Europe: The 100 year echo and serial aftermaths

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This post is a guest contribution by Cees Bruggemans, chief economist of First National Bank.

Financial Times columnist Wolfgang Munchau was most original this week to compare the current European crisis with its distant forebear, the 30-year war 1618-1648 (see “Grim lessons from the 30-years war”).

That conflict had also started small but ended up devastating Central Europe as North vs South and Catholic vs Protestant parts collided (killing 20%-40% of the population in German lands and with the Peace of Westphalia establishing the principle of not interfering in the internal affairs of sovereign states).

I don’t want to improve here on Munchau’s originality, in the manner that distant conflict arose, evolved and fragmented Europe, setting it up for 300 years of conflict, and the comparisons with today’s drift of events (if minus the wholesale slaughter).

But especially when focusing on Germany, and the demands it is making today on weaker EU peripherals, there is some seriously unfinished business in Europe that could do with some more highlighting.

The austerity and discipline being imposed on peripheral stragglers today is often implied to be ‘typically’ German, even harking back to the Teutonic stereotypes running around in German forests 2000 years ago and already giving the invading Romans a hard time.

Yet much of this modern ‘steely’ culture may have been forged in the great furnaces of the 20th century and not just Weimar either.

What may be playing out today may be the unfinished business of 17th century Europe as per Munchau, but it is under the direction of 20th century serial experiences shaping the German nation.

And so we ultimately re-encounter the echo of the Guns of August 1914, as WW1 turned into a bloody stalemate, to be lost by Germany, pushed by the victorious Allies into inhuman reparations, its burdens unnecessarily impoverishing (and giving John Maynard Keynes his big break in showing up these idiocies in “The Economic Consequences of the Peace”), giving rise to the unwise macro policies of Weimar and its hyperinflation, obliterating the German middle class, imposing hardship and seemingly forever deep suspicion of borrowing and out-of-control central banks printing money, finally topped off by the Great Financial Crash of 1929 and its depression aftermath.

That 20-year period (1914-1933) was merely the first modern crucible, the combination of horrific war and financial and economic devastation.

This experience set Germany up for the second, even more horrifically devastating 20-year crucible (1933-1953) during which preparation for war provided initial economic recovery and new prosperity, only to lose it completely in total war and its prostrated aftermath.

This set Germany up for the third time. With some liberty this can be said to be a 50-year stretch (1953-2003).

It took unbelievably hard work and discipline (and Marshal Aid and the US defence umbrella) to start anew and achieve a miraculous recovery from total war, at least in the West.

By the early 1970s, however, after 25-years of outperformance, West Germany like other parts of Europe was promising its citizens an ever more generous welfare state even as the drive behind its growing prosperity was starting to falter, a function of demographic shifts, increased state burdens, reduced risk-taking and investment, which the energy crises of the 1970s, its inflation revival and currency disruptions, made worse.

As the 1970s were left behind, Germany (like other parts of the world) did not fully recover the elan of its post-WW2 growth recovery, partly perhaps because such rebuilding phase tends to have growth opportunities that don’t repeat in more prosperous tranquil times during which supply-sides become less responsive.

So the 1980s were an indifferent decade, leaving Germany and Europe to struggle with the fallout of the 1960s’ party ending and the dagger thrusts of the 1970s.

Only to be confronted at the end of the 1980s by the biggest opportunity of the century, as Communism faltered and fell, East Germany could be reabsorbed while Eastern and Central Europe could be neutralised and safeguarded for the future.

But it came at a price. The immediate cost in the East was to expensively subsidise East Germany’s reabsorption and provide Russia and her former satellites with assistance as they sought to adjust to victorious market capitalism and Democracy.

The German costs included huge annual fiscal transfers, overheated public spending, and the Bundesbank raising interest rates over the backs of all of Europe, causing growth performances to suffer in the 1990s.

Simultaneously, the Western Continental allies imposed their price for agreeing to German re-unification

France wanted the creation of a Monetary Union anchoring Germany. Spain and other peripherals demanded huge development aid infusions for infrastructure projects.

Whereas Germany spend 20 years (1990-2010) applying internal discipline and attempting reform, made easier with the availability of cheap sourcing in Eastern Europe, to regain its trade competitiveness from overvalued currency and labour through unpopular internal adjustments while benefiting from external demand for its superior export goods, the rest of Europe focused on enjoying the benefits flowing from globalisation (cheap consumer imports).

In addition, the past ten years offered EU peripherals big development transfers from the richer parts fuelling economic booms and low German-like interest rates fuelling financial booms (with the resulting import booms also favouring Germanic Europe).

The defining moment of the modern European era came in late 2009, with the dust long settled on the demise of Communism and German re-unification, and the Anglo-Saxon financial crisis only recently overcome, leaving unbelievable detritus in its wake.

The Great Recession set in motion by the Anglo-Saxon financial crisis had disturbed European debt dynamics, sufficiently so that it started to show up in stages how many of the peripheral partners had massively misused their participation in the Monetary Union.

Like Queen Victoria in her day, Germany was less than amused, pained by the belated realisation what the neighbours had been up to in their big prosperity drives, variously in banking (Ireland), property (Spain), general welfare spending (Greece), often while completely losing all growth dynamic for decades through restrictive supply-side practices (Portugal, Italy) and some or all these features also recognisable in the so-called ‘soft core’ partners (Belgium, France, but not limited thereto).

This time it wasn’t the devastating aftermath of total war, or of social welfare overindulgence, energy and inflation shocks or geopolitical neighbours going under and needing assistance.

This time, though Germany itself had made mistakes (mainly in its banking) and required some sacrifice of its own social welfare largesse in order to get its national finances back in order, the main mistakes had been made elsewhere in Europe, as much in spending and debt priorities as in not safeguarding the institutional underpinnings of the Monetary Union, Euro and ECB or structurally safeguarding their growth dynamics.

It was with the discipline forged in two world wars, one generation devastated by hyperinflation and Depression, and another generation deeply burdened by social overreach, energy shocks and the bailing out of failing geopolitical neighbours too big to ignore, that the most recent indulgences of peripheral Europe were put under the microscope.

Given the past 100 years of German experiences it mustn’t come as such a major surprise that the first inclination wasn’t to bail out anyone or to meekly accept the end of the Euro, fragmenting Europe back into its constituent parts.

The benefits of hanging together were simply too great, the costs of breaking up financially too unattractive, while it shouldn’t be beyond anyone to taste and learn from experiences that Germany had gone through serially and still allowed her to thrive in the end (if not without external assistance from American aid, European cooperation or Chinese globalisation).

So the first inclination was not to bail (even if markets hoped, expected and required this, it being in their interest to see their exposed investments fully safeguarded) or to run away (for to outsiders the impossibility of making the Monetary Union work was obvious now), but instead to rather double up the pressure and to ensure everyone honoured their original commitments, and do for a change what the Germans had to do for a century over and over and over again.

And all this with only some limited sympathy (solidarity) for the smaller countries clearly totally in over their heads into non-sustainable situations (Greece, Ireland, Portugal), but doing this piecemeal as it took time discovering they really WERE completely gone.

Such reasoning may lead to outcomes different from the obvious.

If the EU peripherals really don’t want to leave the Monetary Union and Euro, fearing the consequences for themselves and later generations, but want to stay partnered with the stronger European nations, they will need to accept discipline and structural reform on a time scale usually only encountered after a hyperinflation or major war devastation.

Not impossible, but certainly hard, especially where internal rigidity is deeply engrained and the Democratic dispensation prefers easy as compared to hard solutions.

The last word has obviously not been spoken, with a decade stretching ahead of us, in which Europe will have to confront deep questions about itself and the solutions on offer.

In the meantime, German Finance Minister Wolfgang Schaueble opinioned this week that there will not be a market crisis collapse in 2012 as the situation remains ‘controllable’, putting the focus not on markets but squarely on the structural needs of Europe.

It suggests more creative tension and brinkmanship as Europe is forced to face up to its many realities, of the past generation, the past 100 years, indeed the past 400 years. This could take at least a decade to fully resolve, this being the German position all along.

But then they talk from deep experience.

Source: Cees Bruggemans, First National Bank, December 31, 2011.

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