Martin Höpner, who works at the Max-Planck Institute for the Study of Societies in Cologne, recently sent me a copy of his latest paper – The German Undervaluation Regime under Bretton Woods: How Germany Became the Nightmare of the World Economy (published January 2019). He presented this research at a Makroskop workshop in Wurzburg on October 13, 2018 – I was on the same panel as him at that workshop and enjoyed some very productive conversation about these issues. It is a very interesting historical analysis of the way that the German elites (central bank, industry groups, banks, politicians, and trade unions) have collaborated since the 1950s to suppress domestic consumption and maintain the nation’s export competitiveness, even though this has undermined material prosperity for workers. The relevance of the analysis to current debates about the Eurozone and its capacity for reform are that the undervaluation regime is entrenched in Germany’s institutions, its history, its culture, and its power elites and have been that way for many decades. What the Europhile progressives, who still think reform is possible, have to show is that this entrenched position can somehow be abandoned. They have never provided any convincing argument to substantiate that hope/belief. That is why I continue to call them out as dreamers – good intentions but naive to history.
The German disregard for its European partners
In my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale – one of the recurring themes was the way that the German Bundesbank manipulated the value of the Deutschmark in the pre-Eurozone period after the Second World War to ensure that its export sector would retain competitiveness.
This was a central part of the Post War German strategy.
The Bundesbank also reneged on undertakings that Germany gave to its European partners to conduct official foreign exchange rate intervention on a symmetrical basis.
It was one of the reasons that the pre-EMU exchange rate regimes were largely unworkable in Europe.
Even after the Bretton Woods system collapsed in 1971 the European EEC nations insisted on trying to forge ahead with their own version of fixed exchange rates.
When Helmut Schmidt succeeded Willy Brandt as German Chancellor on May 16, 1974, he signalled a hardening of the German policy position to a more conservative ‘fight inflation first’ strategy.
In Schmidt’s inaugural speech on May 17, 1974 to the Bundestag, he maintained the ‘Das Modell Deutschland’ (the German Model) was the way forward, a mix of hard-line attitudes to inflation with social policies to take the pressure off the collective bargaining process.
He sought to contain real wages growth and redistribute national income back to profits to encourage investment, which he claimed would stimulate employment growth in the long-term.
This ended the temporary embrace of Keynesian policy approach that the German Council of Economic Experts had adopted in the late 1960s. That group of economist morphed into a supply-side (neo-liberal) organisation
At the same time, the Bundesbank was entrenching itself in the growing Monetarist dogma. Its early attempts to follow the Milton Friedman rule to set monetary targets failed dramatically, as similar attempts across the globe failed.
That should have meant an end to the Monetarist putsch.
But, while acknowledging it could not control the ‘money supply’, the Bundesbank continued to define its role as maintaining long-term price stability.
Over this period the mark was increasing in strength against the US dollar because of a continued lack of confidence in the US dollar in world markets and the German government was clearly aware of the difficulties this posed for maintaining the competitiveness of Germany’s export industries.
The mark also appreciated against the French franc and the Italian lira over this period.
As Germany hardened its view of fiscal deficits, the unemployment rate rose.
In 1974, before the policy position hardened, the unemployment rate in Germany was 2.8 per cent. By 1987 it was 10.5 per cent, having risen year-by-year over Schmidt’s tenure.
The strains reached breaking point when the mark appreciated strongly against the US dollar in 1977 and early 1978, and the French franc simultaneously weakened against the mark.
The perverse currency movements were imposing costs on the German export industries and provided the motivation for Germany to seek a better way of shifting some of the adjustment burden from its economy onto the weaker currencies of its European trade partners.
In other words, it wanted to reduce the asymmetry in the system that was biased against Germany.
The Bundesbank feared that a lack of discipline in the weaker currency nations would force it to take responsibility for maintaining exchange rates, and, in the context of an appreciating mark, this would compromise their capacity to control the money supply and expose Germany to higher inflation.
Conversely, the weaker currency nations (France, Italy, the United Kingdom) were concerned that they would have to accept the restrictive Bundesbank monetary policy settings or else face major capital outflows.
Under the ‘snake’, the exchange rate regime that the European nations introduced after the collapse of the Bretton Woods system, the dominance of German monetary policy (higher interest rates) forced its trading partners to endure higher unemployment than they desired.
The upshot was that all parties had incentives, for different reasons, to move to a more symmetrical system of exchange rate management.
The creation of the European Monetary System in 1979 was an attempt to introduce this symmetry in exchange rate arrangements in Europe.
The Exchange Rate Mechanism, proposed by Belgium to break the France-German impasse on who should take responsibility for maintaining currency stability in Europe, specified that when currency fluctuations moved beyond an agreed band, each relevant central bank would intervene.
So, for example, if the French franc reached the lower band of its parity against the mark the latter would have reached the upper band of its agreed parity against the franc.
This would mean that both the Bundesbank and the Banque de France would have to simultaneously sell marks and buy francs in the foreign exchange markets.
In theory, there would be less pressure on any one currency to adjust and less monetary disturbance in the respective economies. In reality, the adjustment process was not symmetric because the liquidity effects of the respective interventions were quite different.
Once the system became operational on March 13, 1979, the Bundesbank soon exerted its authority (influence).
To stop the mark from breaching the upper value limit, the Bundesbank was often forced to sell marks usually in return for US dollars or other currencies.
This pushed more marks into circulation, which the Bundesbank considered exposed the German economy to an excessive inflation risk.
In effect, despite agreeing to symmetrical intervention, the Bundesbank reneged and forced devaluations on its partners as well as forcing the other Member States to inflict austerity on their populations in order to quell imports and take some pressure of their currencies.
The Bundesbank also refused to cut interest rates in the early period of the EMS which further exacerbated the currency instability in the weaker (trade) EEC Member States.
One could argue that even though the later innovation – the EMU – has made things more complicated, nothing has fundamentally changed in Europe today.
Further, while Germany’s inflation obsession can be clothed in a philosophical argument that inflation is intrinsically anti-democratic in the sense that it is a ‘non-voted tax’, the ceding of economic sovereignty under the EMS by the other Member States to the Bundesbank was the beginning of the loss of democracy in Europe, which has accelerated since the GFC.
All of this experience in the 1970s and 1980s should have told European Member States that it would be impossible to enter a monetary union with Germany and prosper.
The German economic power and dogmatic refusal to participate properly in these exchange rate arrangements should have been like a red light.
The Germans were gaming the world long before the Eurozone
Martin Höpner’s research paper, cited in the Introduction, traces this German recalcitrance back to the early Post War period – during the early days of the Bretton Woods period.
He calls Germany:
… an undervaluation regime, a regime that steers economic behavior towards deterioration of the real exchange rate and thereby towards export surpluses. This regime has brought the eurozone to the brink of collapse. But it is much older than the euro. It was established during the Bretton Woods years and has survived all subsequent European currency orders.
He compares the traditional “wage-led” approach to growth with “the German solution: the adoption of an export-driven demand regime since the mid-1990s, a regime in which foreign demand acts as the de- cisive growth driver.”
While most analysts seem to be concentrating on the most recent incarnation of export-led gaming by Germany of its Eurozone partners, the fact is that Germany based its industrial development strategy after the Second World War on the creation of an “undervaluation regime” as a means of steering economic:
… behavior towards the deterioration of the real exchange rate and thereby towards the accumulation of export surpluses
Martin Höpner traces the introduction of this policy mindset to Germany after:
German policy-makers discovered Germany’s distinct ability to generate export surpluses after the payments account crisis in 1950/51. The Bretton Woods regime turned out to provide perfect conditions for the institutionalization and further consolidation of a regime that survived all subsequent European exchange rate orders until it became, under the euro, the nightmare of the eurozone and, even more, the world economy.
The strategy meant that Germany promoted its export surplus generation as the expense of domestic stabilisation.
Martin Höpner thinks that an “undervaluation regime is a special example of a mercantilist regime”, the latter which promotes both the growth in exports and the suppression of imports.
While Germany certainly began the Post War period in that mindset, these ideas “lost relevance as the liberalization of trade and capital markets progressed”, especially in the 1960s.
This was the period of “Neo-mercantalism” which “relies on undervaluation” and two requirements held:
1. “competitive disinflation vis-à-vis trading partners”.
2. “resistance against correction of the resulting real exchange rate distortions by means of revaluation.”
These two requirements or behaviours were prominent in German policy making in the 1950s and beyond.
… makes the export sector grow relative to the exposed sectors of trading partners and, as a consequence, leads to the export of industrial unemployment. In undervaluation constellations, export firms find advantageous environments for market niche capture, market power growth, and the accumulation of large amounts of technological knowledge …
Most importantly, such a regime strengthens the international position of central banks, and, where fixed exchange rate regimes are in place, it:
… puts them in a strong position regarding currency market interventions. Countries with enduring current account surpluses then become donor countries in the international arena, a surely more attractive position than the opposite, becoming debtor countries.
Germany certainly used that position throughout that 1960s and beyond to its own advantage – at the expense of its various European partners.
Martin Höpner questions the logic of this strategy:
Undervaluation implies the deterioration of your own terms of trade. Letting this happen is a weird economic strategy because it implies you get back less than you offer in international trade. This is the perversion of everything we would usually describe as the “rational” goal of commodity exchange: getting back (at least) as much as you have given … In the undervaluation constellation, by contrast, giving away is not a means of receiving more, but becomes an aim in itself.
Which is consistent with the basic Modern Monetary Theory (MMT) insight on trade.
Many people still find it hard to understand this point but the fact is that we do not produce to produce.
Rather we produce to consume goods and services. That is the end goal.
So if we can persuade nations to produce but not consume and allow us to consume their production instead without returning any production to them, then we are ahead in material terms.
As we simplify in MMT – exports are a cost and imports are a benefit.
That is undeniable and I find it odd that various economists (even those of heterodox persuasion) turn themselves inside out trying to deny it – and thus criticise MMT, which has made that point very clear.
Martin Höpner is in no doubt:
… undervaluation implies the imposition of consumption abstinence upon citizens and makes them partly work to give away their products too cheaply. And so far we have considered only the loss of wealth which results from distorted prices in actual trade. The usual outcome of undervaluation, however, is a trade and current account imbalance. In such a constellation, a certain proportion of goods is not being traded against other goods, but to a significant degree against increasing numbers of uncertain financial claims against foreign countries.
And the German approach was not “a volatile phenomenon”, which would soon reverse itself and the real terms of trade accordingly.
It was, rather, the product of a “the operation of a regime with long-term stability”.
Further, some think that the export strength flows through to the domestic economy.
Martin Höpner disputes this conventional claim:
Consider wage policy. Holding down wages relative to others boosts competitiveness but also holds down internal demand. Consider fiscal policy. From the point of view of the export sector, the best budgetary policy is the one that minimizes firms’ cost pressures and, in general, any kind of inflation impulse. The domestic sector, by contrast, relies on high internal demand and its most important part, the public sector, on high taxes. Consider monetary policy. Strict monetary policy is a necessary condition for competitive disinflation but, at the same time, problematic for internal growth. It is therefore an open question whether undervaluation is functional for overall growth.
The overall impact on productivity is unclear, too.
The regime also “provokes beggar-your-neighbor accusations on the part of trading partners and thereby fuels transnational conflict”.
These sorts of disputes were prominent in the 1960s as the Bretton Woods system was on its last legs.
They are still around – for example, Trump and China!
Of interest, were the reasons the undervaluation regime initially was imposed in the early 1950s:
1. A balance of payments crisis in the early 1950s at a time when the newly created German central bank was short of foreign currency reserves, needed to participate effectively in the Bretton Woods fixed exchange rate system.
2. Pressure from the US to reduce domestic consumption to free resources for military production in the context of an emerging Korean crisis.
Neither ‘reason’ persisted for more than a short period, which leaves the question open as to why the Germans chose to export unemployment to other nations.
Martin Höpner argues that we have to explore the role of the elites in Germany who had the ability “to impose a hegemonic discourse upon broader society” to advance their own interests.
He notes that during the Bretton Woods period (roughly 1950-1973), Germany’s average annual inflation rate was 1.4 per cent.
The following graph shows the performance of the other key EEC Member States and the US over the period 1950 to 1973.
De- and revaluations of the parities among the European nations during this time were rare because nations were reluctant to approach the IMF for permission to change their exchange rate.
As a consequence, the trade deficit nations(such as France and Italy) tended to absorb the external imbalance and resulting downward pressure on their currencies through a combination of elevated interest rates (relative to Germany and the US) and domestic austerity (to choke off imports).
When that became politically difficult to sell, they would, reluctantly, devalue against the US dollar and the Germany mark.
As the Bretton Woods system was on its last legs, we witnessed massive shifts in parities with the German mark revaluing against the US dollar by 9.3 per cent in 1969 and the France simultaneously devaluing by 11.1 per cent.
In 1971, as the nations agreed to try to resurrect the fixed exchange rate system via the so-called Smithsonian Agreement, there was a massive realignment (revaluation) of the European currencies against the US dollar.
But the German mark revalued more than the other European nations.
There was a further massive revaluation against the US dollar in early 1973 but the system collapsed some months later.
The European nations then entered the snake in the tunnel arrangement, which similarly collapsed soon after.
The problem has always been the massive structural differences between the economies of Germany and the other European nations, which precluded any sort of currency arrangement being stable.
All the progression to a common currency meant was that the pressures arising from the trade and capital flow imbalances were shifted from pressure on the exchange rates to pressure on domestic wages and prices – the so-called internal devaluation pressures.
Either way, the arrangements have devastated workers in nations that have less trade strength relative to Germany yet which have insisted on entering the various currency arrangements with Germany.
Martin Höpner concluded that:
… all countries suffered from overvaluation relative to Germany for almost all the time shown … the German undervaluation translated into export surpluses … the German trade balance shifted from negative into positive in 1952 and remained there during the entire period. After 1966, every German trade surplus was larger than 2 percent … Germans (including migrant workers) transferred more money into foreign countries than vice versa.
In the early 1950s, “the German trade sector was much smaller than today. It started at around 10 percent of GDP in the early 1950s and roughly doubled until the end of the Bretton Woods years (just like it roughly doubled under the euro.”
The following graph shows this ratio from 1950 to 2018. The blue line is the data provided in Martin Höpner’s paper while the second line is current official data from the German statistical agency.
Clearly, there is a level issue in the two datasets but the message is similar.
The ratio of exports to imports has steadily risen and now stands at around 120 per cent.
Martin Höpner comes to the only conclusion possible:
Germany’s relative disinflation and its resistance against exchange rate corrections resulted in significant real exchange rate distortions and these resulted in significant trade distortions. The resulting trade distortions were only slightly lower than those under the euro today. The undervaluation regime was, in other words, very effective.
The rest of his paper analyses the behaviour of the elites driving the undervaluation regime.
1. Bundesbank – its “inflation aversion” set it apart from other central banks. It would increase interest rates whenever it suspected any inflationary tendencies.
It would threaten the government with interest-rate austerity during this period unless it disciplined “wage and fiscal policy”.
The result was that in “ten of the twenty-four years” between 1950 and 1973, the German government “generated budget surpluses” through a “strictly rules-based” obsession.
The result was suppression of domestic demand and enhanced international competitiveness.
So even before the Hartz era in the early 2000s, after Germany had entered the Eurozone, its government was imposing a sort of internal devaluation to ensure its competitive position was retained at a time that its exchange rate was under continual upward pressure.
And, this is the second way in which the Bundesbank contributed to the undervaluation regime. It resisted the upward pressure on the mark which “clearly contributed to the prevention, delay, and minimization of revaluations.”
This behaviour persisted:
Even though Germany accumulated massive export surpluses, current account surpluses, as well as foreign currency and gold reserves.
The German central bank has always been prepared to inflict economic (and social) damage on the partner European Member States to satisfy its own, irrational, inflation anxieties.
2. German industry groups – were “the most pronounced (and loud) opponents of revaluations”/
They were supported by the German agriculture sector which was “highly organized” and was “a protectionist sector par excellence”.
The financial sector also collaborated with the industry sectors to maintain the undervaluation regime because they were tightly intertwined with Germany industry through the provision of domestic credit.
3. Trade unions – were organised in German in a very hierarchical manner, with immense power and influence being exerted by the Confederation of German Trade Unions. Their influence was at a peak in the Bretton Woods period.
This ‘monopoly’ organisation was heavily influenced by Bundesbank dictates as to what wage rises would be consistent with price stability.
The trade unions were also in collaboration with the Finance Ministry and industry groups (through the “tri-partite Konzertierte Aktion”) which led to wage suppression being imposed on workers.
It is fair to say that the trade unions were conflicted during this period and it could not be concluded they were vehement supporters of the undervaluation regime.
They also didn’t seem to understand the dual nature of the worker as a worker and the worker as a consumer.
Martin Höpner tells us that there were no organised consumer organisations to argue that the undervaluation regime resulted in:
the imposition of consumption abstinence upon citizens …
The trade unions were mute on that point and were minority players in maintaining the resistance to revaluation.
4. Political parties – CDU/CSU was “largely captured by export interests” and the SPD only came to realise that revaluation was desirable in the late 1960s.
Prior to that they were vehement supporters of the undervaluation regime.
The overall conclusion is that:
Capture by export (and agricultural) interests may have indeed been largest among the Christian Democrats, but the SPD followed suit most of the time.
Relevance to the Eurozone
It is clear that this undervaluation bias has inflicted massive damage on Germany’s Eurozone partners.
Martin Höpner concludes that:
… has brought the eurozone to the brink of collapse … Today, the world economy, and the eurozone in particular, experience Germany’s ex- port surplus orientation as a nightmare …
But it should be understood as a regime not just a set of “‘wrong’ policy choices”.
That regime is built-in to Germany’s institutional structure and the ideologies of the dominant elites.
It began in the 1950s “long before Germany became an export-driven growth model”.
And it explains, in part, why the architecture of the Eurozone is so flawed and dysfunctional.
The point that Martin Höpner wants to make (in my words) is that all the debates about reforming the Eurozone are really missing the point.
He writes that:
… the German undervaluation regime should shift our attention from the dysfunctional policies within the eurozone to the euro itself … it opens our eyes to the fact that the common currency may be easier to break than the dysfunctional heterogeneity within it.
That is the point I also made in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale.
The Europhile progressives still think reform is possible.
They are dreaming.
How are they going to reverse (entirely abandon) the ideology and practices that drive the persistent German obsession with undervaluation, that are entrenched in its institutions, its history, its culture, and its power elites and have been that way for many decades.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.