Kicking and screaming into 1999

The Socialist victory in France and the German government’s row with its central bank raise the same question: will Europe’s planned single currency start on the due date of January 1st 1999? The answer is still probably yes—but it could have a blighted infancy
TWO gambles on either side of the Rhine have gone badly wrong. The more prominent was the decision by Jacques Chirac, the French president, to advance France’s parliamentary election from next March. Ostensibly this was to get the election over before next spring, when participation in the euro will be determined. More likely, Mr Chirac hoped that a renewed right-wing majority would be strong enough to push through further painful spending cuts or tax increases. These are needed to keep France’s budget deficit for 1997 below the 3% ceiling set by the Maastricht treaty.

Whatever the reasoning, the decision backfired with the election of a Socialist government—and, worse, one that will include members of a Communist Party vehemently opposed to the single currency. True, the euro barely surfaced as an election issue and the Socialists claim to support it. But Lionel Jospin, the new prime minister, repeatedly declared during the campaign that he would not impose further austerity measures to meet the Maastricht targets. He also set four new conditions for backing the single currency: there should be an “economic government” to watch over the supposedly-independent European Central Bank; there should be a growth pact to stimulate employment; the euro should not be overvalued against the dollar; and Italy and Spain must be in the first wave. Mr Jospin, it might seem, believes six impossible things before breakfast.

Since the election, he has said he wants to stick to the Maastricht timetable, mindful that under France’s practice of cohabitation foreign policy is shared with the president (though whether EMU is a foreign or a domestic matter is unclear). What seems certain is that the Socialists’ leader can be expected to try to implement his conditions. He has also suggested that the “stability pact” agreed upon in December should be renegotiated. The stability pact aims to constrain participants’ budget deficits after EMU begins to under 3% of GDP, on pain of swingeing fines for defaulters. The two regulations giving effect to the pact still have to be adopted formally—and the more significant of them requires unanimous support from member governments.

Meanwhile, in Germany, a gamble on the euro has also blown up in the government’s face, though for different reasons. There Helmut Kohl, the chancellor, and Theo Waigel, his finance minister, have been forced to back down in a public row with the Bundesbank, the central bank, over a revaluation of the country’s gold reserves—and, by extension, over how to achieve a stable euro. Since the project was launched in 1991, the government has repeatedly assured a sceptical public that the euro will be as strong as the beloved D-mark, which is being sacrificed to make way for it. That means, ministers have insisted, the strictest possible interpretation of the Maastricht criteria; untrammelled independence for the European Central Bank; and strict enforcement of the stability pact. The German constitutional court has also insisted, in its ruling on the constitutionality of Maastricht, on a strict application of the treaty and its criteria.

The problem for Mr Kohl is that it has become ever more obvious that Germany is itself likely to breach the 3% ceiling on the budget deficit for 1997, the year to which the Maastricht criteria are to be applied. It will also breach a similar Maastricht ceiling on public debt, which is supposed to be less than 60% of GDP. Hence Mr Waigel’s gold gamble. The idea was that Germany’s massive (and massively undervalued) gold reserves, which are held by the Bundesbank, should be revalued closer to market prices. The resultant profit would be handed to the government as a special dividend and used to pay off debt incurred to finance transfers to eastern Germany. That would reduce public debt and also the deficit (though much would depend on the transaction’s accounting treatment), enabling Germany to comply with the Maastricht criteria after all.

But Mr Kohl’s gamble has gone awry too, albeit less spectacularly than Mr Chirac’s. The Bundesbank denounced the plan as the worst sort of creative accounting. If Germany indulged itself like this, it asked, how could it attack the accounting tricks of others? Especially, the central bank did not need to add, the Italians, whom most Germans do not trust as potential sharers of the same currency.

With the press, opposition politicians and even some of Mr Kohl’s own supporters siding with the central bankers, Mr Waigel was forced to negotiate an ignominious compromise with Hans Tietmeyer, the Bundesbank’s president, that puts off the proceeds from a gold revaluation until 1998. Mr Waigel got something from the compromise but the deal leaves a shaken coalition struggling to find some other way of plugging the budget hole. Most analysts expect it to fail, which would leave the deficit for 1997 embarrassingly above 3%. For Mr Kohl, who has rarely put a foot wrong over Europe, the stumble was extraordinary. The decision to pick a fight with the Bundesbank—and, still more, the loss of that fight—has dimmed his aura of invulnerability, with what effect remains to be seen.

The shenanigans in France and Germany have overshadowed all other business in the European Union. The Amsterdam summit comes on June 16th-17th; it is due to adopt a new treaty, revising the one signed at Maastricht. Six months later, negotiations on the enlargement of the EU are due to begin. But the fate of the single currency matters more for the Union’s future than either of these. Indeed, such is the political capital now invested in the euro that, illogical as it may seem, it is not at all easy to envisage enlargement going ahead smoothly—or even at all—were the single currency to fail.

The Scylla of flexibility

Not surprisingly, the combination of the French election upset and Germany’s gold row has rekindled speculation that the single currency could be delayed for a year or two, or even scrapped. If it does go ahead on time, the argument runs, this will be possible only if the Maastricht criteria are fudged—and that must mean letting in Italy, Spain and Portugal, and Uncle Tom Cobbleigh. That would surely mean that the euro ends up as a soft currency and possibly an unstable one. Things could turn out that way. But they do not have to.

Whatever Mr Jospin said on the campaign trail, his government’s approach to the single currency is bound to be coloured by recent experience. In the early Mitterrand years, France tried “the Albanian solution”—going it alone, reflating and letting the franc go hang. That proved unsustainable, and after 1983 France adopted the policy of the franc fort. Since then various governments, beset by intractable unemployment and yet unwilling to deregulate the economy, have toyed with the idea of changing tack again. All have concluded they cannot. After every wobble—most recently when Mr Chirac thought about opposing the euro before the 1995 presidential campaign—pursuit of the single currency has re-emerged as the central element of French policy.

The new Socialist government, which is advised by Jacques Delors, the former president of the European Commission and one of the single currency’s inventors, may follow suit. Certainly, it will not wish to derail the euro. Nor must Mr Jospin’s conditions necessarily have that effect. It has already been agreed that a “stability council” of euro members’ finance ministers should act as the interlocutor for the European Central Bank—and thus as a political counterweight to it.

Turning this into something that could be deemed an “economic government” would not be hard, and might not bother the Germans unduly, so long as the central bank’s independent control of monetary policy is unaffected (ie, so long as the political counterweight is a feather). Paradoxically, some Germans might even welcome European political involvement in, say, fiscal policy, since that would speed up political union in Europe, which is what Chancellor Kohl wants EMU for in the first place.

Attempts to renegotiate the stability pact will, admittedly, be resisted by the Germans. Yet it has already been watered down to meet French objections, making any fines not automatic but subject to approval by governments. Further tinkering might be acceptable. Nobody in Europe wants the euro to be overvalued against the dollar (though, in making this a “condition”, Mr Jospin was implicitly infringing the central bank’s independence in such matters of monetary policy). Similarly, nobody disputes the need to foster growth and employment. The revised Maastricht treaty will include a wordy employment chapter for this purpose.

It will be harder to cope with Mr Jospin’s insistence on no new austerity measures, especially if the French budget deficit begins to rise. Yet the Maastricht criteria are not quite as rigid as many suppose—or as the Bundesbank might wish. The 3% ceiling on the budget deficit may be breached so long as the deficit has come down substantially and is close to the required level; or so long as any excess is temporary and exceptional. Even the Bundesbank concedes that this wording falls short of insisting that 3% means 3.0% and not a pfennig more. Most forecasts of EU deficits suggest that they will be both falling and reasonably close to the target, though few expect them actually to hit 3.0% in 1997 (see table).


This is true of Germany as well as France, for it looks likely that Germany too will find it impossible to make new spending cuts or tax increases in 1997. But it will be more awkward for Germany to wriggle out of the Maastricht criteria than for anyone else, for two reasons. First because German ministers will have to swallow their previous insistence on the strictest possible application of the criteria. Second because, if they do, they could open the way to an embarrassing challenge before the constitutional court (whether such a challenge would succeed is a different matter, given the treaty’s flexible wording).

On one issue, though, flexibility will be more of a problem. This is the position of Italy, whose participation in EMU is the trickiest of Mr Jospin’s conditions. The German government claims it has no view on whether Italy should join; that is a question for the treaty and its criteria. In reality, the Germans are passionately opposed to Italy’s participation at the beginning. They think the country could qualify only through outrageous fudging, and that it is miles away from a sustainable fiscal position or a culture of stability. They fear the euro would be like a marshmallow if Italy were included, and that German voters would be even more hostile to the new currency than they already seem.

Yet there is a fair chance that, partly thanks to its accounting fudges, the Italian budget deficit for 1997 will come in close to those of Germany and France. And though Italy’s level of debt is way over 60%, it is at least falling, whereas Germany’s is rising. On other convergence criteria—notably inflation and long-term interest rates—Italy’s record is impeccable. As is that of Spain and Portugal, both of which may turn in deficits for 1997 that are smaller than those of Germany and France. If, therefore, EMU goes ahead on time with a flexible interpretation of the criteria, the odds must be that not only Spain and Portugal, but almost certainly Italy too, will get in.

Faced with the likelihood of a flexible reading of the criteria and thus a wide EMU, some Germans are suggesting that it would be better to delay the project for a year or two. The idea is that Germany would then have time to get its deficit and debt under the Maastricht ceilings. But Italy might not find this so easy, since its smoke and mirrors—a one-off euro tax and other accounting tricks—apply only to 1997, and the deficit may start rising again in 1998. Hence, Germany’s “Italian problem” would go away. True, there is a slight risk that France also might suffer from a delay, since it would lose the benefit of a huge one-off payment from France Télécom in 1997; but renewed economic growth should help offset that. A delay, its supporters hope, would also give more time to sell the project to the doubting Thomases of Germany; and perhaps (since optimism about the euro seems unconfined) it might even give governments a chance to loosen up labour markets and restructure their economies to cope with the strains that a single currency will undoubtedly bring.

The Charybdis of delay

It all sounds too good to be true. And it probably is. There are formidable objections to delay. The 1999 date was inscribed in the Maastricht treaty. If politicians miss this deadline, why should the markets believe they will meet any new one? Because delay would be likely to lead to a relaxation of fiscal austerity, the criteria may not in fact turn out to be easier to meet in a couple of years’ time. French voters have shown that they are unwilling to accept further restructuring, however desirable; such fundamental reforms will become no easier if EMU is postponed, and may get harder.

Moreover, the immediate impact of delay would be to push up the value of the D-mark, further damaging German competitiveness and employment. Interest rates would almost certainly have to go up in France, Italy and Spain, hurting their economies. And, thwarted of the single currency that they now expect, the markets could trigger currency turmoil that would not only make any new date harder to meet but might begin to undermine Europe’s single market altogether. This could happen if strong-currency countries react to falling exchange rates by raising import barriers against “competitive devaluations”.

It would be hard to ensure that delaying the single currency even for a short time did not turn into an indefinite postponement. That is why Mr Kohl is so strongly against it. Even Italy opposes delay. The only countries that might support it are Sweden, Denmark and Britain. Postponement would be convenient for them, because it would put off the moment when they have to decide whether to sign up. But they are (in the strict sense) non-starters, and their view will cut no ice at all.

So the political imperative suggests that there will be a wide euro, launched on time through a flexible interpretation of the Maastricht criteria. Which raises the crucial question: will such a currency be soft? The markets think it will be. They are already bidding the candidate currencies down together against the dollar (see chart 1). But the markets might change their mind. The outcome will depend above all on the policies of the European Central Bank. It is possible that the bank will be unable to resist political and popular pressures for lax fiscal and monetary policies. But it is also possible that, faced with markets worried about a soft euro, the bank might adopt monetary policies even tighter than it otherwise would. If the bank wants to do this, it might be able to justify its actions by appealing to the stability pact, which, even if revised, will discourage excessive borrowing.

These arguments point to the birth of the euro in 1999. It seems likely that it will include Spain, Portugal and probably Italy. If so, and if it is a strong currency buttressed by tight monetary policies, then its early years could well be painful ones for Europe’s weaker economies. Most politicians claim to be prepared for that. But are voters?

A currency that does not command popular support is likely to have a testing time of it. The latest Eurobarometer opinion polls released last week make gloomy reading. In the Union as a whole, a third of respondents are against the single currency. In six countries, including Germany, the balance of opinion is negative (see chart 2). In France, it is positive, but the margin in favour is shrinking.

Here lies the real obstacle to a smooth birth for the euro. Unless public opinion changes in Germany, Mr Kohl could find the elections next year tougher than he once expected. That is what the German opposition, heartened by the left’s successes in Britain and France, hope. They may even adopt a candidate for chancellor who is wobbly on the single currency, such as Lower Saxony’s Gerhard Schröder. It still seems unlikely that Germany’s Social Democrats will win next year’s vote. But no rule says Mr Kohl cannot lose an election, and if Mr Schröder were to emerge victorious, that would cloud—and could conceivably abort—the single currency’s birth.

For the euro, the really damaging consequence of recent events has not lain in such esoteric matters as the Maastricht criteria or the stability pact. It has been the damage that the project has suffered in the eyes of public opinion. Not only does opinion seem to be moving against the project in France and Germany; worse, it seems to be moving in opposite directions. The French backed a party that wants a wider, “political” euro; the Germans cheered a central bank that wants a narrow “economic” one.

As EMU approaches, the gap between leaders and voters across Europe is widening, and a split may be developing between the electorates of Europe’s two most important countries. That does not mean the euro cannot start on time. But the auguries for its birthday look inauspicious.

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