Why Won’t Germany Turn? Joseph Halevi’s insightful analysis, circa 1995

The question οn almost everyone’s lips is: “How long before Germany recognises that a new architecture is necessary to keep the Eurozone together?” Implicit in the question is a mistaken premise: that Germany’s view of the Eurozone is wrong, that its stance is predicated upon a mistaken analysis concerning the nature of Europe’s macroeconomy. Recently, I posted an insightful paper by Heiner Flessback which depicts the peculiar case of German mercantilism within our common currency area; a strategy that has paid off in the short run for Germany but which will most certainly be the death knell of the common currency from which it benefitted. Today I want to dig deeper with the help of a great economist, a reliable friend and an infuriating co-author: Joseph Halevi. More precisely, I shall draw on a remarkably prescient paper that he wrote in the early 1990s and which was published in 1995 as part of a long-forgotten volume edited by Victoria Chick. In the chapter-paper entitled The EMS and the Bundesbank in Europe, Joseph mapped out Germany’s strategy for the Eurozone in a manner that throws crucial ‘new’ light on Europe’s current trials and tribulations.

In the paper (a scanned, and rather heavy, version of which you can download and print here), Joseph argues that the Bundesbank’s commitment to monetarist orthodoxy has very little to do with either a psychological leftover of Weimar or some theoretical view on the universal merits of a strong currency as a prerequisite for long term growth. Instead, Halevi argues that to understand the Bundesbank time-honoured determination to tight monetarist policy even in recessionary times, we must first grasp the structure of German capitalism and, in particular, the shifting, agonising, closely-knit relationship between German industry, German finance and, of course, the Bundesbank. Such a close reading of the German economy, and its interaction with the Rest of Europe, with Japan (and later China) and the United States, reveals a clear picture of a major economy that operates as a source of deflation for the Rest of Europe (RoE henceforth).

Halevi’s analytical perspective is mainly based on two insights. The first is John Maynard Keynes’ view, which he expounded with all the strength he could muster in the Bretton Woods Conference (in 1944), that if the burden of adjustment falls (during a recession) primarily on the deficit members of a currency union, the result will be that the recession will spread to the surplus countries and the union will come to a grinding halt. The second is Michal Kalecki’s view (expressed eloquently in a 1946 paper entitled ‘Multilateralism and Full Employment’[1]) that a recession in the deficit countries may never result in a restoration of the balance of payments (between deficit and surplus countries) even if the exchange rates are fully free-floating and thus adjustable. It all depends, argued Kalecki, on the extend to which the surplus countries’ exporters exercise oligopoly power not only within the nations where they are based but also depending on their capacity to extend such price-setting power beyond their borders. It was, in other words, as if Kalecki was writing about the Germany that was to emerge, following the Marshall Plan, in the mid-1950s.

Halevi, standing on the shoulders of these two substantial insights by Keynes and Kalecki, goes on to suggest that the German post-war economic miracle must be divided in three phases: The first fifteen years after Bretton Woods (1945-1960), during which Germany’s reconstruction was contributing to a virtuous cycle for the whole of Europe (courtesy of the strong influence of US-controlled institutions), a second short phase that spanned the 1960s (during which a mighty tension emerged within the European Economic Community’s balance of payments), and another phase after the end of Bretton Woods (when Germany’s role as a deflation-exporter (to the RoE) was firmly established.

Halevi’s strength lies in his analysis of the nexus linking German industry’s oligopolistic structure with the German banking sector. During the first two phases (1940s to 1971), German banks were borrowing short and lending to industry long, thus making its necessary for the Bundesbank to keep inflation on a very tight leash so as to facilitate this form of financing of the German miracle; a form of financing that made it possible for German manufacturers to retain a degree of price and output inflexibility (at times of mild reductions in demand) not available to their American, British and French competitors. In short, a tight monetary policy by the Bundesbank was a prerequisite for the maintenance of the industrial-financial complex that propelled Germany to a dominant role within Europe at a time when the western word lived under, effectively, fixed exchange rates linked to the dollar.

When Bretton Woods died, in 1971-2, and the DM rose in value (as it would now if the euro breaks down), the Bundesbank oversaw a large shift in German finance from what Halevi describes as ‘extensive’ to ‘intensive’. From a situation where Germany was exporting industrial goods and importing labour (including Greeks) plus finance capital from abroad, it shifted to a new posture: it exported advanced industrial products plus financial capital (now that the DM had appreciated) while importing low level industrial goods. It was indeed the Bundesbank that, during that transition, pressurised German companies to turn to financing external to their usual ‘comfort zone’. How? By guiding Frankfurt, i.e. Germany’s large banks, to extend the length of their money contracts.

Halevi warns his readers time and again against the mistake of associating causally the impressive productivity of German industry with a normative evaluation of its price stability. He challenges the views of two great scholars that he evidently admires: R. Hilferding and J. Schumpeter. The two men had presumed that, because German capitalism had utilised effectively corporatist structures for planning markets, Germany’s ‘trustified’ capitalism would be immune to crises of aggregate demand. Halevi challenges this view, arguing with Kalecki that, while trustification and corporatism did give German capitalism a capacity to accumulate and hoard productive capital over and above the level of its neighbours, it does not shield it, in the end, from recessionary forces. Indeed, German corporatism generates recessionary forces from within and has a tendency to export them without.

Turning again to the Bundesbank’s crucial role, Halevi argues that during the post oil-crisis global stagnation, the Bundesbank was dead keen to avert a situation in which German foreign direct investment abroad was financed through liabilities against Germany itself. So, the only way that German industry could extend its reach, and establish foreign productive facilities, without such liabilities, was to finance their outward expansion through aggressive trade surpluses with the RoE. Halevi’s interesting point was that this did not simply transpire; that it was not just a result of markets-at-work, but that it was an outcome designed and directed, to a large extent, by a Bundesbank dead keen to preserve German finance under strict German (and Bundesbank) control.

The strategy worked well from 1980 to 1985, at a time when the dollar was rising and the US was sucking in Germany’s net exports. In the meantime, with Germany sitting on its surpluses and with European currencies pegged on the DM, the RoE was becoming a source of increasing demand for Germany while transforming itself into Germany’s periphery. And what does periphery mean in this context? Halevi’s answer is: an economic vital space that provides demand but which grows slower (than Germany) during the good times and contracts faster during the downturn.

Then, in 1989, came reunification. And with it came new challenges for the Bundesbank’s game plan. Germany, almost overnight, lost its surplus position (like the US had in the late 1960s). The RoE could no longer finance the expansion of German multinationals abroad. At that point, they turned to the financial markets for a source of financing, as well as to squeezing their own labour, in a manner so vividly explained by Heiner here. Throughout this phase, the Bundesbank was tightening more and more monetary policy in a bid to deflect deflation, via the circuits of German oligopoly power, to France and to Italy. Alas, one obstacle came in its way: competitive devaluations by the Bank of Italy and the Bank of France. It was these devaluations, and the threat they posed to the capacity of German capital to accumulate, that are at the heart of Germany’s decision to accept the French (Mitterand-inspired) plan for a currency union (which was, it must be noted, first hinted at by Helmut Schmidt).

The first step was the European Exchange Rate Mechanism, ERM, or European Monetary System, the EMS. Its primary purpose, from the Bundesbank’s perspective, was to secure Germany’s capacity to maintain its competitiveness in the face of the dollar’s wild fluctuations through internally coordinated restructuring and free of the fear that France’s and Italy’s competitive devaluations will undercut these efforts. In short, the Bundesbank’s plan was simple: a fixed exchange rate mechanism would help restore the RoE’s incapacity to keep financing German accumulation.

The problem was that speculators, with George Soros the better known amongst them, could see that the currency pegs of the ERM/EMS were unsustainable given the pressures on the balance of payments of Germany’s European partners. So they bet massively against it, until the EMS broke down. At that point the Bundesbank understood that nothing short of a currency union will allow it to see its grand plan through. It was a gamble. And it came with a sizeable  psychological cost, given the voluntary abandonment of the DM. But it was deemed essential given the greater ‘good’ to be had from turning the RoE into the economic zone onto which Germany’s shifted the burden of its adjustment, thus allowing German oligopolistic multinationals to maintain ad infinitum their net exports (of goods and production units) to the rest of the world.

This is, basically, the story that Joseph Halevi told in his 1995 paper. It is an intriguing tale. As always, since economics is not a science, whether one agrees with Joseph’s thesis or not is a matter of judgement (as opposed to empirical or analytical proof). Suffice to say that, if he is right, we have a fascinating explanation of Germany’s resistance to coming to terms with the need to shore up the currently collapsing euro-system by means of establishing a Surplus Recycling Mechanism within the Eurozone (as our Modest Proposal suggests). For if Joseph’s thesis holds water (and I, for one, think it does) the whole point of monetary union was to avoid surplus recycling between Germany and the rest of Europe. Trouble is that, given the state of European disintegration that we find ourselves in, Germany’s impressive commitment to a plan that is now thirty years old threatens to bring down not only the rest of Europe but Germany too.

Of course most German policy makers do not see this. They think that they can pull the same rabbit out of the hat twice. That just like they managed to do in the early 1980s, they can once more pave the ground for German companies to accumulate productive capital (and to expand far and wide) through a careful dose of deflation for the rest of Europe and growth further beyond (China comes to mind here). What they are purposely ignoring is the missing elephant or, to be more ‘precise’, the missing Minotaur: The US deficits which are no longer able to generate the global demand that the current German experiment requires. And when they reply that China will play this time round the role that the United States played in the past, they miss the simple point that, unlike the post-1971 United States, China is an oversize Germany; a monolith whose economic fortunes also rely on net exports. The results of this miscalculation will, I submit to you, be a long Crisis that, in the end, will derail Germany’s European and global plans with detrimental effects on everyone: including Germany’s squeezed middle and working classes.


Joseph Halevi with Riccardo Belliofore have produced a number of papers building on the above ideas. Two were published in this blog (click here and here). Another can be found here.

[1] See his Collected Works, Volume 1, pp.403-16, published by Oxford University Press