Wednesday 18 February 2015

It's the rules, stupid

As the drama of the Greek show down moves to the second stage, observers and commentators cast around for interpretations. Austere Germans versus profligate Greeks is one of the popular topoi, and so is responsible versus irresponsible governments. Yet, what is often forgotten is the main protagonist: the Euro itself.

The Euro as a common currency originated in the German re-unification and the desire of France's president Mitterrand to have the German Mark. And it was Chancellor Kohl's bargaining chip in the negotiations to reconcile France with the fact of a resurgent German economic powerhouse. Attached to the deal was the so-called fiscal stability pact which was promptly broken by Germany and France. The former failed to stick to the pact because national finances spiralled out of control in the wake of re-unification and the costs of upgrading East German infrastructure to West German standards. The latter, France, failed to keep its budget under control because ... well, because they was little incentive to do so. 

To be clear, all this happened well before the financial crash of 2008. In fact, it was Chancellor Schroeder, a social democrat, who, in 2004 embarked on a fundamental reform of employment regulations which set Germany on a path to fiscal rectitude. This first drama of the Euro stability pact is often forgotten in public debate today. But it was a key experience for German politicians. Embarrassed and shamed into a climbdown on the rules they had formulated themselves, they learned a simple but important lesson. A currency is only stable if the budgetary rules are enforced that come with it. 

That's the main reason why German politicians (Social Democrats and Christian Democrats alike) are playing hardball with Greece today. It has little to do with fears of inflation Weimar style. Nor is it to do with spite or resenting the Greeks their living standards financed by debt. Rather, it is the realisation that enforcing the rules strengthens the currency rather than weakens it. Seen this way, a Greek exit (though highly undesirable for everyone involved) may actually send a strong signal to the markets: we are determined to enforce the Euro rules, to safeguard the currency's stability. 

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