The Big Banking Cahuna
by David Brancaccio
As we reported, the German government blinked today in its pitched battle with the country's central bankers. In an embarrassing retreat, the country's finance minister now says the government won't revalue Germany's gold reserves.
But why did the Bundesbank position matter so much...not just in
Germany, but across Europe, and even in the U.S?
If you have a minute, I'll take you through it.
Question 1: Dude...why does the Bundesbank have such an attitude?
Because it's obsessive about inflation. The bank does everything in its power to be sure that nothing erodes the value of the Deutsche Mark, whether elected officials like it not. The reason why has to do with wheelbarrows. Between the two world wars, the German government at the time didn't take inflation seriously, and printed money to meet its obligations. When you print money, the supply goes up and its value goes down. By 1923, the reichmark was worth one trillionth, you heard that right, one trillionth of its value ten years earlier. This was part of the economic dislocation between the wars that helped pave the way for the rise of Naziism. Folks had to use wheelbarrows to carry enough marks around to buy bread. If anyone has the temerity to question whether the Bundesbank is going overboard on this fighting inflation stuff, it's guardians tend to whip out the spectre of that wheelbarrow. When the allies helped fashion Germany's post war institutions, they made sure that the central bank had the strength and independence to keep the currency strong.
Question 2: And how come the Bundesbank totally gets on the rest of Europe's nerves?
It has to do with Europe's common market. The European Union has torn down most of the economic borders between countries, but there's still one huge barrier...Germans have Marks, the French have Francs, the Greeks have Drachmas. Without a gold standard, currencies fluctuate against each other on world markets...which is a hassle for folks trying to do business in different countries. Eventually the idea is for a single European currency to solve this. But for now, the 15 members of the EU have pledged to do all they can to keep their currencies stable and trading in a nice, narrow band. How does a country do this? By keeping its economic house in order and making sure its budget deficit doesn't get too big. If there are swings, the country can tweak its money by raising interest rates to boost it or lowering interest rates if the currency gets too strong. This all can work, if nothing gets too far out of balance.
Well, something did get out of balance. The Berlin Wall came down and the German government made a political decision to quickly unify the eastern and western bits. That cost a heck of a lot of money. The sky over Berlin is now dark with construction cranes. These costs hurt the German budget, and represent a huge boost of economic activity that can drive inflation.
Did someone say "inflation?" Right. The Bundesbank, remember, hates inflation, and during the early nineties kept interest rates high to keep a lid on prices. But all the other European countries are solemnly pledged to keep their currencies stable. So those countries were also forced to match the strongest EU currency, the Deutsche Mark. This meant high interest rates even as unemployment across Europe soared. That's a tough one to explain to the guy on the unemployment line in Naples, Manchester, or Eisenhüttenstadt. They are all saying:
But elected politicians across Europe were themselves left looking stupid, forced to lamely explain to their electorate that they are unable to goose the economy by lowering interest rates because of German reunification. That's a nightmare sell. Conservative French politicians learned that the hard way last Sunday. Here's one way to look at: you think people were ready to clobber Alan Greenspan when he hinted about raising interest rates last month?
Former U.S. Labor Secretary Robert Reich: "I don't think the FED should be raising interest rates tomorrow. It's bad for the economy, bad for working Americans."
But imagine if Greenspan were a foreigner, German or otherwise? Put another way, imagine if U.S. interest rates were set by... the United Nations? Europeans also like to emphasize their all for one, one for all united states of Europe spirit, but all the national tensions are far from gone.
Question 3: Like, why should I care in Redondo Beach, California?
Because all this talk that the single European currency might be scuttled by the German government battle with its central bank over the gold is great for the dollar. A German banking source told us this week that he told his own family to buy more dollars and fewer marks for a while. A stronger dollar might help U.S. travelers...like me, this week. But it also means Made-In-the-USA costs more over here, which can hurt U.S. trade...in the case of Redondo, a California computer maker might find itself stuck with a stark choice if the dollar stays strong because of the mark's problems either accept less profit for its computers sold in a Berlin computer store or raise its foreign prices, which hurts sales. And sales at German cash registers can mean American jobs.
