Year XXXII, 1990, Number 1 - Page 41
GERMAN INFLATION OR EUROPEAN MONEY?
1. Modern economic theory analyses inflation as the possible result of insufficient fiscal revenue with respect to expenditure. The state may resort to inflation, in other words print bank notes and use it to carry out payments, if it has to face financing requirements which are higher than its ability to collect taxes and to receive credit from the public. Some economists have even theorized the depreciation of the value of money, at constant rates, as an instrument for financing current state expenditure.
In the case of Germany, the first great inflation coincided with the financial disequilibrium deriving from the enormous expenses incurred by the state during First World War. Thus, if – between 1880 and 1913, at a time of peace for Europe – German inflation had shown an extremely moderate and at times even negative trend, instead during the years of the First World War yearly inflation rose on average to 28.3 per cent. Immediately after, between 1919 and 1923, inflation reached a yearly 662.6 per cent.
The second large inflationary phenomenon is also tied to a World War. In June 1948 – with Germany in ruins – Ludwig Erhard started off a monetary reform in three out of the four occupied zones. The Deutsche Mark replaced the Reichsmark: those bank deposits whose title deed was legitimate and certain were converted at a 10:1 rate. In practice, the government no longer recognized the legal value of the Reichsmark and reduced the purchasing power of monetary patrimonies tenfold. Every citizen was given forty new D-marks, which represented the foundation for incrementing the new patrimonies. The “old” money no longer had any value.
The 1919-1923 crisis and the 1948 episode have made a lasting impression in the historical memory of the Germans, who now consider the restraint on inflation carried out by the federal bank of issue, the Deutsche Bundesbank, as extremely important.
However, it would be a mistake to consider that the inflationary phenomena which have just been described were the result of mistaken monetary policies on behalf of the Reichsbank, the central bank of the Weimar Republic. The German inflationary crises, in the first half of the century, are rather the result of long-lasting military conflicts of enormous proportions, which saw the German state opposed to almost all of Europe and the world. German inflation is the result of the phenomenon which the historian Paul Kennedy has described exactly as a case of over-stretch: a political, economic and above all military commitment of the great German power in an area which was too widespread for its resources. In other words German inflation is not a consequence of the weakness of Berlin’s central bankers or of lack of good economists in the Germanic world, but rather of the blunders of politicians who imposed on Germany efforts that could not be financed with an orderly fiscal manoeuvre.
Postwar monetary stability in the Federal Republic – the largest of the two states which arose after the fall of the Reich – represents the basis of the strength both of the D-mark and of the West German economy and it is obviously in the first place a result of the population’s hard work, of the moderate wage claims of the working class, of the rigour and independence of the Deutsche Bundesbank and finally of Ordnungspolitik (the economic policy in favour of non inflationary growth, theorized by Walter Eucken and the Freiburg school and put into practice by the federal governments right from the beginning of the fifties). But the basic external factors which contributed to keeping inflation low must not be forgotten.
The inclusion of Federal Germany in the Community framework has finally solved the problems of its borders with Western Europe, allowing economic policy to be directed towards objectives of austerity and stability, wholly respectful of the market, instead of towards forced economic expansion so as to rearm and reconquer territories, which would have made administrative control of resources and nationalization of industries absolutely indispensable.
The Marshall Plan contribution has, moreover, freed the German public budget of the burden of reconstruction, which would not have been bearable in a non-inflationary context. Western Germany’s entry into NATO has finally allowed it to saddle its powerful American ally with the burden of military expense. Costs would otherwise have been extremely high, since the country is situated along the border with the Warsaw Pact.
In conclusion, the integration of Federal Germany into the Western bloc is one of the foundations of non-inflationary post-war growth. Thanks to it, the new West German state has been freed from the fiscal reasons for hyperinflation.
2. Extension and integration are the two key words to the contrastive historical experiences of Germany in the first and second half of the century. During the first fifty years the German attempt to extend its boundaries, to increase its national power and to impose a new order on Europe produced inflationary impulses: Germany underwent a faster depreciation of money than its neighbouring areas. In the second half of the century, West Germany’s participation in European and Atlantic integrative processes – combined with the great German productive potential and the presence of high technological know-how – has made it possible to implement economic policies oriented towards monetary stability both on the part of Centrist governments and Social-Democrat guided coalitions.
As a partial confirmation of the analysis of the anti-inflationary role of West German integration in Europe, it can also be remembered that East Germany has, at least partially, benefited from the advantages deriving from participation in a league of states, although very different from that of the West. The Democratic Republic has in fact frozen all its border problems with Eastern Europe, which caused the Second World War, and has laid most of the burden of defence on the Soviet Union. It certainly was not a free and conscious choice – as in the case of the Western Republic – but in relative terms the economic effects are similar. Estimates of East Germany’s inflation speak of a rate of around 12 per cent a year, decidedly higher than that of West Germany, but in any case much more limited than the “South American” type index of other Eastern European countries (think of inflation in Poland and Yugoslavia).
On the whole, the German economic area – which during the two world wars was most affected by inflation – in time of peace enjoys the advantages of its geographical centrality and can benefit from the traditional sense of discipline and from the wide diffusion of culture which characterize its population. Germany is now characterized by relative stability, in relation to the mean inflation rate in the respective political areas the two Republics belong to.
The option between extension and integration of Germany in Europe – solved, in the post-war period, in favour of the second option, both by free choice and in the wake of the new power balances imposed on the Germans – becomes once more a current issue due to the rapid disgregation of the Communist bloc and the rapprochement between the German Federal Republic and the Democratic Republic.
This alternative is obviously posed in very different terms from those of the past, even the recent past. The outline of European politics has undergone deep changes over the last few months and in many aspects is completely different both from that of the pre-war period and from that of recent years. In the first half of the century, state hierarchy was determined by the size of armies; during the following decades the fundamental factor was represented by nuclear weapons; over the next few years the key to European equilibriums could be money. In a continent where the use of military force is becoming more and more improbable and where forms of market economy seem to impose themselves with respect to planned economy, creating new ties between states, it is no longer necessary to use weapons to solve the problems of interdependence and of force relations. Instead it is much easier to pull out one’s wallet and buy whatever one wants. Whoever has the power of “good” money can use it to find resources all over the continent, making direct investments, acquiring businesses abroad, issuing securities which are held by international savers.
The extension option thus acquires a mainly monetary character. In the case of the Federal Republic this option is no longer represented by impossible territorial claims but by a rapid expansion of the use of the D-mark outside national boundaries. The routes of this expansion process in Europe can be summed up in three points: monetary unification between West Germany and East Germany, currency competition within the area of the European Monetary System and lastly the parallel circulation of the D-mark in Eastern Europe. Obviously, with the use of D-marks on the part of families and businesses not residing in Germany, there must be a transfer of resources towards the country issuing the currency. Monetary phenomena, in fact, always have some form of real offset: it could be summed up as the economic primacy of Germany in Europe.
The option of the integration of Germany into Europe also has a decisive monetary component, which might be synthesized as follows: monetary unification between the two German Republics within the EMS, the realization of a fixed exchange rate system in Europe, the development of the Community budget, the creation of forms of monetary collaboration at a Pan-European level. The real compensation of such a monetary process could be described in the following terms: the productive potential of united Germany is turned to the best advantage by full participation in a political union of Europe; Germany is at the centre of a growth process of Central and Eastern Europe, which involves the whole continent in a balanced way and confers new dynamics to the whole of world economics.
The aim of these pages is to prove that, while the monetary extension option is tendentially inflationary, monetary integration preserves money value stability. The only possibility of integrating the East German regions into the Western political and economic system without causing a “Pan-German” inflationary process therefore consists in a simultaneous strengthening of European integration.
A further Leitmotiv of these pages is the belief that the destiny of European integration is now firmly linked to Central and Eastern European events. The link is evident in the monetary sector: an inflationary solution to the problem of intra-German monetary union endangers the stability of the European Monetary System, threatens the results achieved over ten years of progressive convergence of Western European economic policies and compromises every effort to realize monetary union in Europe.
3. German monetary authorities certainly bear in mind the risk of an over-extension of their currency. In an essay recently published on the Federal Bank’s monthly bulletin, the Bundesbank economists point out, with ill-concealed preoccupation, that the central banks’ German mark reserves amount to 230 billion (September 1989). To make a comparison, this sum corresponds to 20 per cent of the M3 monetary aggregate at the end of that same month and exceeds, in terms of flow, the overall increase of the same aggregate between 1986 and the first half of 1989.
Part of these 230 billion (and precisely 48 billion) has been deposited by the other central banks at the Bundesbank and has therefore been removed from the commercial banking system. However, if the central banks, to defend national currencies, should decide to intervene on the exchange markets, to disinvest their D-mark reserves in the Deutsche Bundesbank and sell them to commercial banks and other operators, the German monetary mass would undergo an undesired increase of the same breadth of the interventions. The 48 billion D-marks deposited in the German Federal Bank – mostly from the American Federal Reserve System – can therefore flow onto the market, increase the amount of money and cause inflation. The remaining 180 billion D-marks have already been deposited on the Euromarket. They are only a part of the 720 billion D-marks which are in the hands of foreign operators. If a redistribution of international portfolios were to take place, the effects on the exchange rate of the D-mark would be immediate: a fall of the D-mark with respect to the dollar would foster the importation of inflation.
Thus, according to Bundesbank economists there are already reasons for alarm. If monetary policy and the Budget in Germany were no longer directed towards monetary stability, foreign investors would alienate the D-marks already in their possession and the inflationary effects would increase internal problems. Monetary stability must therefore remain the objective of German monetary policy.
The Government of the Federal Republic has recently offered the other German Republic to negotiate an intra-German economic and monetary union. The Bonn government proposal was urged in the first place by the Social-Democrat opposition, was supported by the Liberal party, was adopted by the Treasury Minister Waigel and was finally presented, at the highest level, by Chancellor Kohl to the President of the DDR Council Modrow.
The Deutsche Bundesbank has never concealed, according to the occasion, its irritation, surprise and scepticism towards economic and monetary union with the other German Republic. Political reasons seem, however, to have prevailed over technical indications and have impressed a pace on the monetary integration between the two Germanies that the process of European unification has not reached yet. Federal Germany intends to help with all its force the weak economy of the Democratic Republic. Moreover, Bonn wishes to prevent emigration from Prussia, Saxony and Thuringia towards Federal Germany from continuing at the high rate of the last few months. Every month fifty thousand people flock into the western regions, in search of affluence and security. The Bonn government offers its solid currency to those who intend to remain in the present DDR: An economic and monetary union also represents the first clear step towards the re-unification of the country and the overcoming of the state of political inferiority into which Germany had fallen after the experience of Nazism and the Second World War.
The term “monetary unification,” in the case of the two Germanies, raises some ambiguity. In actual fact it concerns the extension of the use of the Western D-mark to the eastern regions: the Deutsche Bundesbank will have to give money at fixed peg to the companies and citizens of the DDR. The possible inflationary consequences are still a matter of discussion among experts. If some emphasize that the economic growth of the DDR will allow it to absorb all pressure on prices, others instead are of the opinion that the extension of the Western D-mark to East Germany is a concession of new purchasing power without any real compensation.
Some preoccupations also derive from fiscal policy. Federal Germany will have to make considerable efforts to reduce the regional imbalances among the Western Länder and the Eastern regions. While the Federal Republic is a substantially homogeneous country, Germany is divided by forty years of different economic development. The present DDR has serious problems that need solving in the sector of technological infrastructures, has to cope with the appalling decadence of its town centres and is suffering from grave ecological problems.
The list of Germany’s problems is not circumscribed to the German area. Once the D-mark has become united Germany’s legal tender, it could be adopted as investment currency and as instrument of exchange by millions of families and companies outside the country. This could take place both within the Community, due to the well-known phenomenon of currency competition in the presence of the liberalization of currency, and in some countries of the East (Poland, Czechoslovakia, Yugoslavia). There is no doubt that, in this case too, monetary extension could sooner or later turn into an over-extension phenomenon. In the case of the D-mark circulating as a parallel money within the whole European area, the Federal Republic’s monetary authorities could lose all ability to control an important part of the national monetary mass. The very conceptual definition of quantitative monetary objectives would become problematic.
Let us assume for a moment that the above-mentioned phenomena (German monetary unification, circulation of the D-mark as a parallel “European” money) took place without the process of European monetary integration being strengthened at the same time. The cohesion of the EMS would certainly be hard put to sustain it. Until now the central Community banks have followed the discount rate policy of the Deutsche Bundesbank. The French, Belgian, Dutch and, on some occasions, the Italian and British reference rates, too, have undergone variations that wholly correspond to those of the German administered rates. The central Community banks have therefore acknowledged the primary role of the Deutsche Bundesbank within the EMS. The D-mark is considered as the anchor of stability of all European monetary policy. The exchange agreement has worked up to now on the basis of two fundamental rules: the Deutsche Bundesbank carries out, in the first place, an orderly and rigorous anti-inflationary policy and, secondly, the other central countries follow the behaviour of the German monetary authorities.
Let us also assume that the Deutsche Bundesbank – having to face an inflationary threat coming from within the country – wishes to reduce liquidity in unified Germany and to carry out a tight monetary squeeze. The European partners will have to face a difficult choice: either they follow the Deutsche Bundesbank and carry out a restrictive policy or they will have to renounce par exchange rate with the D-mark. It may be imagined that conflicting interests will put the credibility of the exchange system to a severe test and that the operators will try to assay its strength on the market. In the lack of an agreement on fixed exchange rates or a real single currency, the expectations of the markets will end up by going towards exchange rate instability in the Community and towards more frequent realignments.
But even in the opposite hypothesis of an accommodating policy of the Deutsche Bundesbank and of the development of German inflationary dynamics, the European exchange rate agreement will still not avoid tensions. The central European banks will in fact have to face a surprising alternative: to maintain par exchange rate with respect to the D-mark, importing inflation from the German area, or to allow their own currencies to appreciate over Germany’s currency.
In conclusion, a European exchange system cannot have as its reference point a country in which inflationary pressures develop. In the case where the central bank of that country reacts with a monetary squeeze, deflationary influences will be transmitted to the whole European area; instead in the case where the central bank’s behaviour allows the insurgence of inflationary pushes, the whole monetary system will be affected by decreases in the value of money. The reference standard of the European monetary system must be represented by the lasting stability of the value of money. Up to now Federal Germany has accomplished its task very well during the ten years of the EMS by guaranteeing an inflation rate which is stably lower than the European average. Unified Germany might not be able to take up the heritage of the Republic of Bonn.
Equally serious monetary problems could derive from the D-mark circulating outside the German area. Since the D-mark is issued by the Federal bank of Frankfurt, the only source for the parallel D-mark market outside Germany is represented by a stable deficit of the German balance of payments, which cannot avoid having consequences, over the medium run, on the exchange rate and on inflation. The anti-inflationary credibility of the Deutsche Bundesbank will undergo another hard test. The Federal Bank will in fact issue a national money with European diffusion and will have cope with the so-called “Triffin dilemma”. On the one hand, it will have to commit itself to avoiding internal liquidity crunch phenomena due to the balance of payments deficit and the external circulation of the currency; at the same time it will have to prevent a “DM-shortage,” in other words a permanent shortage of D-marks outside the Federal Republic, if it wishes to avoid families and businesses deciding to ascribe the role of predominant parallel currency to another money and consequently selling D-marks all at the same time, depreciating the exchange rate.
4. European monetary integration offers the framework for solving the problems pointed out so far.
Let us once more formulate a hypothesis: intra-German monetary unification and the diffusion of the D-mark in Eastern Europe as a parallel currency take place in parallel with a substantial strengthening of the Community. In fact, within the EEC a system of irrevocable fixed exchange rates is decided; moreover, the Community institutions are provided with more substantial resources of their own and the budgets of the member-states undergo European control and co-ordination procedures.
In this ambit German monetary unification merely represents one moment of the wider European unification, an enlargement of the EMS area. In actual fact, East German citizens do not simply receive Western D-marks, in exchange for Eastern banknotes: their new money, although it has the appearance of the banknotes issued by the Bundesbank, is the European money: this European money, although it does not have its material expression in a banknote or in a coin in ECUs, is however defined by the presence of a single monetary mass in Europe. The possible inflationary effects and the monetary troubles deriving from the concession of uno actu purchasing power to the citizens of East Germany must no longer be considered as a consequence of the extension of German liquidity, but rather of the growth, less important in percentage, of European liquidity. It is evident that inflationary dangers are less acute if the whole of monetary Europe and not only the Western mark area confers the new money to East Germany.
Very similar considerations can be also made concerning fiscal policies: if the financial burden of East German recovery – and also of that of vast areas of Central and Eastern Europe – is left only on the shoulders of West Germans, the German state will very likely suffer from considerable financial disequilibria. But a deficit spending policy on the part of the Bonn government, similar to that carried out by the French government during the first years of François Mitterrand’s presidency, is not in the interest of the Germans nor of other Europeans, because it would undermine the exchange rate mechanism within the EMS, would foster inflation in the country with the strongest economy within the single market, would make the implementation of the Delors Plan absolutely impossible and would block the whole monetary integration process in Europe: for this reason a deep strengthening of the Community budget becomes necessary, so as to allow, according to the mechanism of one’s own resources, the financial burden to be shared by all of Europe.
The risk of the parallel circulation of the D-mark outside the German area should also be coped with on a European level. It is obvious that the citizens of Central and Eastern Europe have wanted to travel abroad for years, but they do not have at their disposal a currency which is convertible into other currencies. It is also clear that the new political and economic elites wish to link their countries stably with the world market and, firstly, to the European Community, but the companies do not possess hard currency and their reserves of currency are often very modest. The convertibility route of national currencies is long, because it presupposes that the national economy is able to export goods and to ensure, with the gains from exportation, the solidity of the reserves and the country’s solvency. It might thus be inevitable that, while waiting for the entry of the Central and Eastern European countries into a framework of Pan-European monetary integration, the Community currencies linked by an agreement on exchange rate stability – and in particular the German mark, play the role of parallel currencies.
During the stage when the definite stability of the EEC exchange rates has not yet been achieved – I refer therefore to the next few months the “private” ECU will have to be put alongside the D-mark as a parallel currency in the countries of the East, granting credits and aid in the European currency. In this way, as Michel Aglietta and Christian de Boisseu have underlined in Le Monde, all the twelve Community currencies will be adopted as an instrument for payment or reserve in Poland, Czechoslovakia and in other economic areas which are opening up to the free market. If one assumes that part of the parallel circulation in ECUs does not add to, but replaces the parallel circulation in D-marks, the sum of the Western monetary instruments in Central and Eastern Europe could represent a much lower percentage fraction of overall Community liquidity with respect to what it represents, instead of the German national liquidity alone. Thus, while awaiting definite exchange rate stability within the EMS, it becomes necessary to think of a double Community parallel currency in Eastern Europe: the ECU and the German mark. This way the inflationary effects produced in Germany by the circulation of national monetary instruments in Eastern Europe can be reduced.
Starting from July 1st 1990 the Governors’ Committee of the central banks of the EEC will become the nucleus of the future European central banking system. The Committee will assume, albeit progressively, control over monetary aggregates, the rate policy, and exchange rate strategies of Community partners. It can reasonably be thought that the Committee – in other words the institution which expresses the still somewhat weak monetary identity of the EEC – will have to go deeper into the matter of monetary relations with Eastern Europe: it will therefore have to be given the power to control the use of the D-mark and the private ECU, in other words of the double parallel currency, and will possibly have to arrange the monetary policy measures which allow it to extend or restrict liquidity according to the circulation of currencies outside the Community. In other words, the Governors’ Committee will have to turn into a Federal Open Market Committee of the D-mark and the private ECU.
The Committee will also have to maintain direct relations with the monetary authorities of the Eastern European countries and take up initiatives to grant resources directly to these countries. A European fund in ECUs for monetary stabilization in Central and Eastern Europe – taking as a model recent initiatives in favour of Poland – could represent an important common contribution of Western Europe.
In a second phase – once the reform of the economy of Central and Eastern European countries has been consolidated – it will be necessary to proceed resolutely towards wider forms of monetary integration than the current European Community. The EEC must encourage forms of monetary integration in the East, among countries willing to sacrifice, in conditions of equality, part of monetary sovereignty in favour of common authorities. In Western Europe the ECU will by then have replaced, according to the Delors Plan, the fixed and irrevocable exchange rate system and the individual national currencies. The ECU and a money of account of Central and Eastern Europe can then be tied up by exchange rate agreements similar to those of the European Monetary System. The families and businesses of Western Europe, as well as those of Central and Eastern Europe, will then have at their disposal convertible money which participates in a single European system of European stability of prices and exchange rates.
Finally, a few words on long term prospects. The European Community – probably extended to Central and Eastern Europe – will have the possibility, if it wants, to become the United States of Europe. They will have a common currency that will become one of the pivots of the international monetary system. The option between extension and integration and the same dangers of monetary over-extension will appear at a worldwide level and this article will inevitably have to take on a different title: “European inflation or world money?”.
5. The course of the debate on intra-German monetary union shows that, if there exists on the one hand the political will to assume responsibilities beyond the frontiers and, on the other hand, the willingness to sacrifice national sovereignty, the monetary integration processes are fast. The debate on European monetary integration must now continue with the same intensity. The union between the two marks of the East and the West, if placed within the framework of a rapid European monetary unification, is the basis of a stronger European monetary identity and the beginning of a pan-European integration process. If instead the events of the last months are not accompanied by European monetary growth and by the consolidation of Community finances, the danger exists that structural inflationary phenomena might take place in Germany and that all Europe might consequently enter into a difficult phase. The dilemma over the intergovernmental conference on monetary and economic union, which starts at the very latest at the end of 1990, must be solved: the decisions taken on that occasion will clarify whether Europe chooses the road to integration or inflation.
 Geoffrey Brennan, James Buchanan, “Revenue Implications of Money Creation under Leviathan”, in The American Economic Review, Vol. 71, May 1981; Stanley Fischer, “Seigniorage and the Case for a National Money”, in Journal of Political Economy, Vol. 90 No.2, 1982.
 Harry Runge, Haushaltsfinanzierung durch Notendruck, Berlin, Ducker und Humblot, 1986.
 Andrea Sommariva, Giuseppe Tullio, German Macroeconomic History 1880-1979: A Study on the Effects of Economic Policy on Inflation, Currency, Depreciation and Growth, MacMillan Press, 1987.
 Paul Kennedy, The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500 to 2000, Unwin Jyman, 1988.
 “Die längerfristige Entwicklung der Weltwährungsreserven”, in Monatsberichte der Deutschen Bundesbank, January 1990.
 Michel Aglietta, Christian de Boisseu, “Le rouble, le mark et l’ecu”, in Le Monde, 19.12.1989.
 Alfonso Jozzo, “Perestrojka a passo di rublo”, in Il Sole 24 Ore, 14.11.1989.