Northern, WI 5/2/12 (StreetBeat) -- When it comes to Europe and currencies it seems that it is always the same story, retold over time with just minor variations. Importantly, the central conflict of the narrative is a constant and, no matter how often the story is told, it remains unresolved. But in order for a happy ending to occur there needs to be a resolution of the central conflict; the German problem must be answered.It is not that Germany is a problem per se, but it is just that the country is ill suited to play appropriately with its neighbors in regards to currencies in the post Bretton Woods era. Bringing Germany into harmony with the rest of the continent has been the underlying theme of European union efforts since the inception of the Coal and Steel Community sixty-one years ago. In the big picture great progress has been made, but in the realm of foreign exchange the same stumbling block recurs.
In the early seventies the Bretton Woods currency regime, the post war dollar based fixed exchange rate system, came to an end. Although it had been crumbling for a few years the final collapse is often cited as March 19, 1973 when West Germany decided to float the value of the Deutsche Mark (DM). Among the reasons for doing this was the desire of Germany to “pursue the domestic goal of price stability,” says former Bundesbank economist Otmar Issing. German concern about inflation demanded that monetary policy stiffen and their currency appreciate correspondingly, as it had been freed up to do. In a speech from a couple of years ago Issing explained that this was a problem for some, “The decision of Germany to let the DM float against the US dollar had met strong resistance before because the European partners had very different views on fundamental exchange rate issues. However, the intention to preserve a zone of exchange rate stability between these countries ran into severe difficulties. Finally, following a Franco-German initiative the European Council in December 1978 concluded the agreement establishing the European Monetary System (EMS) which came into effect on 13 March 1979.” So the currencies in the EMS were all tethered into an exchange rate band. The problem with such a system is that a 1) steady or fixed exchange rate is difficult to maintain when 2) capital can freely flow across borders and 3) monetary policy in each country is conducted with domestic goals in mind. These three objectives, known in certain circles as the “uneasy triangle”, don’t always work in concert with one another, as Issing said in his speech, “According to the logic of the impossible trinity or uneasy triangle, adapting a system of fixed exchange rates had unavoidable consequences for the conduct of monetary policy. In contrast to what others had in mind it soon became apparent that the EMS was a system founded on the strongest currency. In short: it was a DM bloc. Member countries that were unable or unwilling to join the disinflationary monetary policy of the Bundesbank were forced into repeated devaluation. Under this system, there was no other alternative than to align monetary policy with the Bundesbank or to devalue from time to time one’s own currency.” Germany, or more specifically the Bundesbank, was dominant in its philosophy and practice of economic and monetary policy. So it was eventually decided that the difficulty of squaring the “uneasy triangle” could be avoided if and only if there was monetary union, says Issing. A common currency would also side step the politically unacceptable consequences of one country dominating the rest of the currency group in the same way that Germany and the Bundesbank did during the era of the EMS. At least that was the theory.
But again Germany is dominant, or at least attempting to be. “At the heart of the euro system problem now is that most of the rest of the countries are no longer competitive with Germany. They are running large current account deficits, and the existence of the euro means they cannot devalue their currencies to make their exports cheaper and their companies more competitive,” wrote the New York Times recently. “With no currency adjustment possible, a German central banker, Andreas Dombret, explained this week in a speech in Berlin, ‘other things must therefore give instead: prices, wages, employment and output.’ The question now, said Dr. Dombret, a member of the executive board of the Bundesbank, ‘is which countries have to shoulder the adjustment burden.’ Dr. Dombret’s answer is blunt: not Germany.”
Although it can be said that all concerned have made extraordinary attempts to find a middle ground through austerity on the one hand and bailouts on the other, a cul de sac may have been entered. Anti austerity sentiment is on the rise and so too are calls for policies aimed at stimulating growth: French Presidential candidate Hollande is counting on it. But Germany, the Bundesbank anyway, is pushing back. Jens Weidmann, the president of the German central bank insists that “national sovereignty” must be sacrificed if the Euro Zone’s fiscal goals are to be met. Hollande would just as soon renegotiate, and he has company. In another time France and others would simply devalue their currency against the DM, but today they must find a way to coexist with German vigilance, and vice versa.
And that is the recurring stumbling block. Germany insists, while others resist. “As for Europe, a monetary union cannot survive without a political union, as the Bundesbank has said time without number. But there will not be a political union cohesive enough for everyone to put ‘Union’ interests above national interests.” Oh, that observation was made seventeen years ago in Bernard Connolly’s book “The Rotten Heart of Europe”.
The problem recurs.
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