged in a game of chicken, since German banks would be significant losers when Greece defaults, and the entire euro area economy including Germany is going to suffer from imposed austerity in Greece and possibly Portugal, Spain and Italy.  Secondly, Germans tend to attribute much of their bad history to the hyperinflation early in the twentieth century, but a key cause of those tumultuous and tragic period were the post World War One reparations that the victors of that war attempted to impose on Germany.  A kinder and gentler approach after the Second World War put Germany back on its feet.  It took over a half century, but Germany seems to have selectively forgotten this gift.  It would be ironic if a European currency union, which Helmut Kohl touted as a device to cement peace in Europe, instead leaves a legacy of greater friction and resentment among its members.

Copyright Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



2 Responses to “Germany’s Peculiar Role in the Present Euro Fiscal Crisis”

  1. kimi says:

    “A kinder and gentler approach after the Second World War put Germany back on its feet.”
    Is the author advocating bombing greece back into the stone age, removing its industrial base while giving it credits and having occupation troops in the country and the government be made answerable to allied high commanders?

    Interesting… do we use nukes?

  2. larrygreenberg says:

    Not at all. Read the article again, and you’ll see that it is critical not of Greece but of Germany’s bullying stance in the crisis. Note is made that German officials were instrumental in promoting economic and monetary union in the first place, that it was Germany that watered down the stability and growth pact in the middle of the last decade (a point made also by Trichet), and that Germany should show greater capacity for forgiveness given its own history.