What Spain’s José Luis Zapatero does not know

THE EUROPEAN JOURNAL, AUGUST 2008:

Sara Moore explores current European Central Bank policy through the historical lens of how Germany used deflation in the Great Depression for political ends. Moore argues that Spain has lost patience with the ECB since it has had to endure high interest rates for the last year. It is therefore legitimate for Spain’s premier, Jose Luis Zapatero, today to ask: Is Germany using deflation today again for the same reason? Perhaps when Zapatero realises just how far Germany bore the responsibiliy for the Great Depression, he will be even more vociferous.

Spain’s premier Jose Luis Zapatero is an ardent European but he has lost patience with the ECB. Spain has had to endure high interest rates for the last year – with pain for her homebuyers because strong Germany said that she needed them to stop her workers making extravagant demands. Now Axel Weber of the Bundesbank seems to have successfully pushed for another rise in ECB interest rates, despite German consumer spending and industrial production easing, to curb the demands of its workers.

While British commentators, beset with their own inflation, might sympathise with Axel Weber’s efforts to damp down wage demands, they worry about something that Jose Luis does not know, that Germany has used ‘deflation’ before for political ends. In fact, Germany’s record in the Great Depression was appalling.

It is agreed that Germany had a more powerful economy by 1928 than in 1913 and in 1928/29 she had the additional financial advantage of not having to pay for howitzers and artillery and the 758,000 men Germany had in battle-readiness before the First World War. She waged a propaganda war over paying war reparations in the 1920s but the French financial controls over her economy from 1924 till 1929 ensured that the actual sums demanded were paid without a hitch. Indeed Germany was deemed so virtuous a payer in 1929, that it was decided that the French controls were superfluous.

Americans lent vast sums to Germany in the 1920s because they believed she was able to repay them. Less known are the large unidentified sums that Germans put on the American stock market between 1928 and 1929 because of worries about the arrival of a socialist government at home. The American stock market rose to dizzy heights as negotiators decided that they could trust Germany to pay her reparations and they gave her a generous new deal which meant she would be paying less in debt from the First World War than Britain.

Expectations were Olympian in 1929 and the stock market was fizzing. The agreement was signed in June but not finally agreed till the end of August. Still Wall Street went crazy but subterranean economic currents should have raised alarms. All the major nations were on the Gold Standard in 1929 and strong Germany was buying gold. Even in June her large purchases were disturbing; by the end of July an alarmed France decided to buy gold too. France and Germany’s gold purchases were so large that eventually Britain felt that she would have to raise her bank rate. Then German citizens began withdrawing their money from Wall Street. A petition was floated by Germany’s largest newspaper owner and leader of Germany’s second largest political party, Alfred Hugenberg, to have the whole German cabinet and even the President tried for treason, on the grounds that Germany had not started the First World War and was not therefore liable to pay any war reparations. The projected success of the petition caused a disastrous drop in the American stock market as insiders realised that not only German war reparations but also related allied war debts and even American loans to Germany might be at risk, indeed all the international community’s trust in Germany since the war could have been misplaced. The 1929 Wall Street crash was huge. Millions of life savings were swept away but insiders remained mute, hoping against hope that their fears about Germany were wrong. The evils of capitalism were blamed for the national disaster and Germany continued to pay war reparations, although now instead of industry it was mainly the man in the street asked to pay. In 1930, an ex-army officer, Heinrich Brüning, became chancellor of Germany.

He told his friends in the unions that his chief aim was to liberate Germany from paying war reparations and foreign debt – without telling them that he also hoped eventually to re-arm and return Germany to a patrician dictatorship! He argued that if he pursued a policy of deflation and diverted all Germany’s efforts into exports it would weaken the ability of America and the Allies to force Germany to pay her IOUs if she chose not to. The German unions therefore agreed to Brüning reducing wages raising taxes and imposing a poll tax on the German people, while diverting all the benefits into exports so as to bring pressure on the Western powers. German unemployment increased dramatically. A coalition government between left and right was formed before Brüning heaped on more taxes. The declaration of a customs union between German and Austria prompted France to withdraw her Austrian loans in protest, a banking crash ensued and Germany pleaded poverty. The abject misery of the German people helped soften the blow when Germany was given a reparations moratorium, even though she was the greatest exporter in the world, with a mountain of cash in the bank.

We must give modern Germany credit for bringing wages under under control and improving industrial efficiency after the unification of Germany. Indeed, this process continued into the 21st Century. After the arrival of the euro (accounting currency 1999, actual currency 2002) German workers suffered years of stagnant or declining wages, enabling the country to claw back 40 per cent in labour competitiveness against Italy 30 per cent against Spain and 20 per cent against France by 2007. Unfortunately, the sometimes disparagingly called ‘PIGS’ (Portugal, Italy, Greece and Spain) had reacted to the ECB’s initial low interest rate policy by stimulating their economies, paying their workers more and – especially in Spain - pumping up their property sectors in the tourist areas. However, they should have paid more attention to the economic policies of the European Union’s strongest state, Germany.

In November 2005, while the ECB gradually raised European interest rates, a German coalition government between left and right was formed to tackle the German budget deficit by raising taxes and cutting public spending. In 2007, the German government decided, in an admittedly pale comparison with 1930, to cut corporation tax and give other advantages to industry, and to raise VAT in order to pay for it. Naturally, the German unions asked for more money to compensate them for the hike in VAT but after wage increases of 4.1 per cent were agreed with Germany’s most powerful union, I G Metall, the head of the German Bundesbank, Axel Weber, declared that wage inflation was getting out of control, that there was a growth in the money supply, and that the ECB needed to raise interest rates again to curb it. In May, France’s bank chief, Christian Noyer, contradicted Weber’s comments on inflation; yet euroland interest rates were still raised to 4 per cent causing hardship for many Southern European countries and an escalation of the American subprime crisis.

Now Germany is pushing for still higher interest rates to control wage inflation, although she was able to control it effortlessly for years and was herself responsible for the inflation that persuaded I G Metall to ask for more money. There is genuine inflation in euroland because Indians, Chinese, Brazilians and other nations want to eat more and buy new motorcars. So the price of oil and food is going up everywhere. But will causing mortgage defaults and unemployment in Europe help solve the problem or just make people in Europe poorer? Germany used deflation in the Great Depression for political ends. It is legitimate for Jose Luis Zapetro today to ask: Is Germany using deflation today again for the same reason? When he knows just how far Germany bore the responsibiliy for the Great Depression he will be even more vociferous.