The ECB thinks it is learning the lessons of 1923, but it's not

It might be learning from 1973 — but those lessons don't apply anymore.

When editors of Bild, Germany’s best-selling tabloid newspaper, arrived at the European Central Bank in March 2012 to grill its president about the eurozone crisis, they brought with them an unusual gift. It was a Prussian military helmet to remind Mario Draghi that back in 2010 the tabloid had deemed him the most "Germanic" of candidates for the ECB’s top slot.

Of course, such editorial approval quickly disappeared after Draghi committed the ECB to buying unlimited quantities of eurozone government bonds amid efforts to do “whatever it takes” to solve the single currency’s crisis. But nevertheless the brief encounter revealed the extent of Germany’s cultural influence over Europe’s monetary guardian. Germans, it is often said, make for better central bankers: prudent and cautious, they like to take away the punch bowl just as the party gets going.

Today we often read in news media of the German psychological "aversion" to inflationary policies. This antipathy has often been attributed by politicians, bankers and journalists to the traumatic events of 1923 when Germany succumbed to the full horrors of hyperinflation. Wheelbarrows full of paper money. Children building small fortresses on the pavement with thick wads of bank notes. We have all seen the photos.

But this was an event that occurred almost ninety years ago; few, if any, Germans today have living memory of it. Moreover, other European countries, such as Hungary and Austria, underwent similar inflationary excess during the 20th century and fail to hold price stability in the same regard.

A national economic mythology surrounds inflation in Germany, and it is one that is having a disruptive impact on the eurozone crisis. With every decision the ECB makes, Draghi has to factor in the expected response of the hawkish Germans. But why has one historical event etched itself upon German popular consciousness, whereas an episode just as devastating, such as mass unemployment, has not? After all, the Weimar Republic in 1920s Germany had to contend with joblessness and ever-lengthening dole queues.

Mass unemployment, like the hyperinflation, was a major reason why the German electorate voted in droves for extreme left- and right-wing parties. Yet the memory of rampant redundancy faded in the post-war era as high rates of economic growth allowed West Germans to enjoy unprecedented job opportunities.

Why then the special attention devoted to hyperinflation? The answer lies in the virtue of monetary mythology. For all the national trauma caused by the events in 1923, the memory of hyperinflation has proved over the decades a very convenient tool for managing price expectations and building a strong belief in the post-war West German central bank.

The story of 1923 has been lapped up by the news media in recent years. “For the Bundesbank, it had always been taboo to finance the state by purchasing its sovereign bonds,” argued Der Spiegel in late 2011. “Behind this belief was the terrifying example of its predecessor, the Reichsbank, which had printed money with abandon in the 1920s in order to support the budget of the Weimar Republic. The result was a hyperinflation that has become deeply entrenched in the collective memory of Germans.”

Similarly, The Economist declared in 2010 that, “Germany’s interwar experience with hyperinflation famously created a political climate amenable to the rise of Adolph Hitler and generated sufficient national trauma that the German central bank (and its descendent, the ECB) has ever since focused first, second and last on keeping inflation well in check.”

Indeed, when asked by The Guardian in late 2011 why the Berlin government was so reluctant to allow the ECB to become last lender of resort for eurozone member states, Hans-Werner Sinn, president of the influential Munich-based Ifo Institute for Economic Research replied, “Because it leads to inflation. We know this from our own history. It’s what Germany did until 1923.”

Quotes like those above litter media coverage of German monetary and foreign policy. But to a large extent they merely echo history lessons that were skilfully articulated by German policymakers in the post-war era.

The importance of being Ernst

A central bank’s power is derived from its credibility with the markets which, in turn, are influenced as much by psychological factors as underlying economic fundamentals. Prior to the introduction of the euro currency, the Bundesbank was able to carefully construct an image of prudence to keep the deutschmark stable - primarily by means of strong policy initiatives and a clear communications strategy.

Officials in Frankfurt used the example of hyperinflation in order to reassure markets that never again would a German state descend into the realm of monetary madness. It was a simple and effective narrative: 1923 was an event that evaporated people’s savings, destroyed the political support of moderate parties, and helped pave the way toward fascist dictatorship. An irresponsible monetary policy, the Bundesbank argued, was unimaginable in a post-war German state.

Just look at the 1970s, for instance - a decade when the old truths of monetary policy no longer seemed to apply. The Phillips curve, an erstwhile economic ‘law’ that hitherto demonstrated the inverse relationship between inflation and unemployment rates, dissipated amid economic turmoil. Suddenly governments had to contend with both problems at the same time, a new phenomenon dubbed ‘stagflation’.

Moreover, the Bretton Woods system collapsed in 1971. European states no longer had the benefit of fixing their currency exchange rates to the American greenback to hold inflation expectations steady. The international rules had changed, and all major economies soon opted for a system of floating exchange rates.

Central bankers in Europe had to fight to keep the trust of international markets in the midst of energy price spikes and economic volatility. In Germany, then, potential inflationary dangers took on new prominence during the 1970s, appearing in Bundesbank presidential speeches, policy documents and national debates. Central bank press statements and conferences allowed officials to complement and reinforce the institution’s hard-line policy actions with historical justification.

The strategy worked. In 1974 most industrialised economies had double digit inflation rates. By contrast West Germany had an inflation rate of 7 per cent, which steadily declined thereafter until 1979. Fifty years after wheelbarrows full of paper money, the deutschmark had become the centre of gravity in the European currency market.

The useful lessons of 1923 tapped into the Germans’ imagination. Cultural memory, it seems, has its own form of economics. When asked about his institution’s influence and power, Karl Otto Pöhl, the central bank’s president during the 1980s, quoted Stalin’s ironic remark, “How many divisions has the Pope?” Other European central bankers could only look with envy at the Bundesbank’s international prestige.

Don’t mention the euro

But what proved a useful instrument for the West German central bank in the decades following the Second World War, now acts as a hindrance to an effective solution to the eurozone crisis. The example of hyperinflation continues to be wielded by German policymakers as a means of influencing the parameters of European monetary debate.

News media still happily recount the narrative, almost without thinking. The Financial Times warned last October, “[t]he eurozone sovereign debt crisis has already generated a lot of angst in Germany – fears about hyperinflation wiping out savings, the ballooning cost of bailouts and the nagging doubt that life was more certain with the deutschmark in one’s pocket.”

Statements like these only serve to reinforce the German case for European austerity; for the impression is given that Germans can’t help but be psychologically opposed to inflationary policies.

And the ECB, for its part, is in a difficult position. The institution owes an enormous intellectual debt to the hawkish Bundesbank: its statutes are modelled on the Bundesbank’s, and it is no accident that the ECB’s headquarters can be found in Frankfurt – a symbolic act that stresses its link with Germany.

But this debt is now becoming an actual burden. The arena of central banking has changed dramatically since the financial crisis. Almost by necessity, monetary policy has become increasingly blurred with that of fiscal in order to counter the fallout stemming from market turmoil.

Indeed, many business commentators have accused the ECB of being too focused on fighting inflation and not enough on stimulating the floundering European economy. It is an accusation that Draghi is all too aware of. The Italian, however, is constrained by the tall shadow of the Bundesbank.

During the Bild interview, for instance, his interrogators put forward the following question: “For the Germans, the head of a central bank must be strictly against inflation, independent of politics and for a strong euro. In this sense, how German are you?” There was a pause. Draghi had to choose his words carefully.

“These are indeed German virtues,” the Italian responded. “Germany is a role model [for the ECB] … In the 20th century the Germans had terrible experiences with inflation. It destroys value and makes economic planning impossible. More still, it can literally destroy the society of a country.”

But the Bundesbank’s opposition to government bond purchases has substantially delayed the ECB’s eventual course of action. It was only last September, despite much German protest, that the ECB president adopted an open-ended commitment to buy up periphery short-term sovereign bonds – arguably seen as a core tenet of any effective solution to the eurozone’s woes.

An event that occurred nine decades ago continues to shape the contours of monetary debate in Europe today. But Germany’s national priorities do not necessarily make for good supranational ones.

When the editors of Bild reminded the ECB president that the tabloid cheekily portrayed him wearing a Pickelhaube on its front-page in 2010, Draghi shared his thoughts on the image: “I quite liked it actually. The Prussian is a good symbol for the most important job of the ECB: to maintain price stability and protect European savers.” It is unlikely, however, that the Prussian helmet will point Draghi in the right direction.

The ECB’s credibility now rests on an effective response to the eurozone crisis. The central bank’s president is quite right when he argues that inflation “destroys value and makes economic planning impossible.” But Draghi now has an opportunity to break from the past.

Were the ECB’s monetary chief to spearhead a successful solution to the euro’s troubles – one that is likely to depart significantly from Bundesbank orthodoxy – he may well go on to form a powerful, new narrative that will in turn shape the parameters of monetary debate in Europe.

Mario Draghi. Photograph: Getty Images

Simon Mee is a freelance journalist currently undertaking doctoral research in German economic history at Oxford University.

Photo: Getty
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After Richmond Park, Labour MPs are haunted by a familiar ghost

Labour MPs in big cities fear the Liberal Democrats, while in the north, they fear Ukip. 

The Liberal Democrats’ victory in Richmond Park has Conservatives nervous, and rightly so. Not only did Sarah Olney take the votes of soft Conservatives who backed a Remain vote on 23 June, she also benefited from tactical voting from Labour voters.

Although Richmond Park is the fifth most pro-Remain constituency won by a Conservative at the 2015 election, the more significant number – for the Liberal Democrats at least – is 15: that’s the number of Tory-held seats they could win if they reduced the Labour vote by the same amount they managed in Richmond Park.

The Tories have two Brexit headaches, electorally speaking. The first is the direct loss of voters who backed David Cameron in 2015 and a Remain vote in 2016 to the Liberal Democrats. The second is that Brexit appears to have made Liberal Democrat candidates palatable to Labour voters who backed the party as the anti-Conservative option in seats where Labour is generally weak from 1992 to 2010, but stayed at home or voted Labour in 2015.

Although local council by-elections are not as dramatic as parliamentary ones, they offer clues as to how national elections may play out, and it’s worth noting that Richmond Park wasn’t the only place where the Liberal Democrats saw a dramatic surge in the party’s fortunes. They also made a dramatic gain in Chichester, which voted to leave.

(That’s the other factor to remember in the “Leave/Remain” divide. In Liberal-Conservative battlegrounds where the majority of voters opted to leave, the third-placed Labour and Green vote tends to be heavily pro-Remain.)

But it’s not just Conservatives with the Liberal Democrats in second who have cause to be nervous.  Labour MPs outside of England's big cities have long been nervous that Ukip will do to them what the SNP did to their Scottish colleagues in 2015. That Ukip is now in second place in many seats that Labour once considered safe only adds to the sense of unease.

In a lot of seats, the closeness of Ukip is overstated. As one MP, who has the Conservatives in second place observed, “All that’s happened is you used to have five or six no-hopers, and all of that vote has gone to Ukip, so colleagues are nervous”. That’s true, to an extent. But it’s worth noting that the same thing could be said for the Liberal Democrats in Conservative seats in 1992. All they had done was to coagulate most of the “anyone but the Conservative” vote under their banner. In 1997, they took Conservative votes – and with it, picked up 28 formerly Tory seats.

Also nervous are the party’s London MPs, albeit for different reasons. They fear that Remain voters will desert them for the Liberal Democrats. (It’s worth noting that Catherine West, who sits for the most pro-Remain seat in the country, has already told constituents that she will vote against Article 50, as has David Lammy, another North London MP.)

A particular cause for alarm is that most of the party’s high command – Jeremy Corbyn, Emily Thornberry, Diane Abbott, and Keir Starmer – all sit for seats that were heavily pro-Remain. Thornberry, in particular, has the particularly dangerous combination of a seat that voted Remain in June but has flirted with the Liberal Democrats in the past, with the shadow foreign secretary finishing just 484 votes ahead of Bridget Fox, the Liberal Democrat candidate, in 2005.

Are they right to be worried? That the referendum allowed the Liberal Democrats to reconfigure the politics of Richmond Park adds credence to a YouGov poll that showed a pro-Brexit Labour party finishing third behind a pro-second referendum Liberal Democrat party, should Labour go into the next election backing Brexit and the Liberal Democrats opt to oppose it.

The difficulty for Labour is the calculation for the Liberal Democrats is easy. They are an unabashedly pro-European party, from their activists to their MPs, and the 22 per cent of voters who back a referendum re-run are a significantly larger group than the eight per cent of the vote that Nick Clegg’s Liberal Democrats got in 2015.

The calculus is more fraught for Labour. In terms of the straight Conservative battle, their best hope is to put the referendum question to bed and focus on issues which don’t divide their coalition in two, as immigration does. But for separate reasons, neither Ukip nor the Liberal Democrats will be keen to let them.

At every point, the referendum question poses difficulties for Labour. Even when neither Ukip nor the Liberal Democrats take seats from them directly, they can hurt them badly, allowing the Conservatives to come through the middle.

The big problem is that the stance that makes sense in terms of maintaining party unity is to try to run on a ticket of moving past the referendum and focussing on the party’s core issues of social justice, better public services and redistribution.

But the trouble with that approach is that it’s alarmingly similar to the one favoured by Kezia Dugdale and Scottish Labour in 2016, who tried to make the election about public services, not the constitution. They came third, behind a Conservative party that ran on an explicitly pro-Union platform. The possibility of an English sequel should not be ruled out.  

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.