Europe and the Future
The Empire Club of Canada Addresses (Toronto, Canada), 25 Sep 1992, p. 38-45
Pohl, Karl Otto, Speaker
Media Type
Item Type
A joint meeting of The Empire Club of Canada and The Canadian Club of Toronto.
The state of the exchange markets. A floating rate in Canada as opposed to fixed exchange rates as in the European Monetary System. A look at both systems. The current monetary situation in Europe and in North America. What the two systems mean in Europe and for Canada. The aim of price stability. The risk of recessionary tendencies in Germany. The Mastricht Treaty. European integration. The issue of Eastern European integration following the collapse of communism. The problems of German unification: transfer payments, development in East Germany.
Date of Original
25 Sep 1992
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Full Text
Karl Otto Pohl, Former President, Deutsche Bundesbank; Director, The Horsham Corporation
Chairman: Robert L. Brooks
President, The Empire Club of Canada


Surely no one forgets the day the Berlin Wall fell. It was a remarkable and exhilarating event. But, as we now know, when the limelight dimmed and the world turned its attention elsewhere, the real work of German reunification was only just beginning.

Machiavelli wrote:

There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success than to take the lead in the introduction of a new order of things.

Putting a country back together after 45 years qualifies, I think, as leading in the introduction of a new order. The job of uniting East and West has proved a more daunting task than I think anyone imagined. Reunification is more than just a renovation--taking a wall down here, putting up a building there. Reunification has meant the melding of two separate economic and social worlds, not quite the proverbial oil and water, but close. And, of course, the effects have been felt all over the world, but especially in both Eastern and Western Europe as others have had to cope with the new order.

Today, ladies and gentlemen, I have the honour of introducing to you a man who was not only a witness to the unification in Germany, but who took a hand in its fashioning. After early stints as a sports reporter and then economic journalist, Mr. Karl Otto Pohl began a distinguished career in the service of his government. As President of its central bank, the Deutsche Bundesbank, and as Chairman of the Central Bank Council from 1980 to 1991, his commitment to the control of inflationary pressures was incomparable. He epitomized the strong central bank hand on the monetary tiller as other governmental policies lurched uncertainly onwards. Imagine, if you will, our own John Crow on steroids.

Moreover, I'm sure you are all aware that Mr. Pohl's alma mater has gained a certain notoriety. The "fed watching" of the early 80s has been replaced by "buba watching" currently. But all things change and, while some think the Bundesbank finally blinked a couple of weeks ago in the face of massive strains in the European monetary system, maybe we can look forward to a slightly less austere central bank here too.

During his time with the Bundesbank, Mr. Pohl was also the German Governor of the IMF and a board member of the bank for international settlements. In May of this year, he became a director on the board of the Horsham Corporation.

Given recent events in Europe, we can certainly agree that Mr. Pohl's presence here today is more than fortuitous. Please join me in welcoming Mr. Karl Otto Pohl.

Karl Otto Pohl

Thank you Mr. Chairman, ladies and gentlemen. It's a pleasure for me to be in Toronto and to have the privilege to address two distinguished clubs. But I have to say that whenever I come to Toronto, there's a crisis.

Last time I was here, 10 years ago, I attended the IMF meeting in 1982 and that was the beginning of the debt crisis, very scary, and we spent many hours trying to keep things under control.

This time I was very anxious that today could have been a very critical and dangerous day for you because of the events in the exchange markets. Fortunately and surprisingly I think, the exchange markets are very calm today. I cross my fingers and, if we are lucky, maybe the crisis is over and the markets will go back to normal next week.

But I think it's fair to say I followed them more from some distance because I spent the week in Washington at the IMF meeting and of course, I had no inside information. I only read the newspapers and the television and got some reports from my secretary in Germany. But if I read correctly, I think the European Monetary System, the main pillar, I would say, of the European Community, was very close to a collapse. I found a piece in The Wall Street Journal the other day by the famous Nobel Prize winner, columnist Milton Friedman. He's already 80 years old but still pretty bright. He wrote an article, it's a long article and I only want to read two sentences from the conclusion. "How many more fiascoes will it take," he wrote, "before responsible people are finally convinced that a system of pegged exchange rates is not a satisfactory financial arrangement for a group of large countries with independent political systems and independent national policies."

So that sounds nice in a country like Canada with a floating exchange rate. And a floating decoupling of the European currencies from the D. Mark would have been the obvious alternative to the European Monetary System which is a system of fixed exchange rates. I don't think it would be a desirable alternative. We had that in the 70s and the situation in Europe is, I think, quite different from the world economic monetary system, if you want to call it a system. It is a system of floating and it has worked since the collapse of the Bretton Wood system in'73 quite well, in my view.

We have survived with that system at least a number of crises, in 1974 the oil crisis, the second oil crisis, the debt crisis and what have you. So because the system was quite flexible it has also helped us to survive, so to speak, the attitude of benign neglect which is a very common and traditional attitude in the United States.

But this attitude of benign neglect, both by the American central bank and the German central bank, has met with a situation never faced before. European interest rates, let's say German interest rates, are about 600 basis points higher than American interest rates. And the consequences of course--pressure on the U.S. currency, the depreciation of the U.S. currency and the upward pressure on the D. Mark--contribute to the turmoil we have seen in Europe.

On this international level, and I think I'm an advocate for flexibility, I don't think floating rates would be a desirable system for Europe because the European economies have reached an enormous degree of integration.

For instance 70 per cent of German foreign trade is with European countries. A system of floating exchange rates, as we have seen in the 70s, could lead to a kind of vicious circle of inflation, more inflation, more depreciation, more inflation and more depreciation.

One has to think about that and remember the experience of the 70s. Britain was forced to leave the exchange rate mechanism of the European Monetary System. But it would be an illusion, I think, to assume that that would leave a lot of room for manoeuvre in terms of lowering interest rates and stimulating the domestic economy because that will immediately lead to further pressure on the exchange rate which, by definition, is a cause for more inflation.

So the room for manoeuvre is rather limited or, in other words, we are all in one boat in Europe, as far as the monetary system is concerned. And the European Monetary System is certainly an arrangement which has helped us to achieve the headway and the integration of our economies which we have enjoyed over the last 12 years or so.

In my view, we have a strong interest in Europe in keeping this system intact, and it is still intact. Britain joined the EMS only a few years ago and has now left again. But before Britain joined, it was the same group of countries, more or less, with the exception of Italy, which is also out for some time.

So the EMS is still intact and I think we have good reason to fight as the Bundesbank and Banque de France did during this week, to keep it that way. This European Monetary System has worked more and more as a kind of a quasi-monetary union, but of course without the common central bank The monetary policy of that system was mainly determined by the Bundesbank, guardian of the strongest policy in that system and the main reserve currency. It's fair to say, I think, that the role of the D. Mark as the anchor of the system, the standard for the stability of the system, was very beneficial and has led for the last number of years to a reduction of inflation in Europe, to more and more convergence of economic fundamentals.

There was a broad consensus, and it seems to emerge more and more amongst European governments, that monetary policy has to aim for price stability. One fruit of this policy was lower inflation and, as a consequence, a narrowing of interest rates. Today, France has a lower inflation than Germany. I have hope this consensus still exists, but recent developments have made that a little questionable. Members of the system are complaining about the dominance of the D. Mark and the high interest rates which are the result of the Bundesbank policy.

When you take into account that unemployment in France, in Italy, in Britain, and other European countries is growing, I think it's very understandable that these countries want lower interest rates in Germany. But the German central bank is in a dilemma. They are determined, and obliged by law, to pursue a policy which maintains price stability.

We know from experience the policy of the central bank has to be supported in other areas, by fiscal policy in particular, and wage policy. And in that respect the other partners of the process have not been very supportive.

Actually wage-rate increases in Germany and West Germany have exceeded gains in productivity over the last two years, and Germany, which has always had a rather conservative and prudent fiscal policy, is now a country with a very huge deficit as a consequence of German unification.

The Bundesbank is still determined to maintain price stability but that policy has led to extremely high interest rates and the risk of a slow-down in economic activity and perhaps, a recession not only in Germany, but also Europe.

One has to be fair. The process of German unification, at the beginning, was very beneficial for all partners in Europe. That is sometimes not always acknowledged and recognized.

Because of the demand which was the economic consequence of the very generous conversion of East Marks into D. Marks and the introduction of the D. Mark plus enormous transfer payments to the former GDR, the economic effect was like a Keynsian-type fiscal expenditure. And you can see it in our import figures; the German trade figures in 1990 and 1991 deteriorated dramatically. It's still a surplus but we need a huge surplus to compensate for the deficit in services and all the other things.

So our playing partners, particularly in Europe, have benefited enormously. I think without this demand push, Europe would have slipped into a recession like the United States, Canada and other industrialized countries. But that is now more or less over because we have reached a new level and there is no additional demand being generated. The only thing left are the high interest rates.

So in my view there is a real risk of recessionary tendencies in Germany as we have seen in other countries. That is one risk. The other risk is, of course, that the monetary system is coming under constraints.

The logical answer to the dominance of the Bundesbank and the dominance of the D. Mark would be, of course, the one that was assumed in the Mastricht Treaty--to establish a European Central Bank and a European currency. In other words, to transfer the decision-making power for the monetary policy from the national level to a supra-national level. And that is the heart and the essence of the Mastricht Treaty.

Surprisingly governments are ready to sign the treaty but citizens in many of these countries are not. I don't want to make any forecast about the future of the Mastricht Treaty, but I think it's almost certain that the process of European integration is going to continue. Because what we are talking about is long-term change and institutional arrangements within the framework of the European Community.

The collapse of communism has also opened Eastern Europe for the integration.

So maybe the whole Mastricht effort is coming to a standstill for the time being. That has a good side; we could stand to reconsider and to re-discuss the whole issue of the future of Europe. I was always of the opinion that Europe could not be limited to the EC or the European Community, but that we should take into account the recent revolutionary changes in the East.

The centre of Europe has moved already more to the east, to the north. Berlin is now the capital of Germany. And it is kind of symbolic that the capital of Germany has been moved, or is in the process of moving, from tiny little Bonne to Berlin. I think that move has symbolic and substantial relevance.

Germany, of course, has to play a crucial role in this process. It is, whether one likes it or not, the power house of Europe. It is not only the biggest country in terms of population, but even more so in terms of economic strength. For the future of Europe it is of utmost importance that Germany gets its house in order.

Ladies and gentlemen, I could entertain you another one or two hours on the very very tricky problems of German unification.

The transfer payments have been widely underestimated. At the beginning there were enormous transfer payments from West to East. There was about 180 billion D. Marks last year, which is five per cent of the GDP of West Germany and almost two-thirds of the national income in East Germany.

The development in East Germany is not as exciting as people thought it would be. On the contrary, it is very sluggish; it's a very depressed area and it will remain so for some time.

It is a historic task to clean up all the terrible mess which was left from the previous system over there. It will take a long time. It will take much longer than any of us expected at the beginning.

But I'm pretty sure that finally we will make it and that, I think, is not only of great importance for Germany but, as well, for the future of Europe which, in spite of all the critical events, has a bright future.

So that is at least what I hope and I hope I'm not too old to see that during my lifetime. Thank you very much.

The appreciation of the meeting was expressed by Isabel Bassett, President, The Canadian Club of Toronto.

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Europe and the Future

A joint meeting of The Empire Club of Canada and The Canadian Club of Toronto.
The state of the exchange markets. A floating rate in Canada as opposed to fixed exchange rates as in the European Monetary System. A look at both systems. The current monetary situation in Europe and in North America. What the two systems mean in Europe and for Canada. The aim of price stability. The risk of recessionary tendencies in Germany. The Mastricht Treaty. European integration. The issue of Eastern European integration following the collapse of communism. The problems of German unification: transfer payments, development in East Germany.