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Germany, Britain and the Euro – and the need for monetary autonomy

The Germany that engaged in the successful 1973 float of the DM, now seems to be missing the main point of that decision. That monetary autonomy is valuable.
Also odd is German backing of currency areas across very differing economies, in tandem with federal fiscal rules absent a federal government.

Inflation and threats to currencies loom large in German history and so German activism on such matters is no surprise. But what is a surprise is the evident failure to get the core issue of monetary autonomy right.

The rise of Hitler was a cataclysmic response to hyperinflation that destroyed German savings of the 1920s. German Marks traded at 67 billion to the US dollar in 1923. Notes were carried in increasing numbers of wheelbarrows, as people desperately sought scapegoats and new leadership.

Ever since, Germans have had extreme inflation aversion. As well as distaste in some quarters for a national currency.  This is despite success from floating the DM in March 1973 and the resulting restoration of monetary independence.
This decision to float the German currency broke the link to inflationary pressures from the US failure to fund the Vietnam War through taxes.

Given the 1944 Bretton Woods agreements, IMF policies had to change. They did, and the centrepiece was a cleanly floating DM from 1973.
The next challenge stemmed from the fall of the Berlin Wall and economic unification. However the sudden imposition of parity of the East and West DMs and resulting unemployment in the East should again have caused a mistrust of politically fixed exchange rates.

The gains from unification could have been deeper had east-west currency values been market reflective, and followed later by a national currency.
Similarly, while the “European Project” makes sense as an expanding free trade area, with real integration of goods, services and potentially labour markets in Europe, to enter such an alliance with a Bundesbank minus a currency makes less sense.

Those trained on Robert Mundell’s conditions for an optimal monetary area were incredulous both at the Euro decision and Mundell’s enjoyment of the celebrations.

Mundell had argued that an area with internal labour mobility, common exposure to economic shocks, and matching fiscal and debt disciplines would benefit from a common currency, with its lower transactions costs. Absent those conditions, countries with economic size would benefit from an independent currency. Ideas for which he received a Nobel Prize!

From 1999, rather than adjust the domestic currency price to non-conforming inflationary or unemployment pressures, or respond to uncommon shocks, the effect of the Euro constraint was that countries as diverse as France, Italy, Germany and Greece had to share an averaging of currency adjustment as macro economic conditions varied across countries.

True there were “agreements” on debt ceiling ratios and ranges, but the failure of Germany and France to play by these rules, made a mockery of them – as also seen in the case of Greece, Portugal and Italy.

While the effect of this averaging of currencies in the Euro may have helped the German economy in a protectionist way, through an artificially low Euro for them, in the last decade, the overall unemployment levels and economic growth outcomes in the Euro areas have been worse than say the UK or Australia.

The Euro – Tested and Failed by the GFC
The next Euro challenge came from the Made-in-USA forced-feeding of housing mortgages and derivatives – leading to the Global Financial Crisis in September 2008.

Resulting bank failures, and massive US, UK and Irish conversion of private bank debt into public debt – on a scale never expected in any reasonable nightmare – was then transmitted in ways barely understood, owing to the nature of the derivatives and the abuse of the diversification, securitisation theorems and credit rating processes.

Capitalism didn’t fail, but some champions did, notably the Federal Reserve and its Chairman Alan Greenspan. Debt markets dried up, and were made worse by a confusion of the debt crisis with an alleged need for more Keynesian debt-financed fiscal stimulus.

Resulting bank failures and very differing degrees of financial and economic discipline across Europe meant that many in Europe suffered magnification of the GFC. Because of the incapacity for individually tailored national currency responses and a resulting resort to debt based fiscal stimulus.

As one who worked for the IMF group in Washington D.C. in 1970-72 assisting the German Bundesbank to float the DM, I was always incredulous in the late 1990s that a common currency – the Euro – would be seriously considered. But that was before the GFC and the uneven spread of debt, which made the need for financial autonomy even greater.

Financial markets it seems, while intensive in their information requirements, also teach us that we never learn; that there are incentives in markets to create  asymmetric information, and that amalgamating or unifying currencies across economies in no way solves the fundamental capacity for huge financial failures.
We now need to manage transition to a larger number of currencies, and to find ways to preserve asset and liability values in cases where contracts and policies assume it’s all about Euros.

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