Rising inflation devalues people’s money. Politicians did everything to make it happen. Now she would have to intervene courageously, which would cost every politician their career. Nobody dares. There is an example of this.
A backroom deal between statesmen, a treaty that’s not worth the paper it’s written on, and politicians reluctant to make unpopular decisions – these are the real reasons behind runaway inflation in the euro area.
This birth defect of the euro, combined with the effects of the global pandemic and a war that is sending energy prices skyrocketing, is the cocktail that is allowing inflation to thrive. Paddling steps by the European Central Bank, which now wants to raise interest rates to curb inflation, will not be enough to stop them.
The backroom deal was one that the fathers of the euro, French President François Mitterand and German Chancellor Helmut Kohl, engineered in a sort of male friendship typical of the time, and especially Kohl’s.
It went like this: The guardian of the euro, the European Central Bank, is based in Frankfurt and is independent on paper. Kohl prevailed. But even then your boss was not allowed to be a German. This is no different to this day and Mitterand prevailed. Because the Germans, as the French President knew, have an aversion to inflation, although it is inflation that makes it easier for them to go into debt, which is what every politician who wants to be elected thanks to his good deeds needs.
Mitterand’s calculation worked. On the other hand, Kohl’s hope of having done enough for an ECB, which should pursue monetary stability as the primary goal, by being formally independent and based in Germany, was not fulfilled.
Instead, the ECB got caught between the mills of national politics: Here the countries, primarily in southern Europe, which were used to inflating their debts, and there the countries, especially in the north, who were trying to keep budgets under control to such an extent that Debt remained fundable.
Because it was clear that both systems did not fit under one roof or in one currency, the member states of the euro invented the EU convergence criteria and wrote them down in the 1992 Maastricht Treaty. Above all, it states that government debt must not exceed 60 percent of gross domestic product. This criterion has been constantly broken since it came into force.
Greece and Italy have always been far from it, Spain and France are now at about twice the level of debt. And Germany, where the debt brake is only suspended because of the Corona and now because of the Ukraine crisis, or – as in the case of the new 100 billion debt for the Bundeswehr – can be circumvented, has also lost sight of the goal.
However, different ways of dealing with debt lead to tensions in a common currency area, because at some point the rich will have to pay for the poor. The debt crisis in the euro area was born, from which the countries could no longer find their way out on their own, which is why the then Italian ECB President Mario Draghi tight-lipped his famous “What ever it takes” in 2012.
It ultimately meant that the ECB would keep printing euro bills until everyone was able to get their debts under control. The “what ever it takes” that Draghi confessed to because of the euro rescue was salvation at the time. From today’s perspective, it is the origin of runaway inflation.
Because the money supply in Europe increased by leaps and bounds. Since the debt crisis, it has increased sevenfold to around 8.8 trillion euros. Only a small part of this is justified by the economic growth in the euro area. The rest comes from the printing press and has led to inflation in most asset classes: first in real estate, then in shares, and finally also in commodities.
Demand skyrocketed, all that money had to go somewhere. However, when the pandemic drastically reduced supply, consumer prices rose and suddenly inflation became apparent.
What happened next should never have been done by an ECB committed to price stability, but now it was taking revenge that Kohl had once created its formal independence and now nobody could interfere with it.
From two percent inflation, the ECB first made a “target corridor” of two percent and then a “symmetrical inflation target” of two percent, which in the end means something like: It is enough to be below two percent for a few years, then a few years are not so bad about it. The ECB decision-makers initially around Draghi and then around his French successor Christine Lagarde did not care that inflation tends to grow exponentially and can suddenly gallop from a leisurely pace like a runaway horse.
If this was the first betrayal of price stability, the second soon followed. Again, it was politics that set the tone, and again it was the ECB that then let nothing and no one dissuade them from following it. When the EU, led by its President Ursula von der Leyen, announced the Green Deal and thus gave top priority to the goal of climate neutrality, the Governing Council of the ECB decided in July 2021 to also be driven by climate protection goals in its decisions.
The ECB accepted the fact that its only mandate, namely to guarantee monetary stability, was ruined, and the national governments even applauded. For them it was finally clear: the ECB would never thwart their plans.
Since then, national and EU-wide corona reconstruction programs worth billions have been launched. The increase in military spending in the EU member states and a subsidy for energy prices, as decided by most national EU parliaments, lead to further burdens worth billions that can be financed as long as the ECB keeps interest rates low – but with it inflation granted free rein.
The manageable rate hikes that Lagarde has now announced are the compromise in a dilemma where, in truth, there are always only two bad solutions.
The last time inflation rates like those experienced in the euro zone and the USA were at the end of the 1970s. The then US President Jimmy Carter put the tough economist Paul Volcker at the head of the central bank as his last reserve. As one of his first official acts, he drastically increased interest rates to up to 20 percent.
Inflation, which had been up to 15 percent at the time, collapsed immediately. The US, however, slid into a recession that eventually swept away Jimmy Charter. So far, nobody in Europe can and wants to take this step.
Surftipp: Finanzwelt – ECB explains: Tasks and goals of the European Central Bank
The article “A double betrayal and a backroom deal are the real reasons for the price chaos” comes from WirtschaftsKurier.
