Operation Self-Deceit: New Documents Shine Light on Euro Birth Defects

By Sven Böll, Christian Reiermann, Michael Sauga and Klaus Wiegrefe

Part 2: 'Not Without the Italians'

Photo Gallery: The Birth Defects of a Common Currency Photos
DPA

Horst Köhler wrote to the chancellor in mid-March. Formerly the German chief negotiator in the Maastricht Treaty negotiations, Köhler had moved on to become the president of the German Savings Bank Association. Enclosed with his letter was a study by the Hamburg Institute of International Economics, which concluded that Italy had not fulfilled the conditions "for permanent and sustainable deficit and debt reduction," and that it posed "a special risk" to the euro.

But Kohl rebuffed his former confidant. Of course the Europeans would have to continue their structural reforms, he replied, but he was confident that the governments would rise to the challenge "in the coming years."

At a European Union special summit in Brussels in early May 1998, Kohl felt the "weight of history" and, without further ado, provided his unreserved support. "Not without the Italians, please. That was the political motto," says Joachim Bitterlich, Kohl's foreign policy advisor.

The documents that have now been released suggest that the Kohl administration misled both the public and Germany's Federal Constitutional Court. Four professors had at the time filed a lawsuit against the introduction of the euro. The suit was "clearly without merit," the government told the court, arguing that it would only be justified in the event of a "substantial deviation" from the Maastricht criteria, and that such a deviation was "neither recognizable nor to be expected."

Really? Following a meeting between the chancellor, Finance Minister Theo Waigel and Bundesbank President Hans Tietmeyer, on the case before the Federal Constitutional Court, the head of the economics division at the Chancellery, Sighart Nehring, noted in mid-March 1998 that "enormous risks" were associated with Italy's "high debt levels." The debt structure, Nehring added, was "unfavorable" and outlays would increase considerably if interest rates rose by only a small amount.

A Love for Italy

But the memo had no repercussions. The chancellor, it would seem, wasn't terribly interested in the details. There was a "built-in flexibility" among politicians when it came to the Maastricht criteria," says Dieter Kastrup, German ambassador to Italy at the time.

Italy, after all, was a founding member of the EU, and the Italians had never behaved as poorly in Brussels as the French did under President Charles de Gaulle or the British under Prime Minister Margaret Thatcher. And, finally, hadn't Goethe too waxed lyrical about Italy? "We all shared a certain love for Italy," says Bitterlich.

Officials in Bonn were pinning their hopes on two men who had set out to clean house in Italy: Prime Minister Romano Prodi, a quiet professor from Bologna, and his ascetic minister for the budget and economic planning, Carlo Ciampi, who had been governor of the Italian central bank for many years.

The two technocrats had come into power after the old Italian party system had foundered in a maelstrom of corruption and Mafia connections. Prodi and his center-left alliance "Ulivo" ("Olive Tree") won the election in 1996.

Kohl had doted on the short, liberal professor from the start. Ciampi, who had attended a Jesuit school in Tuscany, also enjoyed a good reputation with the Germans. "Without Ciampi, Italy would never have managed to be on board at the beginning of the monetary union," says former Finance Minister Waigel.

The country was drifting "toward financial bankruptcy" at the time, writes historian Hans Woller. The red tape involved in establishing a company took more than 60 days to complete. Italians couldn't buy newspapers at noon, because they could only be sold at kiosks, which were closed for lunch. Retirees outnumbered the working population, and many of the 1.5 million people officially classified as severely disabled were in the best of health.

Tricks and Luck

Ciampi and Prodi were relatively successful compared to their predecessors. Through reforms and cost-cutting measures, they were able to reduce new borrowing and bring down inflation. But the country had bigger problems than that, and the government was fully aware of them. Indeed, the Italians twice suggested postponing the launch of the euro in 1997. But the Germans rejected the idea. It was "a taboo," says Kohl's former advisor Bitterlich, pointing out that the Germans were pinning their hopes on Ciampi. "Everyone felt that he was Italy's guarantor, in a certain sense, and that he would fix things."

It is also clear, of course, that Kohl was determined to wrap up the monetary union before the 1998 parliamentary election. His re-election was in jeopardy, and his challenger, Social Democrat Schröder, was a known euro skeptic.

In the end, the Italians formally fulfilled the Maastricht criteria with a combination of tricks and fortunate circumstances. The country benefited from historically low interest rates, and Ciampi proved to be a creative financial juggler. He introduced, for example, a "Europe tax" and carried out a clever accounting trick, which involved selling national gold reserves to the central bank and imposing a tax on the profits. The budget deficit shrank accordingly. Even though EU statisticians ultimately did not acknowledge this trickery, it symbolized the fundamental Italian problem: The budget was not structurally balanced, but in fact had benefited from special effects.

This not did not escape the notice of Chancellery officials. In a memo dated Jan. 19, 1998, Bitterlich pointed out that the deficit reduction was based primarily on the special Europe tax and on market interest rates that had fallen considerably in comparison to rates in other countries. A few weeks later, representatives of the Dutch government contacted the Chancellery and requested a "confidential meeting." The general secretary of the Dutch prime minister and a state secretary from the finance ministry wanted to put pressure on Rome. "Without additional measures on the part of Italy to provide credible proof of the longevity of the consolidation, Italy's acceptance into the euro zone is currently unacceptable," the Dutch officials argued.

Germany's Growing Debt

Kohl, fearing for his most important project since German reunification, refused. He told the Dutch officials that the government in Paris had warned him that France would withdraw from the agreement if Italy were excluded.

The Germans were in a weak negotiating position. When it came to fiscal discipline, they were overbearing in their approach to the rest of Europe, and yet Germany's own budget figures were anything but exemplary. The country's sovereign debt level was slightly above the critical 60 percent mark. Even worse, in contrast to almost all of the other countries that wanted to be included in the first round of the monetary union, Germany's total debt was not decreasing, as the treaty required, but in fact was growing.

The Chancellery was aware of the problem. "In contrast to Belgium and Italy, the German debt level has risen since 1994," they wrote in a March 24, 1998 memo to Kohl and Chief of Staff Friedrich Bohl. The consequences were unpleasant. "In our view, there is a legal problem in Germany's case, because the Maastricht Treaty only provides for an exception if the debt level is declining," the memo continues.

Kohl and Waigel claimed mitigating circumstances. Without German reunification, they argued, the debt ratio would only be 45 percent. The excuse was "met with understanding" by both the European Commission and the partner countries, the officials noted with relief.

Still, the situation made it difficult for Germany to play judge, particularly given the lack of formal proof that Italy was in violation. In the spring of 1998, the statistical office of the European Union certified that the Italians had satisfied the deficit criteria of the Maastricht Treaty. This meant that there was "no longer any reason to bar the Italians accession to the euro," as Waigel recalls. After this hurdle had been removed for the Italians, "they had a sort of legal claim to be allowed to be part of the euro from the very beginning," Waigel's former top official Regling says today.

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