From Single Market (1992) to single currency (2002)

The years 1992-93 were not good ones for the EU (despite the achievement of a Single Market by January 1993) in so far as the two main elements of Maastricht, cooperation in foreign and security policy and Monetary Union, appeared to fail their first tests. These setbacks were largely due to German policy. In the Maastricht talks Germany wanted to see majority voting on at least some aspects of foreign and security policy. The UK opposed voting on foreign policy, and extension of EU power over foreign policy, as the UK believed no European government should find itself compelled or forbidden to use its forces. One reason for the German government’s eagerness on this issue was the desire to escape from its domestic and constitutional difficulties over the use of force. The British thought they should instead solve this internally and not expect Brussels and the EU to do the job for them. The EU’s fledgling CFSP was expected to emerge through discussion and mutually agreed intergovernmental decision. Yet in December 1991 Germany declared it would recognise Croatia and Slovenia within weeks regardless of what other states in the EC wanted. In the face of this threat of unilateral German action and the need to maintain some outward semblance of unity, however false, the EU reluctantly and half-heartedly recognised Slovenia and Croatia on 15 January 1992 and Bosnia on 6 April. This was accompanied by anguished recriminations and warnings that recognition would further inflame the Yugoslavian situation. Britain and France supported by Greece, Portugal and the Netherlands had agreed that premature recognition would provoke Serbia, especially the Yugoslavian Federal Army to step up their attacks on Croatia and break off their talks with the UN envoy Cyrus Vance, for the deployment of UN blue helmets. Why did Germany insist on recognition? The Yugoslavian crisis worsened

considerably in mid-1991 and Kohl wanted to recognise these two states then but was persuaded to delay this by Mitterand. These putative fledgling independent states craved and pleaded for recognition. Germany felt that they themselves had benefited from the principle of self-determination to legitimise reunification and so others should not be denied. Germany supported eventually by Denmark and Italy wanted to accelerate the recognition process because of the principle of self-determination and because they thought any

further delay in recognising Croatia and Slovenia would only encourage aggression by Serbian and the Yugoslav national army. Chancellor Kohl was also pressing for the early entry of Austria into the EU (achieved in the ‘Arctic-Alpine’ enlargement 1995, which admitted Sweden and Finland too). Kohl was effectively resurrecting an old zone of German influence that stretched from the Baltic to the Adriatic; a zone that had been dismantled twice before in 1918 and 1945. Germany could not remain indifferent to EE’s collapse and tried to establish stability where it could in the face of the withdrawal of Soviet influence, regime change and the Warsaw Pact’s dissolution. Germany was ‘filling’ part of the vacuum left behind. Moreover Kohl in 1991, had against the Bundesbank’s advice, traded in the Deutschmark for the euro, so facilitating the French goal of EMU. He was, however, disappointed and dissatisfied that the crafty guileful Mitterand had not done more to deliver or help achieve political union but had in fact aligned himself with the British. Kohl realised in December 1991 that France would not co-sponsor the political federation of Europe that he wanted and insisted upon as the quid pro quo for EMU. This helps to explain Kohl’s rebellious foreign policy over the Balkans in 1991. For Mitterand it was a heavy blow when Chancellor Kohl broke ranks for

the first time and the EU and France were forced to fall into line behind the Germans over recognition. From then on, in the last four years of his second Presidency, Mitterand was preoccupied in Franco-German relations with trying to regain the initiative. Resorting to dramatic happenings and gimmicks supposedly pregnant with symbolism; being photographed holding Kohl’s hand at Verdun; German troops in the Bastille Day Parade. Given the wanton and reckless violence of the Yugoslavian civil wars seen nightly on TV, public opinion did not react against recognition even if they had noticed. Germany, though, had prioritised its national interest at the expense of any

attempt to achieve an agreed common policy. The EC itself was also deficient as Kramer (JCMS 31/2/93) has shown. From early 1991 the EC was negotiating a trade and cooperation agreement with Yugoslavia in Belgrade, yet it failed to appreciate the seriousness of Yugoslavia’s problems and was completely unable to use negotiations on trade as a lever to achieve the EC’s preferred long-term aim of keeping the Yugoslavian federation intact (Heinz Kramer ‘The EC response to new Eastern Europe’ JCMS 31/2/93 fn.27). By October 1991 the EC was threatening economic sanctions, a complete

trade ban against Yugoslavia, if the latest peace accord signed in The Hague was not observed. Successive ceasefires having previously collapsed (Independent 7/10/91), Yugoslavia’s civil wars were not spontaneous eruptions of ancestral, tribal animosity although the region as a whole reputedly enjoyed reopening old wounds and parading their victim status. The wars were started by Serb, Slovene, Croat and Bosnian independence leaders. Among these Slobodan Milosevic, Serbian President, was the eminence grise behind the carnage, ethnic-cleansing genocide. (A. Russell, Telegraph 6/10/00). No Western organisation, power, authority or force could have prevented the

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Yugoslavian civil wars. (S. Eyal, Independent 30/9/92). Milosevic primed and armed the Croatian Serbs. He bolstered Radovan Karadzic, the Bosnian Serb leader. As President of Serbia, Milosevic delivered a rabble-rousing speech to hundreds of Serbs in Kosovo. He instigated and lost four wars (in Croatia 1991, Bosnia 1992-95, repression in Kosovo; and in 1999 in a 78-day air war with NATO lost control of Kosovo). He saw Yugoslavia shrink from six to two states, and reduced a once proud Serbia to a pariah status in less than a decade. Milosevic signed the Dayton Peace Plan in 1995 ending the war in Bosnia and was acclaimed briefly as a peacemaker by the West! Milosevic was a sly, ruthless multifaceted politician (communist, pan-Serb nationalist, the ‘Butcher of the Balkans’, rabble-rouser, statesman, defendant in the International Criminal Court at the Hague). Milosevic deceived diplomats and envoys (DT 6/10/00). It was with Milosevic and his nationalist Serb henchmen that the EC

assumed the prime role of bringing calm and order to the region. The CSCE and the Council of Europe were sidelined despite perhaps being better placed to discuss and maybe help resolve territorial disputes as CSCE did include USSR and other communist East European states. As it was, little Luxembourg in the rotating Presidency of the EC had the nerve and effrontery to inform Croatia and Slovenia that they were too small to be ‘viable’ independent states (J. Eyal, DT 30/9/92). Jacques Poos, the then Luxembourg Foreign Minister, flew into Belgrade claiming vaingloriously ‘this is the hour of Europe, not the hour of the Americans’, almost as the first shots were fired. Of course what was to finally stop Serb aggression was American-led NATO military intervention; nothing else succeeded. Brussels threatened dire consequences if ceasefires negotiated with EC envoys were not kept. Milosevic correctly assessed that the EU might bark but couldn’t bite and carried on fighting. The EC’s conference on Yugoslavia under the Chairmanship of Lord Carrington got nowhere. The EC blundered into the Yugoslavian conflict despite being a wholly civilian soft power whose limitations were only too apparent once serious fighting was under way. The EC monitors (observers) were never intended to stop violence and were almost wholly ineffectual. Failure to find a peace agreement or maintain a ceasefire showed the EC lacked diplomatic power. In October 1991, partly in response to these developments and also in the

lead-up to Maastricht, a Franco-German proposal for a Eurocorps was announced, intended as the embryonic future multinational European Army. Paradoxically like the EDC scheme of 1950 to counter Soviet communist expansion, this new proposal was made as communism disintegrated. Mitterand envisaged European Defence becoming the direct responsibility of the EC with the WEU (whose members were all in the EC) being Europe’s defence pillar. The UK et al. Atlanticists were very much opposed to this and insisted (in a faithful echo of her preference in the 1950s) that the proposed WEU force should be autonomous, constituted within NATO and outside EC

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control but ‘linked to both and subordinated to neither’ (Dedman and Fleay, 1992). The EU passed responsibility in Yugoslavia over to the UN. The UN used

NATO peacekeepers on the ground. The US refused to supply ground troops and Germany was constitutionally unable to do so. The UN failed to protect civilians in Srebrenica, Sarajevo or elsewhere, (European-led) NATO forces were humiliated when four hundred troops were taken hostage, and it took six weeks to deploy the Rapid Reaction Force. The European-led NATO role was as subcontractor to the UN, its operations limited to fulfilling UN resolutions. UN approval was required for NATO air strikes. European states like UK and France were reluctant to get too embroiled in Yugoslavia. Foreign Ministers had long memories concerning the nineteenth-century ‘Eastern Question’; arguably the opening shot of the Great War was fired here; and the French had had a Foreign Minister shot in the Balkans in the 1930s. Like Bismarck all were wary of the Balkans trap. Bismarck memorably quipped that the area was not worth ‘the bones of one Pomeranian Grenadier’ and that ‘ … one must give these sheep stealers plainly to understand that European governments have no need to harness themselves to their lusts and rivalries’. For President Clinton and the US administration this was not the ‘Eastern

Question’ but, as they saw it, a fire in the heart of Europe 400 miles south of Munich and five hundred miles north of Athens. The US let Europeans take the lead in NATO’s involvement there but considered them far too timid. The US wanted to assist Bosnia via a ‘strike and lift’ strategy (bomb Serb

forces and lift the arms embargo on Muslims fighting there). The Europeans led by Douglas Hurd cautioned against this policy. As Kramer said, far from there being a new security order in Europe, post-communism, of interlocking institutions it was more a case of the UN, NATO, CSCE et al. in Yugoslavia making a ‘disorder of inter-blocking institutions’ (Kramer, 1993). In the end a combination of ground troops, air power (including American)

and economic sanctions by 1993-94 brought the fighting to an end in Croatia, around Sarajevo and in Central Bosnia. The use of bombs drove the Serbs to the Dayton talks. In 1999 Milosevic’s refusal to sign a peace plan for Kosovo led to a 78-day air war (NATO bombing from 15,000 feet) ensuring he lost control of Kosovo and had to allow NATO ground troops into Kosovo, ultimately an operation that was an unqualified success in saving lives. It also showed what could have been achieved by earlier intervention. The second reason why the years 1992-93 were not good ones for the EU

was that successive currency crises within the ERM 1992-93 (September 1992, February 1993 and August 1993) threatened the entire EMU project and overshadowed the start of the Single Market in 1993. The ERM was at the very heart of the Maastricht Treaty, part of a long-term French goal of getting their hands on the Bundesbank via EMU and European Central Bank (ECB) and wresting political control of interest rate and exchange rates away from Germany and Bundesbank via monetary integration (see Connelly, 1995;

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Dyson 1994, p. 306). The ERM system of fixed exchange rates was originally established in 1979 with Italy, Belgium, Holland, Ireland and Luxembourg taking part in a Franco-German initiative the aim of which was to restrict fluctuations among participating currencies and achieve monetary stability in the wake of a collapsing $USD (Dyson, 1994, p. 313). A middle exchange rate was fixed and some maximum permitted variations of +/-2¼ per cent was allowed within this band. Under ERM rules the participating Central Banks cooperated and colluded in buying and selling currencies to keep them within this narrow band, in order to avoid problems of ‘competitive devaluation’ and also with changes to the real values of CAP payments and other transfers inside the EC. The independent Bundesbank, guardian of the DM that had never deva-

lued and also markets were certain would never devalue within the ERM, was seen by all as the anchor of the ERM system. From this certainty everything else flowed. The ERM was effectively a ‘DM-zone’. Early on there had been revaluations and currency realignments (changing their relative values) in the European Monetary System (EMS). From 1983 though (following the currency crisis and ERM realignment) France followed a ‘Franc-fort’ policy crucial to its long-term goal of regaining some control in setting interest rates. From 1987 (and yet another currency crisis and ERM realignment) to 1992 there were no more realignments. A huge amount of political capital was expended on the monetary virility symbol of the Franc-fort. The policy was very painful for the French economy as it meant disinflation and a high interest rate (higher than the Bundesbank’s) as the French Franc was not as strong as the Deutschmark and so there was a higher risk involved in holding it. The Franc-fort meant the subordination of French domestic monetary policy interests to French foreign economic policy aims. The Franc-fort policy elevated France (it believed) to co-leadership status at least with Germany in the EC. It became ‘impossible’ for the French to devalue the Franc as this would necessitate abandoning the Franc-fort policy that French corporations, trade unions as well as the government had bought into. To devalue the Franc would have revealed the policy to be fundamentally flawed and misconceived as domestic economic policy. It was not possible for a French government to openly accept permanent membership of a DM-zone. The Franco-German pact since 1951 was based on equality of status, even though in practice it meant decades of French leadership. However, France was not prepared to accept German leadership and so be relegated to a follower role, hence the Franc-fort policy. In reality France was pursuing a similar economic policy to its bloc d’or

policy of the 1930s when France remained on the Gold Standard after the UK and USA had abandoned it, with highly deflationary effects. The Francfort necessitated a high interest rate and resulted in unemployment of 12 per cent. Mitterand may have persuaded Kohl to adopt EMU at Maastricht but the independent Bundesbank took a different view. Other sources might convey an impression that Maastricht saw governments’ institutions

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cooperating harmoniously in the construction of Monetary Union. In reality the Governor of the Bundesbank, Dr Schlesinger, hated the ERM and the whole EMU project although he had little choice except to act as Kohl’s agent in delivering EMU. Problems within the ERM only really arose because of German reunifica-

tion’s induced inflation. By 1994 the German Unity Fund had spent DM115 billion. In 1991 25 per cent of the Federal German Budget was spent in the East (over DM90 billion) financed by government borrowing. Germany also paid out DM50 billion to the states of the former Soviet Union for withdrawing forces from East Germany. The cost of moving the German parliament and government apparatus to Berlin from Bonn was put at DM100 billion spread over a decade. There were other costs too; compensating former property owners in East Germany; debts of East German firms that could not be sold off and more. The point was that these expenditures were not covered by any increase in GDP due to enlargement. German GDP only rose by 10 per cent with reunification but German population rose by 27 per cent. Public sector debt in 1992 rose consequently from 5 per cent to 7 per cent of German GDP and this pushed up inflation from 4 to 5 per cent which meant that the Bundesbank’s interest rates increased to combat inflation. In the 1980s the FRG had had a current account surplus (due to an export

surplus); this changed in the first quarter of 1991 when Germany’s current account became negative (a net importer) and international investors became nervous. Uncertainty had increased by 1992 as Germany was unable to meet all the Maastricht criteria for joining the single currency due to high inflation and budget deficits. Higher German interest rates meant that the UK and other ERM states’

interest rates were higher still. By June 1992 the UK base rate was 10 per cent (and it had been even higher at 15 per cent, October 89-October 90). This meant that classic interest-rate sensitive areas of the economy (like housing) were depressed tipping the UK into recession. Base rates were estimated to be between 1 per cent and 2 per cent higher because of the ERM (T. Congdon, Lothian Foundation, 1992). Overall EU growth was estimated to be 0.5 per cent lower because of the ERM. John Major had forced the UK into the ERM in 1990 and took Britain to the brink of bankruptcy in 1992. The ERM was a trap because markets came to suspect that the fixed

exchange rates were unrealistic and wrong given that there had been no changes in the system or realignments in 1987-92. The UK had had to devalue before in 1947 and 1967 and the markets began testing sterling’s fixed exchange rate. This was a safe ‘one way bet’; speculators could not lose. Suspecting a future depreciation, speculators sold sterling to buy Deutschmarks. When sterling was forced to devalue they would buy back more sterling with the more valuable Deutschmarks, making a good risk-free profit. If sterling didn’t devalue speculators were still holding Deutschmarks and lost nothing. The ERM/sterling crisis of September 1992 was preceded by a run on the

Finnish Markka which had been pegged to the ERM as their own version of

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a Markka-fort policy. The Markka shadowed the ERM but without any of its support mechanisms. Finnish interest rates were forced up to 18 per cent but the speculation meant Finland abandoned the peg and the Markka fell by 15 per cent in value giving speculators a big immediate profit. The Italian lira then became a target as markets had heard rumours of ERM realignments and massive intervention was required to defend the peg which ultimately led to unilateral devaluation. Markets then saw sterling as the one-way bet, on 15 September sterling sold heavily as foreign-exchange markets and the pound closed barely above its ERM floor. In the midst of the crisis during an early evening meeting (15 September 1992) of Bank of England and Treasury officials to discuss strategy for the next day (some advised putting the rate up to 12 per cent before the markets opened). The Governor of the Bank of England, Robin Leigh-Pemberton, read out loud a message from his press office. Dr Helmut Schlesinger, President of the Bundesbank, had given an interview casting doubt about whether existing parities (exchange rates) would hold – a very clear hint that he thought sterling would depreciate. The meeting was stunned by this devastating indiscretion and public admission that the game was nearly up. The end came the following afternoon at 2.15 p.m. after interest rates were briefly hiked to 15 per cent which didn’t work and ERM membership was suspended. Britain had spent £11 billion in reserves, 50 per cent of its total trying to defend its fixed rate (Will Hutton, Guardian 1/12/92). Interestingly, the day Hutton’s piece appeared on the ‘History of Black Wednesday’, Schlesinger made a scathing attack on the ERM calling it ‘a machine for enriching speculators’, which of course it was, especially for George Soros’ hedge fund. Dr Helmut Schlesinger, the hard-nosed President of the Bundesbank,

blamed by the British government for sabotaging the pound sterling in September 1992, refused the following year, in August 1993, to reduce Germany’s discount rate (the DM rate being the ‘floor’ for all other rates) to save the French Franc and the ERM. Schlesinger supposedly refused to reduce the rate as it would have undermined the Bundesbank’s credibility and corrupt it’s principle of using interest rate changes only to maintain price stability. Hans Tietmeyer, his deputy, argued in favour of the wider European interest and reducing the rate to help the French Franc. Schlesinger was quoted as saying that ‘domestically there was no clear indication to support another reduction in interest rates’. Germany’s domestic interests had apparently come first. There was shocked amazement in Paris dealing rooms that the Bundesbank had left their discount rate unchanged in France’s hour of need. Dealers were left stunned and incredulous. Article 109 of the Maastricht Treaty specified that until the start of the third stage of EMU member states were supposed to treat exchange-rate policy as a matter of common interest, Since the 1980s the Franc-fort and the link between the Franc and the

Mark had been the cornerstone of Paris’s economic policy and was the string holding the Paris-Bonn axis together. (This bond in Franco-German bargaining relations is often described as bound by ‘cords of steel’ (Dyson, 1994,

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p. 339).) However, the whistle blower and ex-Monetary Commissioner of the EU Bernard Connelly (1995) pointed out that Schlesinger refused to act to defend the French Franc as he was enraged by Mitterrand’s treachery over the ECB. In a TV broadcast before the French Referendum on the Maastricht Treaty in 1992 (which was also quite anti-German in tone) Mitterand said the ECB would not be left in the control of central bankers but politicians would decide monetary policy especially exchange-rate policy. ECB technocrats would apply the decisions of the European Council, the ECB would not really be independent. Mitterrand’s interpretation was diametrically opposed to the Bundesbank’s and effectively amounted to a ‘re-writing’ of the Maastricht Treaty. Schlesinger (perhaps ignoring its context?) was according to Connelly deliberately punishing France for such treachery. At the time the EMU project looked seriously, perhaps fatally damaged.

The ERM had in any case generated the worst slump in the UK and elsewhere since the early 1980s with stagflation in the UK. In France the economy only had 2 per cent inflation but an interest rate of 13 per cent meant high unemployment of three million plus, over 12 per cent of the labour force. Germany’s economic conditions were worsening yet decades of DM currency stability meant investors happily held on to DMs, so other currencies had to pay higher interest rates to attract funds. The reunification of the FRG and GDR, as we have seen, meant public spending increased dramatically and therefore inflation. The Bundesbank responded by increasing the interest rate to its highest level in thirty years. All other ERM state’s interest rates needed to be higher still. One possible solution to this predicament would have been to allow the

DM to rise sharply in value (a revaluation) as then Germany’s import prices would be reduced, inflation would fall and the Bundesbank could lower its interest rate. This was unacceptable to France as the Franc-fort policy since 1983 was effectively holy writ (a strategy widely supported in corporatist France determined not to use devaluation again as a solution to the country’s economic problems). Only this could deliver monetary union which would give France real influence again over their own interest rate. Regaining some economic control was referred to as ‘symetrie’ in French political circles but there was nothing symmetrical about it as their intention was French control over German monetary policy by controlling the ECB (The Economist 31/5/ 1997). This strategy would be imperilled by French devaluation via a DM revaluation. So France ruled out a general ERM realignment against the DM, as ten years of monetary policy and deflationary economic pain would have been for nothing. Such inflexibility meant that the ERM snapped because it would not bend.

Anglo-Saxon speculators were blamed but in the end it was large French corporations that were the big sellers of the FF, effectively putting profit before sentiment. The ERM’s narrow bands of 2.25 per cent were widened to 15 per cent to prevent any further speculation. Effectively the ERM ceased to exist in practice; it still existed in name but with such incredibly wide buffers