The must read article from Spiegel.de:
Operation Self-Deceit: New Documents Shine Light on Euro Birth Defects
By Sven Böll, Christian Reiermann, Michael Sauga and Klaus Wiegrefe
Newly revealed German government documents reveal that many in Helmut Kohl's Chancellery had deep doubts about a European common currency when it was introduced in 1998. First and foremost, experts pointed to Italy as being the euro's weak link. The early shortcomings have yet to be corrected.
Many of the euro's problems can be traced to its birth defects. For political reasons, countries were included that weren't ready at the time. Furthermore, a common currency cannot survive on the long term if it is not backed by a political union. Even as the euro was being born, many experts warned that currency union members didn't belong together.
Pushing Ahead Regardless
But it wasn't just the experts. Documents from the Kohl administration, kept confidential until now, indicate that the euro's founding fathers were well aware of its deficits. And that they pushed ahead with the project regardless.
In response to a request by SPIEGEL, the German government has, for the first time, released hundreds of pages of documents from 1994 to 1998 on the introduction of the euro and the inclusion of Italy in the euro zone. They include reports from the German embassy in Rome, internal government memos and letters, and hand-written minutes of the chancellor's meetings.
The documents prove what was only assumed until now: Italy should never have been accepted into the common currency zone. The decision to invite Rome to join was based almost exclusively on political considerations at the expense of economic criteria. It also created a precedent for a much bigger mistake two years later, namely Greece's acceptance into the euro zone.
Of course, financial data doesn't play much of a role when it comes to war and peace. Italy became a perfect example of the steadfast belief of politicians that economic development would eventually conform to the visions of national leaders.
However, the Kohl administration cannot plead ignorance. In fact, the documents show that it was extremely well informed about the state of Italy's finances. Many austerity measures were merely window dressing -- either they were accounting tricks or were immediately dialed back when the political pressure subsided. It was a paradoxical situation. While Kohl pushed through the common currency against all resistance, his experts essentially confirmed the assessment of Gerhard Schröder, the center-left Social Democratic Party (SPD) candidate for the Chancellery at the time. Schröder called the euro a "sickly premature baby."
A Miraculous Cure
Operation "self-deception" began in December 1991, in an office building in the Dutch city of Maastricht, the capital of the southeastern province of Limburg. The European heads of state and government had come together to reach the decision of the century, namely to introduce the euro by 1999.
As luck would have it, Italy fulfilled all requirements as the date approached -- surprisingly so, given that it had acquired a reputation for notoriously imbalanced budgets. But the country had undergone a miraculous cure -- on paper at least.
A few months later Jürgen Stark, a state secretary in the German Finance Ministry, reported that the governments of Italy and Belgium had "exerted pressure on their central bank heads, contrary to the promised independence of the central banks." The top bankers were apparently supposed to ensure that the EMI's inspectors would "not take such a critical approach" to the debt levels of the two countries. In early 1998, the Italian treasury published such positive figures on the country's financial development that even a spokesman for the treasury described them as "astonishing."
In Maastricht, Kohl and other European leaders had agreed that the total debt of a euro candidate could be no more than 60 percent of its annual economic output, "unless the ratio is declining sufficiently and is rapidly approaching the reference value."
But Italy's debt level was twice that amount, and the country was only approaching the reference value at a snail's pace. Between 1994 and 1997, its debt ratio declined by all of three percentage points.
"A debt level of 120 percent meant that this convergence criterion could not be satisfied," says Stark today. "But the politically relevant question was: Can founding members of the European Economic Community be left out?"
Government experts had known the answer for a long time. "Until well into 1997, we at the Finance Ministry did not believe that Italy would be able to satisfy the convergence criteria," says Klaus Regling, at the time, the Director-General for European and International Financial Relations at the Finance Ministry. Currently, Regling is the chief executive of the temporary euro bailout fund, the European Financial Stability Facility (EFSF).
The skepticism is reflected in the documents. On Feb. 3, 1997, the German Finance Ministry noted that in Rome "important structural cost-saving measures were almost completely omitted, out of consideration for the social consensus." On April 22, speaker's notes for the chancellor stated that there was "almost no chance" that "Italy will fulfill the criteria." On June 5, the economics department of the Chancellery reported that Italy's growth outlook was "moderate" and that progress on consolidation was "overrated."
'Not Without the Italians'
Horst Köhler wrote to the chancellor in mid-March. Formerly the German chief negotiator in the Maastricht Treaty negotiations, Köhler had moved on to become the president of the German Savings Bank Association. Enclosed with his letter was a study by the Hamburg Institute of International Economics, which concluded that Italy had not fulfilled the conditions "for permanent and sustainable deficit and debt reduction," and that it posed "a special risk" to the euro.
At a European Union special summit in Brussels in early May 1998, Kohl felt the "weight of history" and, without further ado, provided his unreserved support. "Not without the Italians, please. That was the political motto," says Joachim Bitterlich, Kohl's foreign policy advisor.
The head of the economics division at the Chancellery, Sighart Nehring, noted in mid-March 1998 that "enormous risks" were associated with Italy's "high debt levels." The debt structure, Nehring added, was "unfavorable" and outlays would increase considerably if interest rates rose by only a small amount.
A Love for Italy
But the memo had no repercussions. The chancellor, it would seem, wasn't terribly interested in the details. There was a "built-in flexibility" among politicians when it came to the Maastricht criteria," says Dieter Kastrup, German ambassador to Italy at the time.
Italy, after all, was a founding member of the EU.
Tricks and Luck
In the end, the Italians formally fulfilled the Maastricht criteria with a combination of tricks and fortunate circumstances. The country benefited from historically low interest rates, and Ciampi proved to be a creative financial juggler. He introduced, for example, a "Europe tax" and carried out a clever accounting trick, which involved selling national gold reserves to the central bank and imposing a tax on the profits. The budget deficit shrank accordingly. Even though EU statisticians ultimately did not acknowledge this trickery, it symbolized the fundamental Italian problem: The budget was not structurally balanced, but in fact had benefited from special effects.
The general secretary of the Dutch prime minister and a state secretary from the finance ministry wanted to put pressure on Rome. "Without additional measures on the part of Italy to provide credible proof of the longevity of the consolidation, Italy's acceptance into the euro zone is currently unacceptable," the Dutch officials argued.
Germany's Growing Debt
Kohl, fearing for his most important project since German reunification, refused. He told the Dutch officials that the government in Paris had warned him that France would withdraw from the agreement if Italy were excluded.
The Germans were in a weak negotiating position.
The Chancellery was aware of the problem. "In contrast to Belgium and Italy, the German debt level has risen since 1994," they wrote in a March 24, 1998 memo to Kohl and Chief of Staff Friedrich Bohl. The consequences were unpleasant. "In our view, there is a legal problem in Germany's case, because the Maastricht Treaty only provides for an exception if the debt level is declining," the memo continues.
Still, the situation made it difficult for Germany to play judge, particularly given the lack of formal proof that Italy was in violation. In the spring of 1998, the statistical office of the European Union certified that the Italians had satisfied the deficit criteria of the Maastricht Treaty. This meant that there was "no longer any reason to bar the Italians accession to the euro," as Waigel recalls. After this hurdle had been removed for the Italians, "they had a sort of legal claim to be allowed to be part of the euro from the very beginning," Waigel's former top official Regling says today.
Italy Turns Away from Austerity
Many knew that the figures were sugarcoated, and that they hardly represented real debt reduction. But no one dared draw the consequences. Kohl trusted Ciampi's reassuring claims that the Italians would continue to pursue the "cammino virtuoso" ("virtuous path") they had embarked upon and would "be unrelenting in efforts to clean up the budget." The government in Rome predicted that its debt level would sink to 60 percent of GDP by no later than 2010.
Things didn't turn out that way. As early as April 1998 -- that is, prior to the official decision on which countries would be part of the euro -- there were growing indications that Prodi's coalition partners, the neo-communists, were just waiting to return to their old habits. On April 3, the German embassy in Rome warned that this risk should "not be ignored."
'A Qualitative Shift'
This didn't change after the election, either, no matter how many alarming messages Financial Attaché Stenglin sent to Bonn. On Oct. 1, he submitted a blunt analysis of the Italian fiscal policy, which he hid behind the harmless subject line "Italian Government Approves Draft for the 1999 Budget." Stenglin, who had been sent to Rome from his position at the Bundesbank, saw that the development in Italy was moving completely in the wrong direction. The Italian government's draft budget, he reported to Bonn, signified a "qualitative shift in budget policy."
According to Stenglin, the budget showed the lowest cost-cutting figures since the beginning of the consolidation course in the early 1990s. Additional tax revenues, he noted, would no longer be used solely to reduce the deficit, but also to pay for new spending, particularly on social programs.
When Prodi was replaced a short time later by former Communist Massimo d'Alema, the situation deteriorated even further. D'Alema proposed financing a European economic stimulus program through euro bonds and not factoring the associated expenditures into the national deficits.
The Maelstrom of Crisis
A few weeks before the launch of the common European currency, Stenglin's assessment of the situation took on a dramatic undertone, when he wrote: "The question arises as to whether a country with an extremely high debt ratio doesn't risk gambling away the success of its consolidation efforts to date, thereby harming not only itself, but also the monetary union." It was a prophetic remark. In the fall of 2011, when the country was pulled into the maelstrom of the crisis, the debt ratio had risen above 120 percent of GDP once again.
Meanwhile, European leaders are trying to correct the defects of the founding phase of the euro. Austerity and reform measures are being implemented in large parts of Europe, and all countries support the idea of joint responsibility for the currency. Nevertheless, the new euro architecture doesn't differ all that much from the old one.
No Solution Yet
The government files from the founding phase of the monetary union reveal that this construct cannot function. The message the documents convey is that political opportunism will ultimately prevail. A monetary union amounts to more than shifting several billion euros back and forth. It is also a community of fate. Shared money requires shared policy and, in the end, shared institutions.
The euro is now in its 14th year, and after two years of ongoing crisis, there is a growing realization in Berlin and other capitals that the status quo cannot continue. All reform efforts still resemble small steps to nowhere, and yet politicians are beginning to think in terms of broader categories as they cope with the crisis.
All of these measures boil down to individual countries relinquishing more authority and the central government in Brussels acquiring more power in return.
Incredible! And yet investors and the media hang on every word from these self-deceiving political grab-baggers. Perhaps, just perhaps, the recent elections is the beginning of a slow realization by the public that they truly have been duped from the very beginning.