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

By , , Michael Sauga and


Part 3: Italy Turns Away from Austerity

Many knew that the figures were sugarcoated, and that they hardly represented real debt reduction. But no one dared draw the consequences. Kohl trusted Ciampi's reassuring claims that the Italians would continue to pursue the "cammino virtuoso" ("virtuous path") they had embarked upon and would "be unrelenting in efforts to clean up the budget." The government in Rome predicted that its debt level would sink to 60 percent of GDP by no later than 2010.

Things didn't turn out that way. As early as April 1998 -- that is, prior to the official decision on which countries would be part of the euro -- there were growing indications that Prodi's coalition partners, the neo-communists, were just waiting to return to their old habits. On April 3, the German embassy in Rome warned that this risk should "not be ignored."

Three months later, when Italy had secured its participation in the euro, the problem came to a head. On July 10, 1998, Ambassador Kastrup expressed his concern to officials in Bonn that Italy was overcome by "stagnation" and "exhaustion," and that the government there was taking "a break of sorts after its extraordinary effort to satisfy the Maastricht criteria."

The break became the status quo. In early August, the Italian Finance Ministry admitted that the budget deficit had been higher in the first seven months than in the same period the previous year -- a period which had been critical to Italy's acceptance into the euro club.

Stephan Freiherr von Stenglin, the financial attaché at the German embassy in Rome, still hadn't completely lost faith in Rome's willingness to cut costs. "Failing to reach this year's deficit target will likely do considerable damage to the credibility of the Italian consolidation policy," Stenglin wrote. At the Chancellery, a large exclamation mark was written in the margin next to this sentence.

'A Qualitative Shift'

In the mean time, however, the most intense phase of the general election campaign had begun. The battle between Kohl and his challenger Schröder focused on domestic policy, and not the euro.

This didn't change after the election, either, no matter how many alarming messages Financial Attaché Stenglin sent to Bonn. On Oct. 1, he submitted a blunt analysis of the Italian fiscal policy, which he hid behind the harmless subject line "Italian Government Approves Draft for the 1999 Budget." Stenglin, who had been sent to Rome from his position at the Bundesbank, saw that the development in Italy was moving completely in the wrong direction. The Italian government's draft budget, he reported to Bonn, signified a "qualitative shift in budget policy."

According to Stenglin, the budget showed the lowest cost-cutting figures since the beginning of the consolidation course in the early 1990s. Additional tax revenues, he noted, would no longer be used solely to reduce the deficit, but also to pay for new spending, particularly on social programs. The government, Stenglin wrote, could not avoid giving the impression that it was "more interested in a departure from the strict consolidation course of recent years than in doing everything possible to set aside doubts concerning the sustainability of Italy's public finances."

When Prodi was replaced a short time later by former Communist Massimo d'Alema, the situation deteriorated even further. D'Alema proposed financing a European economic stimulus program through euro bonds and not factoring the associated expenditures into the national deficits.

The new SPD-Green Party coalition government in Germany, led by Schröder, rejected the proposal. Nevertheless, the new approach had taken hold in Rome, as Stenglin wrote in a cable to Bonn on Nov. 18. He noted that members of the Italian government were demanding that the budget consolidation be spread out, the stability pact be interpreted more flexibly and Italy be freed "from the shackles of the Maastricht Treaty."

The Maelstrom of Crisis

A few weeks before the launch of the common European currency, Stenglin's assessment of the situation took on a dramatic undertone, when he wrote: "The question arises as to whether a country with an extremely high debt ratio doesn't risk gambling away the success of its consolidation efforts to date, thereby harming not only itself, but also the monetary union." It was a prophetic remark. In the fall of 2011, when the country was pulled into the maelstrom of the crisis, the debt ratio had risen above 120 percent of GDP once again.

Kurt Biedenkopf, a member of the center-right Christian Democratic Union (CDU), predicted the dilemma in which the monetary union finds itself today even before the introduction of the euro. At the time, Biedenkopf was governor of the eastern state of Saxony -- and was the only German governor to vote against the monetary union in the Bundesrat, the legislative body that represents the German states. "Europe wasn't ready for that epochal step," says Biedenkopf today, noting that the individual countries differed too widely in terms of economic performance. "Most politicians in Germany thought that the euro would function even without common institutions and without financial transfers. That was naïve."

Meanwhile, European leaders are trying to correct the defects of the founding phase of the euro. Austerity and reform measures are being implemented in large parts of Europe, and all countries support the idea of joint responsibility for the currency. Nevertheless, the new euro architecture doesn't differ all that much from the old one.

When the euro was first designed, the government in Bonn believed that it was sufficient to stipulate stringent debt criteria in an agreement and to rely on its members to responsibly implement the necessary structural reforms. Today, Europe's new fiscal pact is intended to teach the member states solid budget management and foster a willingness to bring about reform. In other words, the original procedure, which was unable to survive its first stress test, has only been slightly modified. There is still no central institution that could forcibly impose the necessary discipline. Offenders will still pass judgment on other offenders within the circle of European heads of government.

No Solution Yet

The government files from the founding phase of the monetary union reveal that this construct cannot function. The message the documents convey is that political opportunism will ultimately prevail. A monetary union amounts to more than shifting several billion euros back and forth. It is also a community of fate. Shared money requires shared policy and, in the end, shared institutions.

The euro is now in its 14th year, and after two years of ongoing crisis, there is a growing realization in Berlin and other capitals that the status quo cannot continue. All reform efforts still resemble small steps to nowhere, and yet politicians are beginning to think in terms of broader categories as they cope with the crisis. The new fiscal pact is not providing a quick solution yet, and as a result European politicians are developing new visions while old taboos are falling.

While the southern countries and France are coming to terms with a debt brake based on the German model, the German government no longer has any objections to an economic government within the euro zone, a French idea to which Germany was once staunchly opposed. Finance Minister Wolfgang Schäuble, for his part, is considering upgrading the EU finance commissioner to a kind of European finance minister, who would monitor the budgets of euro-zone member states and would also have the power to intervene, if necessary.

All of these measures boil down to individual countries relinquishing more authority and the central government in Brussels acquiring more power in return.

If the members of the monetary union quickly make up for what they neglected before embarking on the euro adventure, the project of the century can still succeed. But the longer then necessary reforms are delayed, the more costly the journey becomes for everyone.

Translated from the German by Christopher Sultan


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