Bundesbank President Tietmeyer once said to his British counterpart, “You have the House of Lords, the Queen and your established traditions – we have the Bundesbank.”
Forty years ago Robert Mundell enumerated the key conditions defining an ‘Optimal Currency Area’, an area within which the benefits of a common currency outweigh the costs of losing the exchange rate as a policy tool. At that time Europe did not pass the test so those who were promoting a single currency went about making it more of an optimal currency by removing barriers to capital and labor mobility and undertaking economic reforms to improve competition and price flexibility. But the impetus for a common currency for Europe – for the Euro – was not fundamentally economic. As David Marsh has entertainingly documented in ‘The Euro – The Politics of the New Global Currency’ it was primarily political.
After three major wars in 75 years, the French and Germans were each keen to find mechanisms for preserving their respective national aspirations without debilitating wars. In a famous speech by François Mitterrand before the German Bundestag in January 1983, the French President declared that Franco-German friendship was the key to overcoming the pain of past wars and breaking the cycle of “transitory victories…condemning the victor to build on blood, and the vanquished to dream of revenge.” Five years later Mitterrand declared that “The Germans are a great people deprived of certain attributes of sovereignty, with reduced diplomatic status. Germany compensates for this weakness with its economic power. The Deutsche Mark is to some extent its nuclear force2.” The French offered the demilitarised and occupied Germans the protection of its diplomatic and military clout in exchange for the stability of the German mark under European rather than German control and keeping Germany tied to the West. But the motives for a European Union and the Euro were complex and filled with conflicting currents.
The primary players, of course, were Germany, France and the UK and from a distance Russia. All wished to protect and promote their respective national interests peacefully and all saw a balance of power among them as an essential element of a peaceful relationship. German leaders wished to promote their economic prowess while taming their own history through close political ties with the rest of Europe. France wish to balance German influence with its own – to ride on the strength of the German mark while at the same time softening German control of its behaviour. As former French Prime Minister Valery Giscard d’Estaing put it: “We need an organised Europe to escape German domination.”
Ever present in the background was the strong German desire to reunite its Eastern and Western parts, the possibility of which produced considerable anxiety among other European countries. Initially the concern was that German desire for reunion and Gorbachev’s overtures might tempt Germany into neutrality between East and West as a price it might be willing to pay. “The Germans might be tempted to leave NATO and adopt a position of equidistance between the American and Soviet-led military alliances4.” With the fall of the Berlin wall and the collapse of the Soviet empire, Germany’s reunion occurred on much more favourable terms giving rise to Western concerns over Germany’s prospective strength.
Marsh’s account of the political issues and manoeuvring is fascinating. He provides interesting background on the main players, mainly French and German leaders and the Governors of their central banks. He recounts with considerable detail the fierce battles between the Central Bank Council of the Bundesbank and successive German Chancellors that ultimately established and entrenched the German central bank’s independence and reputation and made the German mark into Germany’s ‘nuclear weapon’, and the monetary anchor of the rest of Europe.
Having given up the gold standard the French especially were eager to lock the exchange rates of European currencies together as they had been with the gold standard. The German mark was the symbol of strength and stability, so fixing European currencies together meant fixing them to the mark. The French were also eager to reduce ‘the importance of the dollar in world reserves by establishing a European reserve currency’.
The Bundesbank was firmly committed to domestic price stability, which meant floating the mark against the US dollar. Under the arrangements of the 1970 through 1990s (exchange rate tunnel, snake within the tunnel, ERM) fixing European currencies to each other meant fixing them to the German mark and the independent and independent minded Bundesbank kept the mark where needed for domestic German price stability without much regard for the impact on the French franc or other European currencies, the same complaint made about the US dollar. Thus if the franc or some other European currency was under attack in exchange markets, Germany expected France to adjust (tighten its own monetary policy or devalue) while France wanted Germany to share in the adjustment (ease policy or appreciate within the ERM). If France and Europe wished stability with Germany, they had to float against the dollar at the direction of Germany. This tension was at the root of much of the policy debate during this period and France’s strong desire for a voice in ‘Germany’s’ monetary policy.
The sequencing of monetary union and political union also divided many German and French thinkers. Many Germans argued that political and economic union needed to precede monetary union (proposing various economic convergence criteria), while most French thought the reverse.
The dealing and double dealing surrounding the rapid acceleration toward German reunification following the fall of the Berlin wall reads like a thriller. Margaret Thatcher attempted to prevent it; Mitterrand used it to push EMU (monetary union) ahead. Kohl wasn’t sure whether to slow down or speed up the process. In September 1989 Mitterrand told Thatcher that “Without a common currency, we are all of us – you and we – already subordinate to the Germans’ will. If they increase their interest rates, we are obliged to follow suit, and you do the same thing – even though you are not in the monetary system! So the only way of having the right to speak is to establish a European Central Bank, where one will take decisions jointly.”
French Prime Minister Michel Rocard explained that: “There was a balance between unification of Germany and the establishment of European monetary union. Both processes accelerated after the fall of the Berlin Wall. Kohl and Mitterrand were already engaged in both efforts. Mitterrand had to accept reunification more quickly than he thought likely, in the same way that Kohl had to accept monetary union more quickly then he had intended (against the strong misgivings of the Bundesbank and the German public). Kohl’s advisor Joachim Bitterlich … warned [Kohl] that by accepting liberalisation of capital controls and the Bundesbank’s primacy over EMU, and in view of lingering French bitterness over Germany’s rejection of a European withholding tax, France believed it had already made abundant concessions to win a monetary deal7.” Germany’s disastrous redemption of East German marks for the mighty DM at the rate of one for one almost derailed the entire arrangement as high interest rates in Germany drew in European capital to finance Germany’s mistake creating great distress for other European currencies.
Repeated speculative attacks on French and other exchange rates (the British having been taken out of play early in the game), the exchange rate realignments, and battles over the Bundesbank’s interest rate policy (the only one that mattered) during this period (early 1990s) dominated politics in Europe. Governments and currencies fell. French and German confrontations were reminiscent of earlier wars sans bullets, making many nostalgic for the relatively simpler struggles to coordinate macro policies under the more limited options available under the gold and gold exchange standards (the Bretton Woods system) of earlier years. Marsh’s interviews with the key players are fascinating, but often at the expense of a clear picture of European wide financial developments. After widening the mandatory intervention bands for the Exchange Rate Mechanism to 15% on either side, rendering the ERM almost empty, speculative attacks stopped and efforts toward a single currency redoubled.
The Euro replaced the national currencies of participants in EMU on 1 January, 2002. The design of the European System of Central Banks and the independent European Central Bank that oversees it represented a complete victory for the Bundesbank, even to the extent of locating it in Frankfurt. Prior to the Euro’s introduction all member national central bank laws were amended to make them independent, another French concession. Marsh’s engrossing recounting of the process and battles leading to this amazing accomplishment will mildly disappoint those wishing to understand better the economic issues at stake but will richly reward and entertain those interested in the political history of these amazing events.
End Notes:
David Marsh, page 182
Op Cit. page 93
Op Cit. page 69
Op Cit. page 114
Op Cit. page 79
Op Cit. page 135
- Op Cit. page 137