The Euro has reached a record high at $1.3784. Yet there is a dispute between Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France in which Germany is backing the strong Euro and France wants a weaker Euro to boost French exports. Since 2001 the Euro has appreciated by nearly 50 per cent against the dollar, and by a similar amount against currencies such as the Chinese Renmimbi which are linked to the dollar. Some European countries, including France and Italy, are feeling the squeeze. The British pound has also appreciated against the dollar to a 26 year high.
According to a report in The Financial Times, Jurgen Stark, a member of the executive board of the European Central Bank, has described the Franco-German disagreement in quite alarmist terms. He says that the Bank is braced for bruising political attacks from France. “I won’t describe it as a geopolitical risk but there is a new discussion on economic governance in the Eurozone.”
When the Euro was created as a single currency for Europe, it was the Germans who saw themselves as making a sacrifice. In the post-war period, the D.Mark was probably the most successful major currency in the world. It had appreciated steadily against most other currencies, including the Pound, the Franc and the Dollar. It was the currency on which the German economic miracle of the 1950s and 1960s was built. It had an excellent record of providing Germany with low inflation. The D.Mark had also become a symbol of German recovery, the major success of German post-war policy in the period when Germany was still divided. This stability was achieved by the independent German Central Bank, which was made the model for the European Central Bank. Even so Germans regretted the loss of the D.Mark.
Chancellor Merkel has aimed at a restoration of the Franco-German alliance during her period as Chancellor. She was therefore particularly reluctant to express open disagreement with Nicolas Sarkozy, even when he criticised the Euro and the European Central Bank during his election campaign. After all, elections are elections, and candidates have to be allowed a certain licence. No doubt the Chancellor hoped that President Sarkozy, once he had been elected, would revert to a more orthodox view about inflation, the strength of the Euro and the independence of the European Central Bank.
However, the Chancellor’s willingness to indulge the French President has now come to an end. He had gone on criticising the European Central Bank and had called for a weaker Euro to help the experts of the Eurozone. Finally Chancellor Merkel gave her reply on German television. Did she agree with the French President’s criticism of E.C.B. policy? “Absolutely not. I would definitely object to this, and so would the entire government. The population should be protected against inflation. This is very important. That is why the independence of the European Central Bank is the alpha and omega. And that is why Germany will not budge on this.” So much for the French President.
In one sense, Germany is right. The German experience of inflation convinced the German people, after wipe-out inflations in 1923 and again in 1945, that the discipline of an independent central bank was necessary and caused far less suffering than allowing inflation to accelerate. France had a very bad inflation record in the twentieth century because the French did not accept the discipline. If Europe is to make a success of the Euro, the E.C.B. must remain independent.
However, the nations of the Eurozone are not all equally good at controlling costs and raising productivity. The Southern countries of France, Italy, Greece, Spain and Portugal have been moving away from the cost control policies of Germany. “One size fits all” is too painful for them. If the German policy on the Euro does prevail that will be good for the strong countries, but it may – as President Sarkozy suggests – be intolerable for France, and it already looks intolerable for Italy.
for The Daily Reckoning Australia