The Secret History of the Euro’s Birth

A few days ago I tried to sketch out how the upcoming UK-EU In-Out Referendum actually boils down to an argument over whether it is possible to have a European Union with most members in a currency union, and a few of them resolutely outside it.

When we Brits look across the Channel, we tend to see the negatives of Euroland – a currency system bolted together without a coherent monetary or fiscal framework to support it. Because we forget that it was not conceived by economists at all; but rather by politicians. It is first and foremost a political solution to a political problem. To be precise: it was François Mitterrand’s solution to how to manage the consequences of the reunification of Germany in 1990.

François Mitterrand was the President of the French Republic from 1981 to 1995 – a fourteen year reign during which the main architecture if the European Union of today was conceived. Mitterrand himself was a strange, highly intelligent, complex man. His slightly sinister reputation this side of the Channel is rooted in the fact that, culturally, we don’t really like canny operators who plot and scheme throughout a career lasting nearly six decades. (So long as the plots are effective and the schemes good ones, the French admire such people). He was a socialist more out of pragmatism than ideology: he came to believe that only progressive politics could unite France – and Europe – though he started his political career on the right.

Mitterrand was probably just as influential in the history of the modern world as Margaret Thatcher (who was the British Prime Minister during most of his time as President). If not more so. If Margaret Thatcher epitomised the ideological opposition to a Europe divided by the Iron Curtain (Capitalist West and Communist East), Francois Mitterrand mapped out what Europe would look like after the Iron Curtain fell.

Before the fall of the Berlin Wall in November 1989, French policy echoed De Gaulle’s maxim that “We love Germany so much that we are glad there are two of them”. Recall that the free-market Federal Republic of Germany (FRG or West Germany) lay from the Rhine to the Elbe; and the communist German Democratic Republic (GDR or East Germany) stretched from the Elbe to the Oder. Both German states arose out of the Allies’ occupation zones at the end of World War II (WWII).

The fall of the Berlin Wall is an event the significance of which is difficult to explain to those who were born after the mid-1970s – except if you happen to be German. In which case, you will have been brought up with all its mythology.

On a personal note, I remember being sent as a very young banker to visit the Deutsche Aussenhandelsbank in East Berlin in 1985. We had to cross from West to East Berlin at Checkpoint Charlie. Even John Le Carré’s novels cannot convey the weirdness of that transition. Apart from the obsessive security of the Red Army, there was the contrast between a modern Western city and the shell-pocked remnants of WWII in the East. One had an eyrie feeling of travelling back in time from 1985 to 1945. Now, of course, Berlin is totally transformed, magnificent atria and all that (Britische Arkitekt!).

Sorry. I reminisce. Where was I…?

In a remarkable book, Mitterrand: A Study in Ambiguity , the journalist and historian Philip Short reveals that, as late as November 1989, Francois Mitterrand was warning the German foreign minister that the consequences of German reunification could be yet another European war against Germany. The same month, the Soviet leader, Mikhail Gorbachev told Mitterrand that, if German reunification went ahead, he would be toppled by a military coup.

Then Gorbachev lost his nerve, and indicated that the Soviet Union would do nothing to prevent German reunification (even within NATO). Reunification now became not only feasible but inevitable. In fact, the merger of West and East Germany came to pass much quicker than expected, on 03 October 1990, just eleven months after the Wall had come down.

Later, on 19 August 1991, Gorbachev was toppled, though briefly. Thanks to Boris Yeltsin, order was restored in Moscow and the plotters were foiled. Yet, in December 1991 the Soviet Union dissolved – and poor old Gorbachev faded to nothing. The Cold War was over (for now, at least).

In these extraordinary historical circumstances it was Mitterrand who seized the initiative. Mitterrand saw an irreversible common currency as a way of anchoring a unified Germany of 80 million people into Europe, and of spreading Germany’s prosperity across the continent. This currency would not just be shared by France and Germany but by all the EEC (as it was then called).

In a historic secret meeting with the German Chancellor, Helmut Kohl, in the spring of 1990, Mitterrand offered a deal. France would not stand in the way of German reunification if Kohl and the German political class committed, irrevocably, to give up the mighty Deutsche Mark and to replace it with a European common currency.

Margaret Thatcher was still stridently opposed to German re-unification and dead against a European currency. But, after the Americans decided to back reunification (so long as Germany remained in NATO) there was little she could do. In any case, the critical months coincided with her fall from grace. She was deposed just six weeks after German re-unification had already become a reality.

Now Helmut Kohl, for all his XXL size bluffness, was another shrewd operator. Like Mitterrand’s, his career is not fully appreciated in the English-speaking world. He was the German Bundeskanzler from 1982 to 1998 (almost as long as Bismarck). So he was the longest-serving of the three big European political beasts of those two decades. We should really talk about the Thatcher-Mitterrand-Kohl Era (1979-1998). Though, it was Kohl who was described as the greatest leader of the second half of the 20^th century (by Bill Clinton).

It is surely significant that German reunification had become a dead certainty as soon as Kohl decreed that the Deutshe Mark could be exchanged for the hitherto unconvertible Ostmark at a rate of one-to-one, in July 1990. East Germans (Ossies) queued at banks to unload their useless Ostmarks. Many found themselves relatively wealthy overnight.

But Kohl’s problem in agreeing to a common European currency was that the Germans were proud of their mighty Deutsche Mark. It represented Germany’s rehabilitation after the ruins, material and moral, of WWII. It mirrored the Wirtschaftswunder. Kohl could only sell the idea of a common European currency to his own people on the basis that it would be a European Deutsche Mark, and that the Germans would be in the driving seat. And he sold it to German industry with the argument that German exports would no longer risk being rendered uncompetitive by the relentless appreciation of the German currency.

At the Maastricht summit (December 1991 – the very month that the Soviet Union disintegrated) Europe agreed that the new European Central Bank (ECB) would be located in Frankfurt, and that its first president would be a Frenchman – against much Dutch opposition, as they had their own candidate.

Eventually, a compromise was agreed whereby Dutch central banker Wim Duisenberg, became the first ECB President (in 1998) but would be replaced by the Frenchman Jean Claude Trichet (whose name sounds like “trickster” in French) half way through Duisenberg’s official eight-year term. In the event, Trichet was not able to take over the ECB presidency until he was finally cleared of serious fraud charges in his native France. He eventually assumed the role on 01 November 2003. Mr Trichet is generally thought to have been a lacklustre ECB chief. He was a retired civil servant cum commercial banker with little understanding of the momentous role of the new institution that he headed.

The French wanted to call this new currency the Ēcu, or Crown, a French coin first issued by Louis IX. The Germans later out-manoeuvred them with their own preference. Euro, to German ears, sounded more neutral and modern.

At Maastricht, John Major, the British Prime Minister, came away with an opt-out for Britain on the single currency project. He explains in his memoirs that, while he could see the merits of the scheme (lower transaction costs and all that) he was persuaded that the European economies were just too divergent to impose a single currency straight-jacket.

Unlike the French and the Germans, the British saw the issue as an economic one, rather than a political one. In part, this reflects the differing intellectual and philosophical traditions of Franco-German and Anglo-Saxon thought. The Franco-German tradition is idealist (in the philosophical sense that problem-solving starts with the ultimate goal) while the Anglo-Saxon is empirical (it identifies the practical problems you will encounter in trying to get there). Indeed, much of the problem has been that Anglo-Saxons do think differently – and have radically different legal systems – precisely Enoch Powell’s grouse back in 1975.

But the die was cast. The timetable for the European currency was set and the Exchange Rate Mechanism (ERM), which Britain had joined in the last month of Mrs Thatcher’s premiership, was given the role of stabilising European currencies ahead of the momentous day when all exchange rates would be fixed for good.

The following year, however, on Black Wednesday (16 September 1992) Sterling was spat out of the ERM by an FX market that refused to believe that the Bank of England would play the game. This was a searing experience which changed the British mind-set forever. It also destroyed the Tories’ reputation for economic competence for nearly 20 years. (The young David Cameron, by the way, was at that time an advisor to Chancellor of the Exchequer, Norman Lamont).

While Britain limped away, the German and French political elites were henceforth joined at the hip. For all their enthusiasm for the Eastward expansion of Europe into the formerly Iron Curtain states, the British were now marginalised. Their dream that there could be tri-partite leadership in Europe (Germany-France-UK) was now a chimera.

As Euroland evolved, two Europes emerged: the Ins and the Outs. Most Outs still aspire to be Ins (Croatia, Latvia etc.). The Hungarians and the Poles are more circumspect. Denmark, though an Out, pegs her currency to the Euro. The Out-Forevers (the UK, Sweden, Czech Republic), as I said last time, are now regarded by the Ins as hardly European at all.

And then the British found fault with the internal management of the single currency, especially after the Financial Crisis.

Despite being a de facto political entity, the French and German political elites did nothing to address the Eurozone’s fundamental imbalances. The main one being that Germany has been running a current account surplus of 7% of GDP which corresponds to a similar deficit in the South. Modern German identity is tied up with the notion of itself as an exporter, sometimes called export nationalism[i]. And German exports have risen from 29% of GDP in 1999 to 51% in 2013. That is entirely admirable; but where Germany runs surpluses, its trading partners will run deficits. In a floating currency system, that would not be a problem as the currencies of deficit counties would depreciate. In a fixed currency system, that is not possible. Instead, the deficits accumulate as debt.

Structural reform is still not even under discussion. Furthermore, the Euroland banking sector remains inefficient and undercapitalised. As a consequence of all this, the Eurozone has lurched from one financial crisis to another on its periphery – and its woes are clearly far from over. So long as unstainable deficits persist, there will be bailouts. Who will pay for them?

On one reading of the Maastricht Treaty, which the British parliament finally ratified in 1993, the UK is still obliged to join the single currency by 2020. No one believes now that that will happen – the world, and Europe, have moved on. So there will have to be at least one treaty change anyway!

So the OUTs in the forthcoming UK referendum are not just ignorant xenophobes, as they are sometimes portrayed in European media. The British are unhappy because they are shackled to an unstable system which was not of their devising (and which they warned against).

But if Britain were to vote to leave the EU in 2017, where exactly would we go? That’s what I want to discuss shortly.

[i] See Germany’s dark night of the soul by Hans Kundnani, The Spectator, 31 October 2015.