France and Germany held largely contradicting hopes and aspirations for Europe’s common currency. To France the key issue in establishing a European monetary union was to end monetary dependence, both from the vagaries of the U.S. dollar and from regional deutschmark hegemony, and to establish a global reserve currency that could actually stand up to the dollar as part of a new international monetary order. By contrast, the main German concern was to forestall the threat of deutschmark strength as undermining German competitiveness within Europe. Reserve currency status and currency overvaluation stand in conflict with Germany’s export-led growth model.
In light of the euro crisis both nations are bound to reassess the euro’s viability. No doubt France has seen all its hopes for the euro disappointed. France is facing the prospect of a lost generation today, a prospect shared with other debtor nations in the union, and a prospect that undermines the Franco-German axis and may soon turn it into the ultimate euro battleground.
Looking back, France and (West) Germany followed contrasting economic strategies in the post-WWII era. Broadly speaking, Germany’s so-called social market economy relied more on market forces and export orientation whereas France’s economic model reserved a greater role for government planning and intervention. Judged by their respective post-war GDP growth rates and the levels of per capita GDP reached by 1980, both models proved similarly successful. In the currency sphere, however, a stark divide existed as France experienced persistently higher inflation together with downward pressures on the French franc, while the deutschmark gradually attained global reserve currency status and regional monetary hegemony.
Neither side was particularly pleased with the outcome. Reserve currency status comes along with currency overvaluation, which conflicts with Germany’s export-led growth model. On the other hand, asymmetric adjustment pressures stemming from competitiveness losses due to higher inflation, eventually provoking franc devaluation, were perceived as national humiliation in France – a state that Mitterand’s “franc fort” policy U-turn of 1983 was meant to end. But franc fort also meant French subordination to Germany’s Bundesbank, which was hardly a satisfactory state of affairs either. Only a common currency would end French subordination and German regional hegemony, by restoring egality in European monetary affairs while focusing monetary policy on conditions in Europe rather than just Germany. For Germany’s chancellor Helmut Kohl the euro was to secure Germany’s permanent integration in Europe – as the guarantor of peace.
United in their belief that the time for monetary union was ripe but unable to resolve fundamental Franco-German discord about economic policy, the monetary union was left incomplete and narrowly focused on the areas in which German views were nonnegotiable anyway. Given Germany’s strong negotiating position owing to its currency anchor role and special status of the Bundesbank, Germany generally prevailed in hammering out the design of the euro policy regime. In particular, single-mindedly focused on price stability and fiscal discipline, the Maastricht regime largely neglected fundamental issues such as fiscal union and demand management, financial stability policy, exchange rate policy, and intra-area competitiveness. These euro birth defects left the currency union exceptionally vulnerable and also prepared the ground for the ongoing euro crisis.
Essentially, a currency union is a commitment to a common inflation rate. The ECB’s definition of price stability as “below but close to 2 percent” attaches a number to that commitment, and thereby provides a stability norm for wage trends. National wage trends corrected for productivity (i.e. unit labor costs) cannot stray from this stability norm for long without causing imbalances. With nominal exchange rates gone, unit labor cost trends determine whether intra-area real exchange rates stay in balance.
The widely-held view that euro crisis countries lost competitiveness due to excessive wage-price inflation is missing the point. Germany was the true outlier, although in the downward direction. As Europe converged to Germany’s historical 2-percent stability norm, Germany settled for zero instead. o Oddly, while France truly stayed the course, the shared commitment to the 2-percent stability norm, it is France – rather than Germany – who is once again facing asymmetric adjustment pressures today, sharing the same predicament of other euro debtor countries that are already in deep crisis.
Despite strictly abiding by the golden rule of currency union, France is expected to undo a roughly 20-percentage point differential in national unit-labor cost trends that built up under the euro as Germany settled for zero and the two euro axis countries’ bilateral trade position turned massively in Germany’s favor. As Germany’s current account surplus surged beyond 7 percent of GDP, France saw its surplus of 1-2 percent of GDP at the start of the currency union turn into a deficit of that order. Accordingly, while Germany built up a large creditor net international investment position under the euro regime, France turned from creditor to debtor status.
Further deep fault lines are dividing the two partners today as public finances too have parted company since 2010 and the French economic model became seriously unclenched since 2011. Having shared the impact of the “global slowdown” of 2001, a common shock, both countries famously breached the 3-percent ceiling of the so-called Stability and Growth Pact in its aftermath. But as Germany submitted to unconditional austerity, France took a more cautious and growth-friendly approach. In Germany, fiscal austerity, wage restraint, and structural reform combined to systematically suffocate domestic demand, leaving exports as the sole engine of growth of the “sick man of the euro”. By contrast, French growth was driven by domestic demand, with net exports acting as a drag on growth. As the German consumer suffered from manic depression and worshipped frugality, the French bon vivant saw the future more favorably; French birth rates rose while German rates declined.
Public debt ratios moved in tandem until crisis struck. Germany cut its budget deficit more aggressively while higher French GDP growth played its part in holding France’s debt ratio at bay. Effectively, as witnessed by their stark trade imbalance, more vibrant French spending, both private and public, was critical in allowing Germany to balance its public budget on the back of export surpluses alone.
Despite the euro Germany is still pulling the monetary shots in Europe. And Germany is determined to not return the favor today. Not stimulus but more retrenchment is on the mind of Germany’s stability apostles. Competitive austerity is the German cure-all to be administered across Euroland in high dosage. First applied to the small economies of Greece, Ireland, and Portugal, the currency union’s number 3 and 4 economies of Italy and Spain were next in line. Today, it is France’s turn to jump off the austerity cliff. Crunching the union’s number 2 economy will strengthen deflationary forces across Europe. Adding insult to injury, Germany’s finance minister Wolfgang Schäuble asserts that nobody in Europe would see any contradiction between fiscal consolidation and growth, even as the enormous wreckage of allegedly “growth-friendly” consolidation are blatantly visible to anyone who is not completely blinded by German monetary mythology.
The German model has plunged the European Union into existential crisis. A model the workability of which depends on others behaving differently from Germany cannot be made to work by forcing everyone to behave just like Germany. Germany first got sick under the euro as a result, but then underbid its partners to cure itself. It is high time for France to challenge the German mantra that stability causes growth. Because unless you actually find a willing sponsor of your perpetual export surpluses, it just doesn’t. It may be left to France to either convince its euro axis partner to finally accept this simple truth, or else to call an end to the euro folly that has brought needless catastrophic hardship to millions of Europeans.
This column is based on the longer Levy Working Paper no. 762