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  • NYTimes does Deutschland

    By FLOYD NORRIS

    “We need not just a currency union; we also need a so-called fiscal union, more common budget policies. And we need above all a political union. That means that we must, step by step as things go forward, give up more powers to Europe as well and allow Europe oversight possibilities.”

    — Chancellor Angela Merkel of Germany, June 2012

    Imagine for a moment that two decades ago, a newly unified Germany set out to take over the European Continent, as the previous unified Germany had tried and failed to do half a century earlier. This time it would use money, not guns, to accomplish the goal.

    There is, let me hasten to note, no evidence of any such conspiracy. But if there had been, things might have played out more or less as they have.

    What follows is a brief history of the euro. The phrases in italics, showing motive and prescience on the part of the Germans, are invented to support the conspiracy theory. But the facts have not been changed.

    Our tale begins almost 20 years ago, in the summer of 1992. Europe’s great experiment with semi-fixed exchange rates was coming under pressure largely because of the decision by the German central bank, the Bundesbank, to sharply raise interest rates. It felt a need to do that because of inflation brought on by the generous terms of German unification, which grossly overvalued the East German mark.

    Those high rates brought a flood of money coursing into Germany. The mark rose nearly 20 percent against the American dollar during the spring and summer. Since other European currencies were pegged to the mark, with only a small margin of wiggle room, they also rose, damaging countries’ ability to compete in world markets. To maintain the peg, those countries were forced to raise interest rates when their economies were already weak, worsening the domestic situations.

    Speculators concluded that the pegs could not last. Huge short sales of Italian lire and British pounds forced the governments to spend foreign exchange reserves to support their currencies.

    In September first Britain and then Italy abandoned the peg. Their currencies depreciated rapidly. In due course, others followed. The British blamed the Germans for their high interest rates. The Germans rejected that. “One-sided accusations of responsibility are beside the point,” said Germany’s chancellor, Helmut Kohl.

    The lesson of the 1992 debacle was aptly summed up by C. Fred Bergsten, the director of what later became the Peterson Institute for International Economics. “If governments try to do inconsistent things, such as maintaining an exchange rate and not having policies that back up that rate, then the exchange rates get knocked off.”

    The lesson many Europeans learned was a different one — that common currencies had to be rigid, so there was no possibility of an attack on a weak currency by speculators.

    Europe had already agreed, in the Maastricht Treaty signed early that year, to seek a course of eventual currency union, with details to be worked out later. The rules called for the countries to pursue complementary economic policies, but lacked any real enforcement mechanism. There was to be no way for a country to leave the euro zone. Once in, countries were to stay forever.

    Conceivably, Germany learned three things from the 1992 experience, and mapped out a course with those lessons in mind. First, absent fixed exchange rates, its export-oriented companies faced the risk of periodic competitive devaluations from the rest of Europe. German exports had peaked in 1990, and did not fully recover until 1994. They would not fall again for an entire year until 2010, after the credit crisis devastated world trade.

    Second, a currency union could help German exports if the euro’s value were held down by less competitive economies. Italy had been forced repeatedly to devalue the lira as rising costs made its exports too expensive. A common currency would not stop the rising costs, but it would prevent a new devaluation.

    Finally, if Germany adopted a low-interest-rate policy, and superlow rates arrived in European nations accustomed to high rates, banks could open the credit spigot and create a debt-financed boom in much of Europe. That would invite a mushrooming of imbalances. Ultimately, deeply indebted countries would face a crisis, one that they could solve only if they acquiesced to German policies and surrendered a large part of national sovereignty.

    In July 1992, the Bundesbank raised its key interest rate by 75 basis points, to 8.75 percent, perhaps sealing the fate of the lira and pound. It reversed part of that increase in September, but that was a case of too little, too late for Britain and Italy. Over the next few years, it cut the rate repeatedly. It was at 2.5 percent by the time the euro was inaugurated and the new European Central Bank took over responsibility.

    As the years went on, Germany held down its wage costs. Its exports boomed as European neighbors used borrowed money to buy German goods. German banks helped to finance housing bubbles in the periphery — usually not directly, but through loans to other banks.

    In hindsight, the critical moment in the crisis may have been when Ireland’s banks failed in early 2009. Had the Irish government taken the position that it would stand behind deposits, but that loans made to the banks would be allowed to default, German banks would have been in trouble, and probably would have needed to be bailed out by the German government.

    Instead, the Irish government chose to guarantee all the banks’ obligations — a commitment it could not afford. Ireland had been running budget surpluses, but now it needed to be bailed out. The German prescription for Ireland, as it would be for the other countries that soon got into difficulty, was austerity. Since they could not devalue their currency, countries would have to reduce wages and raise taxes. Germany categorically rejected the idea of allowing its own inflation to rise, a move that could take some of the pressure off the troubled countries.

    The last several years have been a time of repeated crises, with Germany appearing to be rigid until, at the last moment, it agrees to something to avert disaster without actually doing anything to allow the troubled countries’ economies to grow.

    The European Central Bank gave cheap loans to banks to enable them to buy their own countries’ bonds, and they did. In the process, that allowed many foreign investors, including German banks, to bail out. As depositors grew worried and withdrew money from banks in troubled countries, the European Central Bank made up the difference by lending money to national central banks — and borrowing from the Bundesbank. The effect has been to relieve the German private sector at the expense of the public sector.

    The endgame may be approaching. Troubled countries are facing an increasingly clear choice. They can stay in the euro zone, and face years of endless recession. They can abandon the euro, perhaps bringing catastrophe but giving them the freedom to devalue their new currencies. Or they can accept the German offer: Surrender sovereignty. Accept German leadership and domination of a unified Europe. Then we will bail you out.

    If Europe does not accept the offer, and the euro disintegrates, it is hard to know how it will play out. There are, by design, no rules about how the euro zone could be untangled. But after the dust settled, Germany would be among the losers. A new German mark would no doubt be much stronger than the euro is now, making life a lot harder for German exporters. That reality has led some in Europe to think that Germany is bluffing, and that it will continue to pay the bill even if it cannot get what it wants.

    That has angered Germans. “A Game of Euro Chicken” was the headline on a commentary by Jan Fleischhauer in last week’s edition of Der Spiegel, the German magazine. “For Germany, being part of the European Union has always included an element of blackmail,” he wrote. “France has been playing this card from the beginning, but now the Spanish and the Greeks have mastered the game. They’re banking on Berlin losing its nerve.”

    The Greek election on Sunday will be fascinating to watch. The leftist party led by Alexis Tsipras finished second in the inconclusive May election by offering to reject austerity and stay in the euro zone. That is an alternative not being offered by the rest of Europe. If Mr. Tsipras wins this election, there could be a showdown. But if the establishment parties recover enough support to form a government, then the play could continue, with Greece — now in its fifth year of economic decline — trying to cut spending without destroying the country. If there is again no election winner, there is no telling what will happen.

    The euro was supposed to seal European integration and prosperity and assure that never again would the Continent begin a world war. Whether or not it manages to survive, the common currency has instead fostered anger, recession and resentment. Greeks and others see in this a German conspiracy. Germans see a conspiracy to force them to pay for the continuing sins of others.

    If this flies out of control, the world economy may well be the loser, regardless of whether any of those conspiracies actually existed.

    Floyd Norris comments on finance and the economy at nytimes.com/economix.
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