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Options for Europe – Part 25

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).


The EMS struggles in its ‘first life’ until France caves in

As a result of all the jostling between France and Germany and their respective support nations, the EMS was effectively just an agreement to limit currency fluctuations between the Member-States and provided no real scope for an economic and monetary union as presented in the earlier Werner Report. Even within this restricted structure – which one commentator termed “a victory of political intuition over expert opinion” (Mortenson, 1990: 28) – things were floundering.

The decision to consider the establishment of a European Monetary Fund – a European central bank – was effectively abandoned by the end of 1980. Already the transfer of central bank US dollar and gold reserves to the EMCF as part of the creation of the ECU base was a compromised arrangement driven by the Bundesbank concern that it would build up excess stocks of the relatively useless ECU. The compromise saw the central banks depositing the assets through short-term ‘swap’ contracts, which meant they did not cede ownership. Limitations on the use of ECUs in settling debts between central banks were also put in place and it was prevented from creating ECUs in its own right. All these arrangments/restrictions were designed to ensure the EMCF could not act like a central bank.

Within this environment of reluctance, it was always obvious that the Bundesbank would prevent the creation of a European Monetary Fund, which was envisioned as the European counterpart to the US Federal Reserve and the Japan’s Bank of Japan. Legal complexities were put forward by the Germans as a means of undermining the development of the Fund, while the French Gaullists rehearsed their usual pre-occupation about losing sovereignty to a supra-national body (Hoffmeyer, 2000). Once the socialists were elected in France in 1981 all talk of the Fund evaporated. What was left was a voluntary arrangement between central banks about reducing currency fluctuations which had limited political support and the economic divergences among the signature nations were of such magnitudes, that this arrangement would be constantly stressed to breaking point. Hoffman (2000: 55) concludes at that point “The Visions were again in shambles”.

The shambles was quick to manifest. Between March 1979 and March 1983, there were seven currency realignments and eleven up to January 1987. Table 1 shows the currency realignments in the EMS up to January 12, 1987. Several of these realignments were at the request of the government in question as a means of restoring lost competitiveness due to inflation differentials widening whereas others were required to maintain the overall integrity of the system given the difficulty the central banks were having keeping within the ‘parity grid’.

Source: Bank of International Settlements, Various Annual Reports.

The fourth realignment on October 5, 1981 was significant because it followed with the May 1981 election of François Mitterand, the first socialist President in France’s Fifth Republic. Speculation against the Franc in the second-half of 1981 forced the Banque de France to engage in large scale intervention in the international currency markets to stop the Franc from falling below the agreed bi-lateral parities. This was considered unsustainable and the French government sought a major realignment against the Deutsche Mark, which was accomplished by a 5.5 per cent revaluation in the Mark and a 3 per cent devaluation in the French Franc and the Italian Lira. This was a massive turnaround against the Mark and a lesser devaluation against the other currencies. The French government had to seek a further devaluation in June 1982 and again in March 1983, mostly to deal with the strengthening Deutsche Mark and the diverging economic policies between the two nations. These realignments were of such a scale that it was clear that the EMS could not continue unless the non-German Member States within the system fundamentally reoriented their domestic economic and monetary policies to follow the restrictive stance taken by the Germans. This ‘non-German’ cohort, principally meant France and Italy.

The French experience is particularly interesting. After indulging in the early Monetarist experiments under Giscard d’Estaing and Raymond Barre, the political fallout associated with the sharply rising unemployment, that demonstrated the poverty of that policy framework, led to Mitterand’s election. His government immediately set about doing what a sovereign government should do – and that is, to use its fiscal and monetary policy capacities to advance the welfare of their citizens by expanding employment opportunities, reducing unemployment and expanding the social wage. The problem is that the French were not willing to abandon their commitments under the EMS to keep the Franc within the agreed bands. They wanted everything – political popularity by reducing unemployment and improving living conditions within France, a straitjacket on German pretensions to European power, and, Germany to underwrite the income support mechanisms defined by the CAP. On the one hand, domestic policy sovereignty was crucial if it was to lower unemployment and this predicated against their involvement in the ‘European Project’ as it was being defined by the EMS. On the other hand, the desire to undermine German influence and to find a way to fund their farmers under the CAP forced them to engage in the ‘European’ dialogue. Caught betwixt!

By the third currency realignment in March 1983, the French were at the crossroads and the incompatibility of these competing ambitions was obvious. At that point, France had a choice. It could retain policy sovereignty freedom to pursue its legitimate domestic objectives by letting the Franc float or staying within the EMS and subjugating their domestic policy freedom to the dictates of Germany – that is, the Bundesbank. Unfortunately, for the French and for Europe in general, as later developments (the introduction of the Euro) demonstrate, the French chose the neo-liberal path, however culturally alien this was to them (Balleix-Banerjee, 1997).

The French government fell lock-step into the expanding economic consensus, which was an evolving Monetarist approach that involved using rising unemployment as a policy tool to discipline the inflation process. The days when governments saw unemployment as a policy target were gone – now it was to be manipulated so as to undermine the capacity of workers to gain wage rises in line with productivity growth. That political reality was too stark and necessitated a smokescreen being erected to disassociate the rising unemployment from macroeconomic policy choices. Rising unemployment rates were reconstructed by the political and bureaucratic spin doctors as a ‘structural’ problem reflecting a failure of individuals to be self-reliant and assiduous in job search and skill development. A bevy of securely employed and highly paid economists pumped out a massive amoutnt of so-called ‘research’ papers, which served to give authority and legitimacy to this ideologically-tainted view. Most of this ‘authority’ lacked credibiilty, but then mainstream economics has never really been concerned with its theoretical inconsistencies or lack of empirical traction. After all, mainstream economists adopt the rule that when the facts contradict the theory, the facts must be wrong!

The shift in policy in March 1983 – the so-called ‘tournant de la rigueur’ – took France back to the ‘fight inflation first’ policies of Giscard d’Estaing in the late 1970s and ended the few years of social advance in France. The shift in language “la rigeur” instead of “d’austérité ” (austerity as coined by Raymond Barry) was just window-dressing. The socialists were selling out and shifting direction as part of the neo-liberal political convergence that captured social democratic parties in most advanced nations during this period. While the so-called “désinflation competitive” (Fitoussi et al., 1983) aimed to break the repeating cycles of devaluations and high interest rates it was heavily motivated by the long-standing preoccupation among the French politicians and their industrial support base to stay competitive against the Germans – as sort of one-up-man-ship (Howarth and Loedel, 2003).

The idea of a sudden shift in policy in March 1983 should also be seen in the context of the long-standing intellectual battle between the planners and the economists in the Ministry of Finance as to the pros and cons of the free market and the growing obsession among economists in the Banque de France about the primacy of price stability in economic policy targets.

The tensions were there before March 1983 and each previous time that France was forced to devalue (October 1981 and June 1982), the Banque de France demanded policy cutbacks. Duchaussoy (2010) confirms the hostility of the Banque de France to the Mitterand government’s growth policy. Its governor, Renaud La Genière wrote to the then Economics and Finance Minister, Jacques Delors in 1981 urging him to pay more attention to price stability and to cut the public deficits (“De son côté, la Banque de France manifeste également une certaine hostilité à la politique qu’entend mener le gouvernement. Son gouverneur, Renaud de La Genière, exhorte dans ses lettres le ministre des Finances Jacques Delors à infléchir la politique suivie. La Banque craint que celle-ci ne s’avère dangereuse et ne menace, à terme, l’objectif de réduction de l’inflation institutionnalisé depuis cinq ans”). The tension between the Bank and the Treasury, captured in the correspondence between the two institutions, revealed that a real enmity had developed between the monetary and fiscal policy makers in France over this period (“La teneur des lettres que s’échangent le directeur du Trésor et le gouverneur de la Banque conduit à penser qu’une inimitié réelle grandit entre deux des plus hauts fonctionnaires de l’Etat”).

In 1983, having moved from being the Economics and Finance Minister (1981 to 1983) to Economics, Finance, and Budget Minister (1983 to 1984), Jacques Delors strengthened the neo-liberal program that Raymond Barre had begun and the reduction in domestic inflation that resulted from the ‘scorched earth’ approach was celebrated as the first serious sign towards a convergence reality, while the sharp rises in unemployment were brushed under the carpet and forgotten. Various bureaucrats, supported by free market academics worked overtime to convince everyone that the unemployment was not a result of a lack of jobs created by excessively restrictive fiscal and monetary policy but rather a sign that people were not searching for work hard enough and were lulled into a welfare-dependent lassitude. The war on the victims of this folly in macroeconomic policy gathered pace through the 1980s and culminated in the 1994 release of the OECD Jobs Study, which became the bible for those intent on facing the fact that the unemployed cannot search for jobs that are not there.

There was also clearly a distinct shift in attitudes among the socialists from March 1983. For example, the ultimately tragic French socialist politician Pierre Bérégovoy wanted France to leave the EMS when he was Minister for Social Affairs in 1981. By the time he became the Minister of the Economy and Finance in 1984 he was a champion of austerity and a strong French Franc, and even more assertive about these matters than the Jacques Delors (Guigo, 2013).

On May 16, 1983, the European Council passed a resolution “in favour of the French Republic under the Regulation on Community Loans (European Council, 1983: 44-45), which extended “4000 million ECU or the equivalent amount in other currencies”, on the condition that France “put into effect, in accordance with the adjustment programme which it has presented”. The program involved cutting the government deficit and “setting a limit of 3% of GDP to budget deficits of 1983 and 1984”, restraining social security and unemployment insurance payments and cutting the capacity of state owned enterprises to borrow. Further, the Banque de France was required to reduce the money growth target to create a “marked reduction in the rate of domestic credit expansion”. The French government was urged to encourage “the development of savings” in France.

The decision was brazen. For being compliant and abandoning its ‘Keynesian’ desires the French government was given some short-term funds to bolster their exchange rate. The tone of the discussion and the wording in the official resolution ((European Council, 1983) were akin to the paternalistic statements issued by International Monetary Fund at times when it has extended loans to struggling nations who accept, in return, harsh ‘conditionalities’, which undermine the government’s capacity to advance the well-being of its citizens.

The upshot was not dissimilar to the sort of consequences that some of the poorest nations in the world experience after becoming involved in taking IMF loans with ‘conditionality’. France’s output gap nearly trebled between 1982 and 1985 as economic growth, household consumption and private investment slumped and more than a half million workers joined the jobless queues over the three year period. The official unemployment rate rose from 7.4 per cent in 1982 to 10.2 per cent in 1985 and continued to increase after that. Not unsurprisingly, the saving ratio fell from 16.4 per cent in 1982 to 13.5 per cent in 1985 as a result of the failing economic growth and rising unemployment undermining household incomes.

However, the bureaucrats judged the outcome to be a success and applauded the French for adopting the German solution. Everyone was pursuing ‘Modell Deutschland” now!


Additional references

This list will be progressively compiled.

Balleix-Banerjee, C. (1997) (1997) La France et la Banque Centrale Européenne: débats politiques et élaboration de la décision, janvier 1988–septembre 1992, PhD Thesis, University Panthéon-Assas, Paris II, January 10, 1997.

Duchaussoy, V. (2010) ‘De la relance à la rigueur La Banque de France et le début de l’ère Mitterrand (1981-1983)’, La Lettre No 32, Institute François Mitterrand, June 22, 2010.

European Council (1983) ‘Decision 83/298/EEC of 16 May 1983 concerning a Community loan in favour of the French Republic’, Official Journal of the European Communities, L153/44, 11/06/1983. 0044-45).

Fitoussi, J.P., Atkinson, A.B., Blanchard, O., Flemming, J., Malinvaud, E., Phelps, E.S. and Solow, R. (1993) Competitive Disinflation. The mark and budgetary politics in Europe, Oxford, Oxford University Press.

Guigo, P-E (2013) “Pierre Mauroy et le dit “tournant de la rigueur”‘, Huffington Post, June 19, 2013.

Mortensen J. (1990) ] Federalism vs. Co-ordination: Macroeconomic Policy in the European Community’, Centre for European Policy Studies Working Paper No 47, Brussels.

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