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December 4, 1997
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1.
"European Monetary Union—The Movie" would have to begin
with the following scene. The place is the library of the Elysée
Palace, the time is about March 1990. Only three people are present: Francois
Mitterrand, the French president; Helmut Kohl, the chancellor of soon-to-be
reunited Germany; finally, since neither speaks the language of the other, a
faceless interpreter sworn to silence.
Mitterrand is in a melancholy mood. During the last few months, ever
since the collapse of the Berlin Wall in November 1989, he has tried every
conceivable diplomatic strategem to stop, or at least brake, the quickening
pace of German reunification. But to no avail. Glumly, he stares into the
fireplace, as his friend Helmut talks. "Look, Francois, this time it
won't be like Versailles in 1871, when Paris was encircled by German armies,
when the new Reich was proclaimed on the ruins of French pride. We have
Franco-German friendship, we have the European Union, our forces are
completely integrated in NATO; indeed, we don't even have our own general
staff any more."
The mention of NATO, America's foot in Europe's door, hardly cheers
Mitterrand. So Kohl goes on. "My dear friend, this is 1990—not 1914
and not 1939. These days, my countrymen are polishing their BMWs, not their
jackboots. Come on, Francois, what do you say?"
Mitterrand continues to stare into the fire for a minute that seems to
stretch on forever. Finally, he bursts out, "Bon, Helmut, c'est ce
qu'on va faire. You get all of Deutschland, if I get half of the
Deutschemark."
2.
The point of this imaginary scene is that the euro, Europe's
soon-to-be common money, is a political currency. It was born out of the
abrupt transformation of world politics: Moscow's capitulation in the cold
war, which suddenly revealed the true power relationships on the Continent. In
a few months, Germany would be "whole and free" again, as George
Bush had put it. Once united, the country would also shed the ancient
dependencies that had tied two thirds of it, the Federal Republic, to France.
But Helmut Kohl is not Wilhelm II. Like Bismarck, he understood the
precarious position of Germany about to become the most powerful country in
Europe again—at least if power is measured by the size of Germany's
population and GDP, and by its central strategic position. Like Konrad
Adenauer and Willy Brandt, Kohl knew that Germany was too weak to act alone,
but too strong for the rest of Europe to leave it alone. The lesson of the
past hundred years for him was clear. When Germany, its power untrammeled,
struck out on its own, the result was ever greater disaster. When it was
safely locked into European institutions—when its power was tamed by
cooperative arrangements with other countries—Germany flourished beyond
anyone's expectations.
Now the division of the country imposed by the cold war was about to
end, and Kohl wanted to reassure France and all of Europe. The Deutschemark,
the strongest currency on the Continent, was the very symbol of German
primacy. What better way to soften its edge than by more
integration? By way of the euro, one might say, Gulliver proposed to tie
himself down. The sentiment and the logic of self-containment were
as commendable as Kohl's intentions were historically honorable.
But Gulliver would not actually immobilize himself—that was the
elegant part of the deal. In essence, the euro would be the Deutschemark writ
large. It would be administered by a European central bank patterned after the
German Bundesbank which, in turn, was largely modeled after the American
Federal Reserve. This super-Bundesbank would be totally independent of
political control; with its mighty autonomy, it would impose strict financial
discipline on countries like France or Italy, whose central banks usually
acted as handmaidens to their profligate political masters in Paris and Rome.
So Germany would
not so much sacrifice its precious currency as it would extend its
sway beyond the informal Deutschemark zone that already encompasses Austria,
Denmark, and the Benelux countries.
To the French, invaded three times by Germany in the space of a
lifetime, the euro nonetheless offered fair compensation. The losers of the
Franco-Prussian War of 1871, the French had emerged from World War I and II
only as nominal victors. In each case, they saw their strategies for postwar
containment of Germany come to nothing. By 1922, at the time of the Rapallo
Treaty, with Soviet Russia in economic difficulty and the Anglo-Saxon powers
turning in on themselves, Weimar Germany had actually improved on the
strategic position of the Wilhelmine Reich. By 1955, West Germany, freshly
installed in NATO, was free of occupation forces and had become a junior
partner of the United States. And now, in 1990, the last constraints would
melt away. On October 3, reunification day, the Federal Republic would expand
by one half while regaining complete sovereignty. Kohl's offer to give up the
Deutschemark was a godsend for Mitterrand. And so, on they went to
Maastricht—with good instincts, but bad economics and politics.
3.
In Maastricht, a small town in the Netherlands, the twelve members of
the European Union (now fifteen) gathered in early 1992 to pledge something
history had never recorded before. They would sign away several of the largest
sovereign powers at the command of the modern nation-state. These are the
power to mint money and the power to regulate its quantity as well as its
price both at home (the interest rate) and abroad (the exchange rate).
The Maastricht Treaty contains two critical dates. At the beginning of
1999, those countries whose economies meet the standards set at
Maastricht—the fabled "criteria"—will yield their monetary
sovereignty to a European Central Bank, which is to manage both the money
supply and interest rates of all the European countries taking part, with
national currencies irrevocably chained to one another. For the next three
years, the euro and the various national currencies will exist side by side.
But on January 1, 2002, marks, guilders, francs, etc., will vanish. There will
only be euros and cents.
Such a brief summary of the Maastricht Treaty hardly suggests the
enormity of the task ahead. Before national currencies can become e
pluribus unum they must be brought into line. To conceive of what that
will involve, we can visualize several locomotives, each running under its own
power, strung together to make up a single train. Each engine must steam ahead
at the same speed in the same direction at the same time. All currencies must
behave as one, with no fluctuations among them and hence with virtually
identical interest and inflation rates—as if there were only one lead
locomotive that pulls all the others with their engines switched off. If there
is no strict coordination, the locomotives will run into one another and go
off the rails, or the couplings linking them will break. In the real world,
the required degree of coordination is called "political union" or
"federation"—something like the United States.
Had Messrs. Kohl and Mitterrand made this logic explicit, the euro
would have died right after it was conceived. Frenchmen and Germans don't want
to be like the citizens of Michigan and New York; nor do Italians, Spaniards,
or Britons. They like Europe, but they like even better their national
homelands, which have been around for one or two millennia. They don't speak
each other's languages; they do not share each other's memories.
So the would-be members of the euro club are not like railroad cars
just coasting along or waiting pas-sively in the Brussels switching yard. Each
has its own "engineer"—its government whose politicians face
re-election. Each has its own "engine"—its macroeconomic policy
that determines spending and taxing, debt and interest. Each follows its own
"time-table"—i.e., it is situated at different points in the
business cycle.1 And none can ignore its
own history and the basic national assumptions and habits that define the
unwritten social contract by which the state gives to, and takes from, its
citizens. By comparison with France's, only a small part of the British
economy is state-based or state-controlled; Germany's falls somewhere in
between.
Compare this to the United States. Michigan and New York don't conduct
macroeconomic policy; their money, like that of every other state, is managed
nationally by the Federal Reserve. Lansing and Albany have limited powers to
tax and spend, but the country's fiscal policy is decided in Washington, by
the US Congress and by the executive branch. France, Germany, and other
members of the European Union are not and will not be like any of the fifty
American states. They are sovereign entities, with national parliaments and
executives, and the large countries like Britain, Spain, and Italy have
proportionally far more effect on the European economy than the economy of
California does on the economy of the US.
How can they be kept on the same track? This is where the famous
"criteria" of the Maastricht regime come in—the gates to the
inner sanctum of monetary union. In essence, the criteria demand of each
would-be member that it stop behaving like a sovereign state. In order to
qualify for euro membership, their annual budget deficits must not exceed 3
percent of GDP. Accumulated public debt must stay within 60 percent of GDP.
Long-term interest rates must be lower than 10 percent, and the inflation rate
must be lower than 3 percent. In short, though each state, like a locomotive,
still obeys its own driver, engine, and timetable, it has to act as if it were
Michigan or New York. It has to forget virtually everything that turned
fiefdoms, duchies, and city-states into modern nation-states between the
fourteenth and the nineteenth century: first the king's, and later the
parliament's, supremacy over public finance.
At this point, only Luxembourg qualifies on all counts, if the
criteria are applied rigorously. By next May, the European Union must decide
who else makes the cut on the basis of the 1997 figures. "Eurostat,"
the statistical research branch of the European Commission in Brussels, has
just announced that, except for Greece, all the members of the European Union
are likely to squeeze by.2 How will they do so? By
creative bookkeeping, if not outright cheating.
4.
Take Germany, once the fiscal disciplinarian of Europe. Without some
imaginative maneuvers, its annual budget deficit would be closer to 4 than 3
percent of GDP at the end of the year; and its total debt, rising of course,
has passed the 60 percent limit. How, then, will Germany fulfill the criteria?
Deutsche Telekom, the state-owned telephone service, is being sold off on the
stock market. So is Lufthansa. The receipts will look good on the nation's
books by the end of the year. Also Theo Waigel, the finance minister, has
conveniently discovered that the gold held by the Bundesbank—the German
version of the Federal Reserve—has been badly undervalued for many years.
Revalue it to reflect the market price for gold, shunt the paper profits into
the federal till, and the deficit shrinks some more.
The Italians, whose country, next to Greece, has the largest deficits,
are desperate to be founding members of the euro club, and so they are
prettying up the books all'italiana, while trying to impose
austerity measures on the economy. This led to a bit of political commedia
dell'arte in October. Assaulted by the Communists on grounds of excessive
social cruelty, the Prodi government fell—only to be resurrected
forty-eight hours later. This does not bode well for a sustained
budget-cutting policy past the magic date in May, when the EU must decide on
admission to the euro club.
First prize for creative accounting must go to the French, though.
There is no way that the defiant Socialist government of Lionel Jospin, which
took power from the Chirac
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1 A recent report
by the British treasury made this point in warning of the dangers posed by the
euro to the British economy. As the London Observer reported on October 19:
The Treasury review underlines that
the British economy is seriously out of line with continental economies, with
Britain's recovery years more advanced. Treasury officials have warned that
cutting British interest rates to continental rates—appropriate for
countries where economic conditions are more depressed—could detonate a
runaway boom, with inflationary pressures that could not be responded to by
devaluation.
In view of such advice, we can understand the government's
position that any decision on the euro must be delayed until after the next
election. (back)
2 Eurostat is not
a totally independent body. Attached to the European Commission, it assembles
and evaluates economic and budgetary data given to it by each national
government. For a sober analysis of Eurostat's operations and the bookkeeping
tricks of EU governments, see Andreas Oldag, "Schlüssel zur
Währungsunion liegt bei Eurostat" (The Key to Monetary Union Rests
with Eurostat) and "EU-Mitgliedstaaten entwickeln immer neue Ideen, um
ihre Haushaltsdaten zu schönen" (EU Member States Come Up with Ever
New Ideas on How to Prettify Their Budget Data), Süddeutsche
Zeitung, October 25-26, 1997, p. 2. (back)
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coalition earlier this year with promises of 350,000 public jobs, can
bring about a budget deficit as low as 3 percent of GDP. But the French have
told the Germans they have found a brilliant solution. They will simply
withhold tax refunds for a while, thus "proving" that France, when
the 1997 figures are tallied, is marching straight toward the 3 percent
deficit target.
Why the obsession with meeting criteria which are more or less
arbitrary anyway? Theoretically, the European governments and central bankers
could have set the deficit-to-GDP standard at 5 rather than 3 percent, and the
public debt-to-GDP ration at 80 or 100 rather than 60 percent. But the exact
limits are not the critical issue. The real point, to recall the railroad
metaphor, is simultaneity, with everybody moving at the same speed in the same
direction.
Unless they do, the couplings break. This is exactly what happened in
1992 when George Soros, betting on the Deutschemark, sold billions of pounds
sterling on the international market, forcing Britain to devalue the pound and
leave the European Exchange Rate Mechanism (ERM). This was the system set up
in 1979 to preserve rough parity among European currencies—a forerunner
of the euro. Italy followed and devalued, too. So did Spain, Portugal, and
Sweden. This episode may now seem past history, but its lesson is still valid.
Nations may pledge the kind of fiscal and monetary probity that keeps exchange
rates in lockstep. But then governments look at their unemployment rates and
think of their coming elections. They then choose economic policies—a bit
of easy money there, a few more public works there—that strain, and then
break, international monetary agreements.
The history of the ERM nicely illustrates the skeptic's worries about
the euro. It worked as long as the dictatorship of virtue was regularly
relieved by an occasional brush with sin. Until 1987, there were many
realignments of the different currencies, on the average once every eighteen
months. Everybody could stay on the wagon precisely because he could take an
occasional swig from the bottle. But after 1987, currencies became fixed, to
be defended at all costs and against all comers. Hence, the pressures derived
from incompatible economic policies began to build up, exploding five years
later with Britain's withdrawal in 1992. Thereafter, realism was given its
due: exchange rates, previously within a range of 4.5 percent, were allowed a
leeway of 30 percent, which is another word for "floating currency."
Today, life on the wagon has become a bit easier, above all because
inflation and interest rates have been dropping throughout Europe, even among
famously improvident states like Italy. Advocates of the euro have been citing
this cheerful news as proof that Maastricht is working. Alas, this may be like
that famous correlation that links the decline of the stork population to the
receding birth rate, both of which happen to be the case in postwar Europe.
The fact is that inflation has been falling throughout the entire Western
world since the early 1990s. If Maastricht had acted as such an effective
taskmaster, why did inflation also ebb in the US and in Britain, countries
that were not clamoring to get into the euro club?
5.
By next May, most of the European countries, prodded by France and
Germany, will most likely certify themselves ready for the euro. They will
look at the dressed-up numbers, wink and nod; in the case of countries where
even the most creative accountant could not hide the gaps between rule and
reality, the others may agree to be charitable and say that since they are
trying so hard they can join anyway.
What then? Traditionally, states have used the exchange rate as a
major cushion against external shocks, and they have manipulated the money
supply, the interest rate, taxes, and spending for the sake of stability and
growth at home. But in 1999, the
exchange rate, as an instrument of national policy, will have gone the
way of the halberd. Monetary policy will be set by the European Central Bank.
And fiscal policy, including taxes and spending, though legally still in the
hands of states, will be severely constrained by the demands of the
"stability pact" that the Germans have insisted other members of the
European Union must sign. Essentially, the pact says that the Maastricht
criteria must rule forever. Or as some French politicians suspect, it will be
the Bundesbank-writ-large that will rule, plus a softer version of the US
balanced-budget amendment. (This is why the French above all have been pushing
for an Economic Council that would set macroeconomic policy for the euro zone
and thus counteract or dilute the stringent monetary policies of the European
Central Bank.)
The resulting loss of autonomy is an economist's nightmare. Individual
governments in the euro zone will no longer be able to do what they have done
since the invention of the printing press. They will no longer be able to
increase the money supply to drive down interest rates and stimulate
investment. They will no longer be able to devalue their currency so their
exports will grow. If they are obedient to the stability pact, they will have
a very limited ability to increase aggregate demand through deficit spending.
With national monetary policy determined supranationally, and fiscal policy
heavily limited, a national economy is left with three, and only three, ways
out of trouble. And each of them spells more trouble.
To take a simplified example, let us assume that there is stubborn and
growing unemployment in the northeast of France, a traditional industrial
region. There are only three solutions to the problem. One: wages fall,
attracting new investment and generating new employment. But wages do not fall
in Europe, and least of all in France. National or industrywide collective
bargaining agreements inhibit payment of different wage rates in different
regions. In the United States, the Carolinas or Alabama, with wages lower than
California's or Connecticut's, may lure capital investment from inside and
outside the country. European capital in search of profits migrates to the
Czech Republic, if not China.
The second solution is geographical mobility. If capital does not come
to the workers, they go to where the jobs are. In the early 1970s, Sunday
papers from Houston and Dallas sold well in depressed Detroit, where the Big
Three auto makers were being done in by foreign competition. Unemployed auto
workers would scan the want ads and then pack up their families to move to
Texas towns that were then booming. Some of the workers by now have moved back
to Michigan, which is again in strong economic shape.
By comparison, Europeans do not move. Theoretically, Lille's
unemployed could migrate to high-growth regions like southern England or
Munich. But unlike relatively poor Turks or Serbs, they don't. First of all, a
lavish welfare state, plus large benefits for shrinking industries (steel or
agriculture), allow people to stay in places from which the jobs have
departed. Second, if they did want to move, they would face
intimidating cultural barriers, above all a new language, unlike Detroit
workers in Texas. Third, although Germans have used Turks for menial labor,
much as the French have used North Africans, Europeans are less and less
willing to accept "cheap foreign labor" that can do more skilled
work. Construction workers' unions in high-wage Germany have been fighting
hard against Polish migrants. They would not welcome migrants from Lille
either.
Which leaves the third, and most troublesome solution: transfer
payments on a Europe-wide scale. In the absence of wage and labor flexibility,
this has been for decades the favorite European economic strategy for dealing
with unproductive regions. The rich Italian North subsidizes the
mezzogiorno, the agrarian South. Prosperous Bavaria pays large
subsidies to Bremen, a Social Democrat-ruled city-state on the North Sea,
which has been keeping shipyards alive against all economic reason. Indeed,
Western Germany has annually been plowing the equivalent of the entire
Marshall Plan—which gave aid to fifteen
countries for three years—into Eastern Germany, a region of 15
million people, since reunification.
Bavaria pays grudgingly for Bremen, but it pays. Lombardy supports the
Italian South, but resentfully so; indeed, the secessionist Lega Nord has been
demanding partition for years. Now imagine that Germany and Italy have to
shell out billions to help their less fortunate brethren in Euro-Land. What
is, and will be, lacking is the kind of common identity that justifies
expenditures, often rather grudging ones, on behalf of poor regions or groups.
"Europe" is a construct, not a country. Though it has a flag
(fifteen golden stars on deep blue), it does not evoke the kind of loyalty the
Stars and Stripes evokes among Americans. The European Union is not—and
will not be for a long time—a community of identity and obligation. And
money, as a German saying cautions, is where friendship stops.
6.
The larger point is that Europe, by plunging into monetary union, is
putting last things first. It is erecting a vast structure without having
prepared the indispensable foundation, a common state. One might think that so
sweeping a sacrifice of sovereignty would require a "general will,"
expressed in an institution that transcends the feeble European Parliament in
Strasbourg and the rudimentary apparatus of governance in Brussels. Power in
the EU is still lodged in the Council of Ministers representing the fifteen
member states, not Europe. History confirms such a somber assessment. Bismarck
had to force twenty-five little Germanies to accept the Reich before the new
state could move on to a national market and currency. It took the United
States from 1788 to 1913, from the approval of the Constitution to the
founding of the Federal Reserve Board, before it established a central bank
and true monetary union (with a murderous civil war in between).
Political union must precede monetary union—that is what
historical experience keeps stressing. Nor is monetary union a kind of furtive
shortcut to political union, as Europe's federalists might presume. Money, in
fact, does not bind what pulls apart. The first thing secessionist states do
is to print their own tender—as the American Confederacy did in 1861, as
Slovakia did in 1993. Money, as every unhappy family knows, is a prime cause
of discord and divorce.
Still, the euro will spawn powerful benefits. Big business, even in
Britain, loves it because it will do away with costly hedging operations to
insure against currency fluctuations. It will make the mechanics of
international payments easier and sweep away the exchange-rate risks of
long-term investments. Europe's exporters also surmise that the euro will be
"softer" than, say, the mark, franc, or pound, and thus give them a
competitive edge over exports that must be paid for in dollars and yen.
Europe's large banks and insurance companies can hardly wait for the euro.
They see a vast market awaiting them in which every bond, stock, and insurance
policy will be denominated in a single currency. That will bulldoze barriers
of habit and tradition and deliver a continent-sized playing field for the
best and biggest financial institutions in Europe. Corporate capitalism
salivates over the euro, and for good reason.
But the citizens of France and Germany do not do so, if we are to
believe the opinion polls—at least the polls not conducted by the
European Commission, which likes to produce good news for its masters. In
those countries whose economies have the most valid chance of meeting the
criteria next May, opposition to the euro or desire for a delay unites up to
two thirds of the populace. And fondness for the euro tends to grow with the
distance from the Maastricht criteria, most dramatically in Italy.
Kohl, Chirac, and their colleagues are thus plunging head-on into a
current of popular distaste against the euro. They have been able to brave the
resistance to the plan
because only very few politicians, whether on the center left or
center right, have dared to seek votes by turning against it. To oppose the
euro is to oppose Europe—the equivalent of motherhood. On the Continent,
at least, nobody of stature and ambition wants to be seen in the company of
the main opposition to Maastricht—whether the neo-right, like Germany's
Republikaners, or the paleo-left, like the French Communists. That has
deadened the debate, leaving behind a mood of sullen passivity fed by hopes
for postponement.
7.
A lengthy trial run of, say, three or five years of strict observance
of the rules of economic convergence would be a wiser course than adopting the
euro now. For it might or might not prove what the euro enthusiasts merely
assume: that nations, though they remain nations, will act as if they were
not. To repeat the cruel textbook truth, they must remain in tandem not just
in the period before the deadline, but forever more. They must stop acting
like sovereign states in matters monetary and economic.
By next May, when the cut is to be made, the euro-aspirants will have
proven only one thing: that they are capable of making a desperate dash for
the 3 percent deficit line. But in order to cut the deficit, they have sold
off public assets instead of reducing government expenditures. These are
one-time solutions that do not change the underlying dynamics of fiscal
policy. And since the states act as their own referees, they have been able to
fudge the numbers quite nicely.
True, inflation has dropped throughout Europe, and medium-term
interest rates are converging. But there is less progress than meets the eye.
Inflation rates, as was noted before, are down in the entire West, reflecting
a mildly deflationary world economy rather than the fiscal virtue of the euro
candidates. Italians today dwell proudly on the fact that the yield spread
between Italian and German government bonds, about six percentage points just
two years ago, has come down to less than two. But Italy's plummeting rates do
not prove that the Italians have really changed their ways, and that goes,
mutatis mutandis, for the others, too. Money traders have simply
concluded that, for political reasons, France and Germany will have to take in
Italy, a founding member of the old European Economic Community, no matter
what. They are happily buying lire bonds (which drives down Italian rates)
because they no longer need to fear yesterday's devaluation risks. And why
not? In 1999, these bonds can simply be converted into euros or Deutschemarks
at predictably fixed rates.
In short, the EU countries have not proven that they can sustain
convergence over the long run. Long-term discipline was precisely the test set
up more than five years ago. But Europe cannot be said to have met it. Hence
the wisdom of postponing the plunge for three or five years. During such a
period, the candidates could confound the skeptics by actually doing what they
should have been doing since 1992. They would live up to the logic of monetary
union by scrupulously sticking to parallel macroeconomic and monetary policies
as opposed to merely selling off the family silver and cooking the books.
By definition, inflation and interest rates would then remain in
lockstep, and so would exchange rates. This would be de facto monetary union,
though with national currencies still in circulation. At the end of the
"trial marriage," real monetary union would be a mere formality, or,
to return to the train metaphor, visible proof that everybody had maintained
the same speed and direction not just in the run-up but over the long haul.
In so submitting to a general will, each of the European nation-states
would prove that it is indeed ready for self-transcendence. But the European
nation-state is still vigorously alive—that is the problem. Nor do Kohl
and Chirac even contemplate yielding their power to a European president
lodged in Brussels. And their citizens, who do not really understand the
enormous loss of sovereignty the euro entails, still want to be ruled
from Paris and Berlin, and not from Brussels. But who is going to read
through the 250 pages of the Maastricht Treaty, which flummox even trained
lawyers?
Never in the history of democracy have so few debated so little about
so momentous a transformation in the lives of men and nations. And so the
train will probably leave the station on time, on January 1, 1999, but with
screeching wheels and shaky couplings. If it goes off the rails, as economics
and politics suggest it will, the consequences may contaminate much of what
Europe has achieved during the past forty years.
—November
6, 1997
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