Monetary Leadership After Maastricht
Jude Wanniski and David Goldman
September 17, 1992


Only months ago, it was hard to peruse a business publication without finding a sermon on the superiority of Europe's top-down form of economic management. We were told ad nauseam of how, after unification, the European economic behemoth would topple the U.S. from its position of world economic leadership. On the contrary, we read the Maastricht Treaty as the last dying gasp of Europe's Cold War bureaucracy, not the wave of the future. What do the provincial Landesbank presidents who control the Bundesbank have in common with rock-throwing youths in Rostock? Perhaps it is an overpowering urge to reject the responsibilities which Germany accepted so reluctantly under conditions of cold war. The Bundesbank is saying: "We do not want a German tax subsidy to support the economic refugees of Maastricht. Leave us alone to remain an ordinary country with provincial concerns."

This leadership vacuum can only be filled by the United States. There is no other economic superpower capable of assuming the burden of monetary leadership -- which the U.S. shrugged off in August 1971 by simply walking away from the Bretton Woods system that had been established in 1944. What are the chances of this happening at this moment of turbulence and uncertainty? Not very great, as the White House is subsumed by an election campaign that seems increasingly unwinnable. The Treasury Department, which would normally take a lead role in such matters, as it did in 1944, is occupied by a Secretary who has negative understanding of international money and banking. The International Monetary Fund holds its annual meeting Sunday in Washington and as far as we know there is not even a plan for the President to attend.

On the positive side is the fact that White House chief-of-staff James Baker III is among the few people in the Bush Administration who understand perfectly well what is happening in Europe and, we think, what might be done about it. It was Baker as Treasury Secretary in September 1987, after all, who told the IMF gathering in Washington that a new international monetary regime should be developed, not with the dollar at the center of the system, but with an independent reference point, an independent arbiter of central bank error -- "a commodity basket, including gold." It was precisely because such a system was not in place that the stock market crashed on Wall Street one month later, and amidst the debris, Baker's IMF speech was forgotten.

Forgotten by all, that is, but the Federal Reserve governors and Chairman Alan Greenspan, who have since 1987 directed the Fed's energies at stabilizing the dollar -- not against other currencies, but against a commodity basket, including gold, which trades almost exactly at $350 today, ten times the old Bretton Woods parity. The time is ideal for a return to a dollar standard. If he would choose to do so, President Bush now has the platform from which to launch Baker's 1987 plan.

The equanimity with which U.S. securities markets reacted to events across the Atlantic provides fresh support for Greenspan's position. With the dollar stable against gold, the world market is unconcerned about wild swings in currency parities. Otherwise, the short-run effects of Britain's departure from the exchange-rate mechanism of the European Monetary System are entirely positive, as today's 4% rally on the London stock exchange makes clear. In a Baker regime, sterling would be seen not as devaluing at all, but  as a freeing of itself from the Deutschemark appreciation, Frankfurt's monetary death-grip. For a world economy in recession, the broader consequences of the Exchange Rate Mechanism's collapse are indeed of great concern. Europe founded its now-shattered regime of fixed exchange rates in 1978, at the height of the Carter Treasury's enthusiasm for dollar devaluation. This was a response to America's abdication of leadership in world monetary affairs. If Washington fails to offer leadership, the disintegration of the world's only group of stable currencies bodes ill for world trade.

German politicians after the collapse of Communism are like goldfish dumped from the bowl into the bathtub; they continue to swim in tight circles. Since the founding of NATO and the European Community, Germans have grimly tolerated institutions which made them the battleground in the event of war on Europe's central front, and the checkbook for the European Community institutions which underwrote Europe's political stability. Instead of overhauling this oligopolistic, bureaucratic system which suppresses individual initiative, Germany's leaders have pressed on their people even more taxes, to subsidize the Eastern provinces and the weaker European economies. Germans cannot throw rocks at Brussels bureaucrats, so they throw them at Eastern European refugees.

In retrospect, it is no surprise that Germany's institutions, imposed as they were by the Allied occupation, have failed to adapt to the great changes in the shape of the world. The issue today is not simply the Bundesbank's egregious blunders in monetary policy -- which virtually all world opinion abhors -- but Germany's incapacity to back away from these blunders. Just before Hurricane Maastricht struck the foreign exchange markets, the Bonn government was preparing an income-tax surcharge to finance the "costs of reunification." The failure of Germany's Eastern states to recover following reunification, though, stems from the imposition of the world's most oppressive tax system on a part of Germany which resembles a developing country. East Germany fell prostrate under the combined weight of taxes which the wealthier West could bear. Bonn discovered that the Eastern subsidy had no bottom. Raising taxes to pay for the subsidy will continue the vicious cycle.

It is remarkable that not a single voice has been raised in German public life against the fiscal origin of the present crisis. Why, indeed, does the Bundesbank persist in deflating the German economy, when all of world opinion is arrayed against it? Through Frankfurt's prism, Germany must inevitably reduce demand for money by raising taxes, so the central bank must reduce the supply of money in compensation. As it happens, the Bundesbank provoked enormous demand for liquidity, as investors accumulated DM liabilities and dollar assets in anticipation of an eventual fall in the DM exchange rate. Relentlessly, the Bundesbank tightened further, ultimately causing the present crisis. Germany does not have a problem with reunification as such, but rather a problem integrating an economically depressed region into a bad fiscal system. Without addressing the fiscal origins of the crisis, all of the Bundesbank's monetary choices seem problematic. Eventually, we believe, Frankfurt's resolve to pursue deflation will crack under the combined pressure of Germany's economic decline and Europe's political crisis. For this reason, we continue to foresee a dollar that remains steady against gold and strengthens against the DM.

It is not surprising that the Bundesbank failed to change its official lending rates today; to have done so would have compromised Frankfurt's credibility, at least the way the Bundesbank sees things. We are encouraged, though, that the money rate in the German market fell about 50 basis points overnight, to just over 9%. Although it is difficult to draw conclusions from short-term money market behavior under chaotic conditions, the Bundesbank does seem to be leaning towards ease. We think the most likely scenario involves an easing of Bundesbank monetary policy after a brief face-saving interval, perhaps just after next week's International Monetary Fund gathering. In this case, world securities markets would react positively. They would act even more positively if the White House and President Bush accept the challenge of monetary leadership, an opportunity this crisis presents.