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How keeping down the D-Mark remains Germany’s key principle

How keeping down the D-Mark remains Germany’s key principle

As Ireland seeks emergency funding, home truths in a Hamburg hostelry 30 years ago reverberate still today

by David Marsh

Mon 15 Nov 2010

”The key principle of German economic policy was to persuade the French and Italians to lower the value of the D-Mark so as to make Germany more competitive.” As the euro area enters a new period of anguish, caused by a gut-wrenching rise in Irish bond yields, these words from more than three decades back should rightly be haunting the treasuries and central banks of myriad European nations.

The schism in the euro area between creditor and debtor countries entered a new phase last week with a war of words pitting Angela Merkel, the German chancellor, against representatives of the smaller debt-laden states that now have their backs against the wall. Germany is apparently paying little heed to the fact that monetary union has been massively helpful to the German economy by underpinning a sizable boost to export competitiveness in the last decade.

The evocative end-1970s message on the D-Mark was communicated to Denis Healey, Chancellor of the Exchequer in the British Labour government, by Manfred Lahnstein, a senior official in the German government charged with negotiating the start-up of European Monetary System (EMS) – the semi-fixed exchange rate scheme that eventually led to economic and monetary union (EMU) and the euro.

Lahnstein’s words to Healey – over a glass of beer in Hamburg in 1977 or 1978 – were passed on to Jim Callaghan, then Labour prime minister. The UK leader reasoned that the EMS would harm British exports by keeping the pound unduly high on the foreign exchanges. This sealed the British government’s decision to keep sterling out of the exchange rate mechanism (ERM) of the EMS when it started in early 1979. (Bizarrely, the UK did join 11 years later in 1990, shortly after German unification. This was an experience that shackled the pound at too high a rate against the D-Mark before the UK left in ignominy in September 1992. The episode has been responsible for turning the UK for at least a generation – and probably for much longer - against membership of any kind of fixed currency scheme with the other Europeans.)

Last week, meanwhile, saw fresh signs that Ireland’s record cost of borrowing is having a wider impact on debt markets across the euro area. The bond markets for peripheral countries are at depressed levels indicating that many market participants expect debt defaults or restructuring in Greece, Ireland and Portugal. Expectations are growing that Dublin and Lisbon will have to follow Athens in seeking a European Union rescue. These expectations hardened over the weekend with indications that the Irish government has started preliminary technical conversations with European officials about drawing on the €440bn European Financial Stability Facility agreed in May. That shouldn’t be a surprise; in fact the surprise is that Ireland – where the Government is still denying any intent to seek emergency funding – is taking so long to make up its mind on applying for EFSF money.

Chancellor Merkel meanwhile reaffirmed that the cost of any future Greek-style bail-outs will have to be borne more heavily by private investors. “Let me put it quite simply: in this regard there may be a contradiction between the interests of the financial world and the interests of the political world,” Ms Merkel said. “We cannot keep constantly explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people who have earned a lot of money from taking those risks.”

Her government’s adamant stand caused an unusual public spat with Jean-Claude Trichet, president of the European Central Bank. At the end of October, he said involving private sector creditors in any future write-downs would unsettle existing bond market investors – a prediction that proved only too true, as the sell-off of the past fortnight has underlined.

The finance ministers of the European Union’s five largest economies on Friday tried to calm markets by stating that any plans to force private debt holders to bear the burden of future sovereign bailouts will not affect current euro debt holders. However the weaker countries are certainly pinning the blame for the present malaise on the German government’s move three weeks ago to re-open negotiations on European treaties and broach the issue of private sector sacrifices in future debt restructuring.

The Berlin government’s intransigence over the debt issue, while politically understandable from a German point of view, seemingly pays little note of the realities of the euro economy which are currently heavily tilted towards Germany. In pre-EMU days, if the German economy were growing at an estimated 3.7% as it is this year, the German currency and interest rates would both come under upward pressure – damping exporters’ performance and the growth outlook.

Now, however, with all EMU economies shackled together, and devaluation an impossibility for the peripheral countries, the hard-up states have nowhere to hide. Germany continues to profit from excellent export performance – and it can self-righteously point the finger of blame for the euro area’s woes at those debt-ridden peripheral states. That glass of beer shared by Healey and Lahnstein in a Hamburg hostelry more than 30 years ago provided the opportunity for Germany to pass on to the British some unpalatable home truths. Other countries in Europe may be wishing that they had received a similar message before they entered the euro.

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