Wednesday, April 24, 2013

German reunification and the birth of the euro

Otmar Issing, former ECB and Bundesbank chief economist recalls how he warned against the creation of a  currency union between Eastern and Western Germany at the time of unification. “I must confess that we were totally wrong on the political fundament. We could not imagine early February 1990 that in October, we would have a united country,” he told CNBC in Oct 2010 on the 20th anniversary of reunification:

Simon Kuper, The Financial Times columnist, recently speculated that Margaret Thatcher’s early opposition to German reunification, gave President François Mitterrand an opening to demand Chancellor Helmut Kohl’s agreement to the launch the euro. A year before in 1988, Jacques Delors of France, the European Commission president, had set up a committee of central bankers plus himself as chairman, to explore the issue of a common currency.

In an interview conducted for a journalist's PhD thesis, Germany's longest-serving postwar chancellor said that he would have lost any popular vote on the euro by an overwhelming majority.

"I knew that I could never win a referendum in Germany," he said. "We would have lost a referendum on the introduction of the euro. That's quite clear. I would have lost and by seven to three."

The Daily Telegraph said this month that the interview was conducted by Jens Peter Paul, a German journalist in 2002, the year when the Deutsche Mark was replaced by euro notes and coins, but has only been published now.

In it, Kohl describes adopting the euro as an emblem of the European project, which he said had prevented war on the continent. Born in 1930, Kohl's politics were shaped by his country's history in the 1930s and 1940s; his final years in power were focused on promoting European unity.

In the interview, he said: "If a chancellor is trying to push something through, he must be a man of power. And if he's smart, he knows when the time is ripe. In one case - - the euro - - I was like a dictator ... The euro is a synonym for Europe. Europe, for the first time, has no more war."

As for Mitterrand using the euro as a bargaining chip, a man who could be in both the Résistance and Marshall Pétain’s Vichy government at different times, knew how to play his cards.

However, Kohl, Mikhail Gorbachev, the leader of the Soviet Union and President George H. Bush, were the main players.

Kohl could have delayed the euro project but just 14 months after the rebirth of a united Germany in October 1990, the Maastricht Treaty was signed to give effect to a common currency.

Later, at a summit In Dublin in 1996, President Jacques Chirac wanted the new currency called the écu (not to be confused with ECU — the European currency unit) named after a gold coin minted in 1266 during the reign of Louis IX. However, to the Germans, it sounded like the word cow.

This paper details fraught Franco-German relations prior to the euro’s launch.

So, the French saw the euro containing German economic power but didn’t bargain that both consecutive annual budget deficits since 1974 and annual trade deficits since 2002 would weaken itself.

There was no alternative to reunification but the politics got much more attention than the economic impact. However, taking on this project and the euro was quite a lot. Again, the politics were more important than the economics when it came to the euro.

Kohl was thinking of the political benefit for his CDU party by allowing East Germans to exchange their currency for Deutsche Marks at parity but even firms in the East that could have survived during a period of adjustment, didn’t have a chance.

It’s not uncommon for contemporary politicians to be seen as dwarves compared with perceived giants of the past.

The styles of Angela Merkel, current German chancellor, and Helmut Kohl (1982-1998) are polar opposites. Even so, Kohl did not level with the German people when he was embarking on momentous journeys.

I think it is a bit facile to believe that it would have hugely mattered if Merkel was more candid with the German people  about seeking support for huge transfers to struggling economies.

In Wolfgang Schäuble, she has a powerful finance minster who has no reason to have personal loyalty (even after seizing the party leadership, she refused to nominate him for the German presidency in 2004). They appear to agree on the major issues.

The Eurozone could do with strong leadership in its four biggest members.

But for Dominique Strauss Kahn’s sexual escapades, François Hollande’s political career would have continued to have been a litany of disappointment. He did not get a ministerial job under François Mitterrand, in 1981-95 (there were 2 two-year periods where the right had the majority), nor when the Socialists ran the legislature in 1997-2002. As for Spain, an FT article said last January: “Spaniards often describe their prime minister as a typical Galician – reserved, reluctant to give a clear answer, ever keen to keep his options open. Popular lore has it that when you meet a Galician on a staircase, you never know whether he is going up or down.” Italy’s political crisis continues.

Otmar Issing, the first ECB chief economist, said in 2010 (video above) that in early 1990, he was a member of the council of economic advisers (the so-called ‘wise men’) and the group issued an open letter opposing a West-East German currency union (with parity between both currencies). Issing said all the economic risks they warned about came to pass.

Chancellor Kohl was furious and cut ties between the chancellery and the group.

Merkel is indecisive while Kohl acknowledged acting like a ‘dictator’ in pushing forward the euro project. He certainly seems to be a stubborn person and while it’s not unusual for family to be sacrificed for political ambition, it seems strange to me that a father would maintain an estrangement with his two sons for decades. In 2001, they lost their mother to suicide (she had a rare allergy to sunlight).

In the sweep of history, German reunification will be inextricably linked with the genesis of the euro.

“Reunification is not only one of the underlying causes of the euro crisis, it is also one of the reasons behind our inability to solve it,” Wolfgang Münchau, the FT columnist and a native of Germany, wrote last year. “This is exactly the tragedy of Helmut Kohl: with his great political coup of German unity, he sowed the seeds for the destruction of his greatest political dream of European unity.”
"The hasty reunification cost almost two trillion euros in transfer payments, and it was the greatest example of economic mismanagement in the history of the world. It was a record, which is only now about to be smashed by the euro-disaster. One can hardly be surprised that the (formerly West) Germans, who had to put up with the transfer payments to East Germany (and must still put up with them) want no further transfer union in Europe…Due to the costs of reunification, Germany entered the euro at an inflated exchange rate. The result was that for a whole decade German economic policies concentrated on boosting Germany’s own competitiveness against third parties instead of strengthening the economic performance of the Eurozone as a whole. And that was one of the major causes of the crisis that would come later. 
German and European unification can therefore largely not be reconciled, because they have both turned out badly economically. I believe that future historians will take a critical view of German unification and Kohl’s merits, which is the view today."

Saturday, April 06, 2013

Probability of Euro breakup in medium term is very low

I think the probability of a Euro breakup in the medium term is very low. What happens in the longer term after a decade or more, of low growth as Europe adjusts to a lower standard of living than experienced in recent decades, who knows, if we're not dead.

In the medium term, the system would likely be able to handle the departure of a small member, in particular after the July 2012 commitment by Mario Draghi, ECB president, to do "whatever it takes to preserve the euro. And believe me, it will be enough," through unlimited purchases of bonds in the secondary markets; the euro accounts for about 25% of global currency reserves and crucially, the peoples of struggling economies will not rush to re-embrace currencies that were synonymous with gouging by elites, high inflation and poverty.   

Developing economies have cut the share of euros in foreign currency reserves in 2012, reflecting a reaction to Europe’s sovereign debt crisis.

The International Monetary Fund's report on currency reserves held by countries around the world, show that developing economies offloaded some $45bn worth of euros in 2012 and have sold almost $90bn worth of euros since the second quarter of 2011.

The IMF report indicates that the recent downturn in euro holdings marks a break following more than a decade of growth among developing nations. They now hold just a quarter of their foreign currency reserves in euros, a drop from 31% in 2009 and the lowest level in a decade, according to the Financial Times. The dollar has held steady at about 60%.

China would be very reluctant to abandon the euro.

The support of almost three-quarters of Italians for retaining the euro in a post general election poll as reported by Corriere della Sera, at least shows that there is little faith in returning to the lira. Alexis Tsipras, the leader of Greece’s SYRIZA (Coalition of the Radical Left) and maybe the next Greek PM, is not advocating quitting the euro.

Italy is the big risk with gross debt of 127% of GDP (gross domestic product) -- the highest since Mussolini came to power in 1924.

Italy does have a growth crisis having grown an annual average 0.3% of GDP in 2001-2010. However, it has run primary surplus (before debt servicing costs) for many years and its budget deficit is quite small.

Crucially, household debt is under control and while interest on the debt takes 5.5% of GDP, that is half the 1990s ratio.

Italy’s GDP growth of less than 3% in 2011-2010 compares with that of France, with about the same population, by 12%. The gap perfectly reflects the difference in hourly productivity - - stationary in Italy, up by 9% in France. Italy’s disappointing performance was seen in the country as a whole, North and South alike.

In the course of a decade, Italy received foreign direct investment inflows equal to 11% of GDP, compared with 27% in France.

Italy could leave the Euro and have an exports bonanza just like the UK got from the collapse in sterling with its rounding error exports value to China?

Italy's unemployment level is as bad as it was in the mid 1990s and the youth unemployment crisis has been unchanged for 40 years.

So austerity could be ended but what happens then?

While Italy has several global brands and 70% of the workforce are in the service sector, The Economist said in 2011 that unlike Germany, it has run a current-account deficit every year since 1999 and a trade deficit since 2005. Italy may still have the world’s sixth-largest industrial base, but Britain, often portrayed as an industrial weakling, makes and exports more cars than Italy does.

So to the inconvenient truth, Italy’s destiny is mainly in its own hands. Outsiders can only have a limited impact on a dysfunctional system and the resultant stunted economy.

The rulers tend to be old and nepotism is rife in a system where family-owned businesses are significant.

The average age on taking office of Italy’s 12 prime ministers since 1990 was over 62. 

Italy has been electing clowns for decades and at last month it elected a professional clown.

“The big problem of the economy is a society that combines elements of the Indian caste system with that of the medieval guilds,” Enrico Letta, the PD’s (the centre-left Democratic Party) deputy leader told the Guardian in 2011. “Our watchword is social mobility, particularly for the young, who suffer most if people are co-opted into jobs instead of gaining them by fair competition.”

Absent the euro, at least the clowns would have only themselves to blame.

So many problems to handle: The secondary school dropout rates are about 20% in Italy, and 25% in Portugal and Spain. Spain and Portugal have cut the rates from over 30% by reducing education expenses.

Whether it is fast, slow or no adjustment in the face of challenges ahead, there are no guarantees that current European standards of living can be maintained. There are over 7m with mini-jobs in Germany that enable people to earn €400 monthly without any tax deduction. There are 120,000 Germans over 75 years of age, with mini-jobs because of inadequate pensions.

Don’t criticise the Germans because that is what is also ahead for the outsiders in Ireland.