Despite the aura of relaxed confidence pervading European capitals and financial markets as next year's deadline for meeting the convergence criteria for European monetary union approaches, the lines for a politically divisive battle are becoming clear. On one side stand German Chancellor Helmut Kohl, French President Jacques Chirac, the European Commission, and the vast majority of senior European politicians, who care far more about making European monetary union (EMU) happen on time than about how they get there. They worry that if monetary union is delayed once, it could be delayed more easily a second time, and a third, and so on until the great postwar drive for European union -- and the Franco-German alliance at its center -- fizzles out. On the other side stands the German "stability coalition," composed of the Bundesbank, the Federal Constitutional Court, such popular German tabloids as Bild Zeitung, and opposition-controlled power centers in the Bundesrat, or upper house of parliament, and LŠnder governments. If Kohl and company worry that any delay would threaten European union, the stability coalition worries that rushing into EMU might cost Germany its sway over European economic policy, with control passing to a broad coalition of economically weaker southern European countries, led by a resurgent France.

German voters' opposition to giving up the deutsche mark buttresses the stability coalition, with most polls showing three-to-one majorities opposed to putting euros in their pockets.[1] Only a constitutional provision against referendums (to prevent a recurrence of the Weimar experience) and the tremendous confidence voters have in Kohl have allowed the chancellor to get this far with monetary union despite those odds. But Kohl faces a personal referendum on this issue in December 1998, when he must stand for reelection. That means he will be going to the polls only weeks before formally -- and irrevocably -- handing over the deutsche mark to a gaggle of Europeans on January 1, 1999. If he condones flagrant cheating by French budgeteers, or too obviously looks the other way if France misses the deficit targets of the Maastricht Treaty on European Union by a wide margin, he risks turning the election into a referendum on giving away the deutsche mark. With that as the central question of the campaign, even the spavined Social Democrats could not be counted out entirely.

The most important threat to Kohl and thus to the EMU process comes not from bending the deficit or accounting rules for France but from the attempts it would trigger from Spain, Portugal, and eventually even Italy -- sometimes referred to as the "Club Med" countries -- to use the same bent rules as a way of clambering into EMU in the first round. That is why German officials protested in September when France included in next year's revenues the windfall gain from taking over France Telecom's pension system. Depending on how far the accounting conventions are bent for France, Spain and Portugal could breeze into EMU with room to spare. In the worst case, from the stability coalition's point of view, bending the rules for France would put the European Union (EU) on a slippery slope, with each country demanding just a slightly looser interpretation of Maastricht. As the requirements of being a good German and a good European came into direct conflict, Kohl would quickly find himself in a political and financial tangle he has tried hard to avoid during his 14 years in office.

Not for a moment would the stability coalition tolerate a drift toward both wider membership and looser criteria. Reimut Jochimsen, a senior member of the Bundesbank's Central Bank Council, which sets monetary policy, has publicly fired a warning shot, saying that if southern -tier countries with "the will, but not the means" to meet EMU criteria are let into the system, interest rates in Europe would rise, thereby hinting at a financial crisis. Students of the 1992 European currency crises will remember that Jochimsen issued a similar early warning to Britain and Italy before they were swept out of the European Monetary System.

Opposition to early membership by southern-tier countries is in part a matter of anti-southern bias, but for German voters and their representatives in the stability coalition it is also a matter of fiscal prudence. As mid-May hearings in the Bundestag brought out, if Club Med countries entered EMU in the first round, massive new expenditures from the EU "cohesion fund" would be required to ensure that the less-developed economies could afford the austerity politics of Germany and France. The fact is that the northern countries could ill afford the combination of their own austerity programs and new spending for the cohesion fund. The inflationary bias of these new expenditures and the political problems of cutting domestic spending while paying out huge new sums to other countries make wider membership in EMU a possibility that Germany's stability coalition will seek to block at all costs.

Blocking or delaying monetary union is well within the reach of disgruntled stability coalition members if they choose to use their influence over financial markets. Since traders have bought into the notion that EMU will happen, they are more vulnerable to any sign of danger. Loaded with European bonds, stocks, and currencies, fund managers around the world need only a hint of trouble before they stampede for the exits. A word of protest from the Bundesbank, the European Monetary Institute, or the German Federal Constitutional Court would be enough. Reality always makes a belated -- and sometimes violent -- appearance in European politics, and it will be no different this time.

Fortunately, there is a way for Kohl and Chirac to avoid this nasty dilemma while the market gods are still smiling on them. They should forge ahead by declaring a mini-EMU between France and Germany and not risk devastating their economies in a fruitless attempt to hit an arbitrary deficit target agreed to five years ago. But getting there would require them, first, to admit the twin truths that deficits will be above Maastricht targets and that monetary union is primarily a political tool to cement the postwar peace and, second, to make those truths all but irrelevant by taking a patented Helmut Kohl bold leap forward.


There will be no crisis and nothing to solve unless France or Germany misses the Maastricht-dictated budget deficit target of 3 percent of GDP by an undisguisable margin in 1997. "Undisguisable" is the key concept here. In other words, the deficit must be large enough that it cannot be manipulated into a politically acceptable gray zone with politically acceptable tricks. The definition of political acceptability is that it allows France in but excludes Spain, Portugal, Italy, and Britain in the first round of EMU. Whether willingly or not, the European Commission and the Organization for Economic Cooperation and Development have gone along with the strenuous efforts of French officials to disguise their budget performance. Deficit predictions provided by French Treasury officials show France meeting the Maastricht target in 1997 (see Table 1).

On the surface the numbers seem to make perfect sense as they glide toward the Maastricht deficit target. However, minor, realistic changes in assumptions produce a politically unacceptable deficit of 4 percent of GDP in 1997 (see Table 2). The first two columns of Table 2 strip away three unjustified assumptions embedded in the official figures for this year and present a far grimmer picture for the current budget. In the first column, the adjusted total receipts figure reflects the estimates of most official documents (including those from the French Treasury itself). In the second column, the adjusted total spending figure more closely reflects reality based on actual spending for the first quarter. Overspending in the second half of 1996 is conservatively assumed to run at less than half the rate recorded in the first. In that column, net social security spending is also changed to reflect estimates released by the Social Security Commission this June. The third column presents the French budget picture without the contested use of one-time revenues from the France Telecom pension system and from the "other receipts" category in Treasury documents. The fourth column lowers the economic growth assumption of 3.5 percent embedded in official French figures by half the amount that official growth was overestimated this year. The last column shows the combined effect of government spending just one percent above 1996 levels (in nominal terms) and of social security deficits in line with those predicted by the Social Security Commission.

Even if the France Telecom transfer is included, the deficit is 4 percent of GDP for 1997. A still more dire outcome of 5 percent is forecast by dissident Treasury officials who believe the JuppŽ government has wildly optimistic spending and revenue expectations. Splitting the difference between official and dissident estimates also yields a deficit of 4 percent. Anything near that level would set in motion a three-way battle with Kohl and Chirac in one corner, the Bundesbank and its allies in the other, and the Club Med nations who want into EMU between them. Financial markets could not be expected to ignore such a juicy situation.


In an ideal world, Kohl and Chirac would slowly let out the truth that France will not hit the deficit targets but that monetary union will go ahead regardless. Thus they would publicly acknowledge that monetary union is first and foremost a political matter. It would complete the great postwar drive for a permanent Franco-German alliance before their generation fades from the scene and takes its searing memories of world war to the grave. Continuing to ignore the problems ahead and insisting that all is well is flirting with disaster. Financial markets can seem astoundingly naive when it suits their purposes, but delusion does not last forever, and when these naifs get a whiff of trouble they will dash for the exits and leave political leaders wondering why everyone stopped believing all at once.

Before that happens late this year or early next year, Kohl and Chirac should make the 4 percent deficit for France into a political nonevent by talking it to death. Simultaneously, they should disarm the stability coalition, for whom that kind of talk is heresy, by quiet negotiations with southern-tier countries. Financial incentives, ex officio membership for those countries in all central bank councils, and a pledge not to begin using the euro until all countries are in EMU should go a long way toward making a two-step EMU politically acceptable for Spain and company.

But this is asking a lot of politicians. So if the politics of confession don't fly, there is another way for Kohl and Chirac to make monetary union happen. One fine Saturday morning, the sooner the better, they should make monetary union a fait accompli by announcing a permanent link between the deutsche mark and the French franc. The benefits of such a link would soon spread far beyond solidifying the Franco-German core and would create an extra-Maastricht dynamic for EMU that would break through the increasingly dangerous adherence to the arbitrary and irrelevant deficit targets agreed to in Maastricht in 1991. Both Kohl and Chirac have the temperament and experience to risk the political outrage of their European colleagues. They could defuse some of the distemper by offering the Benelux countries, Austria, and Finland instant membership in their currency link. Despite public disavowals, they would all rather join than be relegated to second-tier status. With the inner core cemented, the transition to full monetary union and the start-up of the European Central Bank could continue even if it had to be at a slower pace than was anticipated.

Offsetting the concerns of the stability coalition over this sudden move would be the obvious exclusion of the Club Med countries from this monetary union that takes place outside the Maastricht treaty. Meanwhile, bond vigilantes in the financial markets could be relied on to punish any of these countries flirting with the dangerous game of currency devaluation as a means of gaining trade advantages. The steep rise in interest rates that would result from a speculative attack on devaluers would efficiently discourage that course of action. Thus Kohl and Chirac would be able to reassure stability coalition members that the Frankfurt culture and rules would be grafted onto a mini-EMU before moving to full European monetary union.

Kohl and Chirac would also have to reassure stability coalition members by imposing a strong fiscal pact between the participating countries that would prevent them from using increased deficit spending to offset German-influenced monetary policy. The sticking point in ongoing talks has been sanctions against high-deficit countries. The stability coalition believes that sanctions for budget-busting countries must kick in automatically rather than depend on the unlikely prospect of political leaders voting to impose them. Chirac might accept more automatic discipline as the price of achieving an extra-Maastricht currency pact that would spare him the pain of immediate, election- threatening budget cuts in 1997. Once France agreed to German terms, any new entrants would have to sign on or remain outside the charmed inner circle.

Despite the threat of unanticipated consequences, French and German currencies ought to be linked as a necessary next step in the process of creating an EMU. Otherwise this politically important opportunity might be lost as the flagging credibility of the Maastricht criteria precipitates cataclysmic turbulence in the financial markets. Fortunately, a unique confluence of opportunity, political incentive, and personal leadership is now in place to pull off this endgame coup. Helmut Kohl has repeatedly shown himself to be ready and willing to leap before he looks when the choice is between making history and letting history unmake him. From his decision to permit deployment of American Pershing missiles in Germany in the early 1980s to his leveraged buyout of East Germany, Kohl has taken high-stake risks that leave other politicians moping in their memoirs about missed opportunities. Within a year he will confront the most imposing cliffs of his life. I hope he jumps.

[1] On the high side is a May 1996 Forsa poll showing that 84 percent of voters wanted EMU to be delayed or scrapped; in between are the Louis Harris poll for The Independent and the Election Research poll, both of June 19, 1996, which showed 67 percent opposed to EMU and 29 percent in favor. The narrowest margin, found in an Emnid poll for Der Spiegel the week of June 24, 1996, was 52 percent opposed and 40 percent in favor.

Table 1. French Treasury Budget Assumptions

(in billions of francs)

1995 1996 1996 1997 1997

Actual Planned Actual Baseline Planned


general government 1,553 1,569 1,552 1,596 1,553

social security 73 17 47 5 24

total spending 1,626 1,586 1,599 1,601 1,577


general government 1,230 1,281 1,264 1,328 1,269

miscellaneous 13 10 20 5 63

total receipts 1,243 1,291 1,284 1,333 1,332

nominal GDP 5.1 4.9 3.1 3.5 3.5

growth (%)

government deficit 383 295 315 268 245

deficit as % of GDP 5.0 3.6 4.0 3.2 3.0

source: French Treasury

Table 2. French Budget, Adjusted Assumptions

(in billions of francs)

1996 1996 1997 1997 1997

Lower Higher Lower Slower Higher

Revenue Spending Revenue Growth Spending


general government 1,552 1,586 1,553 1,574 1,601

social security 47 50 24 40 35

total spending 1,599 1,636 1,577 1,614 1,636


general government 1,251 1,251 1,269 1,250 1,250

miscellaneous 10 10 8 63 63

total receipts 1,261 1,261 1,277 1,313 1,313

nominal GDP 3.1 3.1 3.5 3.1 3.1

growth (%)

government deficit 338 375 300 301 323

deficit as % of GDP 4.3 4.7 3.7 3.7 4.0

source: author

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  • Richard Medley is Associate Director of Yale University's Center for International Finance and a political adviser to Soros Fund Management and other American investment firms.
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