Euro at risk of being weaker

Euro at risk of being weaker due to the German government change and Bundesbank president’s early departure.

Before the euro came into being at the start of 1999, Germany, and particularly the Bundesbank, imposed a high degree of fiscal and monetary discipline on other European countries. Germany’s exchange rate was strong. But now, more than twenty years on, this discipline has gone and the Deutschmark's prior strength has morphed into euro stability. Next month we will see the German government change to a more left-leaning coalition while the uber hawkish Bundesbank president will step down. These are changes that could tilt Germany’s role in the eurozone further and possibly start to push the trend of a stable euro towards one of a weaker euro.

The “cost” to Germany of EMU has been the elimination of the prior strength of the Deutschmark. It has been replaced by the euro which has traded sideways on a broad trade-weighted basis since it came onto the scene. Of course, many would say that this is not a ‘cost’ at all, as stability is better than neverending appreciation. But it does suggest to us that the strong fiscal and monetary discipline that was the bedrock of the Deutschmark's rise has been replaced by something that’s a bit more wishy-washy. Perhaps that’s why many German members of the ECB have resigned before their term has ended.

Current Bundesbank President Weidmann has chosen to leave at the end of this year and he’s now the fifth German member in a row to leave early. Poor monetary discipline by the ECB is thought to be part of the reason for his early departure and this was certainly the key factor in previous resignations such as those of Stark and Weber. And you can see other examples of the cost of EMU as far as hawkish German officials are concerned.

For German inflation is not just running at its highest levels for eighteen years, but is also amongst the highest in the region. In fact, it is in the top third for the whole of the EU; a position that was virtually unheard of prior to EMU (with the notable exception of German reunification in 1990). This must irk hawkish German monetary officials more than the high level of inflation itself.

But it is not just on the monetary side where Germany’s position has been compromised. In politics too, we’ve seen Germany forced to accept outcomes that seem hard to square with the country’s pre-EMU beliefs, such as the bailouts during the eurozone debt crisis. And now, the 16-year leadership of Chancellor Merkel is coming to an end with her conservative-led coalition being replaced early next month by a leftwards shift made up of the SPD, Greens, and FDP. Perhaps fortunately, the new finance minister Linder is from the FDP and someone who should prove stricter on the budget than the other choices SPD leader Scholz could have made. Nonetheless, it is still likely to be a lot different from the days of uber hawkish budgetary disciplinarians like Wolfgang Schaeuble who was in place from 2009 to 2017.

Some may argue that the disappearance of the likes of Schaeuble in the past, and Weidmann next month are continued steps on the path towards less fiscal and monetary discipline in Germany – and the eurozone - that will harm the euro going forward, and perhaps especially if the region is just embarking on a difficult fight with inflation. Others will argue that these discipline issues lost their relevance back in 1999 when the monetary started and might help explain why the euro had a rough time in the first few years of its life. We lean towards this latter view which means that even if policymakers in Germany are less hawkish than many of their predecessors, there won’t be a heavy cost for the euro.