World Naval Developments

Close French Vote’s Implications

The most important end-of-summer event was the virtual col­lapse of the European monetary system. Because the collapse threw the future of the European Community into question, it also brought into question the possibility of any unified Euro­pean foreign and security policy. These ideas are not dead, but they have not been questioned very seriously. They have, until this year, been virtually accepted as desirable and likely goals. For example, even when the British government has ques­tioned Community action, its metaphor has been “the European train”—and its tracks do not allow for any deviation.

As of last December, the Community goal was a single cur­rency. As a means to that end, a European rate mechanism was set up to stabilize all European currencies relative to one an­other. It provided for government pledges to keep their currency within narrow bands around the agreed values. This might seem no more than reasonable bookkeeping, but it had very real con­sequences. Not all Western European economies have anything remotely like the same structure, or indeed the same strength; they vary, for example, in the extent to which they depend on exports of manufactured goods. Germany depends very heavily on such exports, while Great Britain depends more heavily on “invisible” exports, such as income from banks.

The rub came with German reunification. The cost was enor­mous, and the German public was unwilling to be taxed to Pay it. As in the United States of the 1980s, the solution was heavy borrowing. The German government rarely had deficits, but that soon changed; the annual deficit is now about $40 bil­lion, equivalent (on a per capita basis) to about $120 billion for the United States. No one has any idea of the ultimate cost of reunification, which includes not only budgeted funds, but also the inflationary effect of exchanging numerous East German marks for Deutsche marks on a one-for-one basis. The Ger­man deficit may seem small, but it is probably calculated on a ^Very different basis than is our own. It is often suggested that the U.S. deficit includes numerous capital items that do not fig­ure in foreign deficit calculations.

The Germans had to offer high interest rates to borrow money °n this scale. The German central bank was already using high 'merest rates to avoid inflation (threatened by the sudden influx °f East German marks); the effect has been to sop up money that might otherwise go to buy goods and services, driving up their ^costs. Presumably, the fear of inflation is a reaction to the hy­perinflation of the early post-World War I period, a hyperinfla- h°n incidentally caused by the Germans themselves (they were, ^ln effect, canceling out a French indemnity calculated in marks).

The interest rates were a matter of domestic policy, but they uad foreign implications. Because money can flow freely from one currency to another, any nation that sets very high interest mtes will tend to attract foreign currency. Holders of other cur­rencies buy the high-interest currency to gain the interest, and 'me consequence is that the high-interest currency gains value.

¹ takes more dollars to buy a Deutsche mark, for example.

The cost of reunification had to be met by raising German in- J®rest rates higher, because the government badly needed money. ¹ his is much what happened to the U.S. dollar under the Rea­gan administration: measures designed to make Treasury notes attractive to Americans also made them attractive to foreign­ers. As the dollar gained strength, it became easier to import goods, and much more difficult to export them. The trade gap widened, and U.S. domestic industry suffered badly. Much of the current debate is over just how to reverse these effects; the weakness of the dollar is doing just that. For example, Ameri­cans are finding it more difficult to travel overseas, so they are not “invisibly” exporting nearly as much money abroad.

The European situation was complicated by the exchange-rate agreement. As the Deutsche mark rose against other curren­cies, such as the dollar, the European Community members were pledged to keep their own currencies in line with it. In effect, they had agreed to overvalue their own currencies grossly. A

The crash of V-22 #4—Bureau Number 163914—was caused by a mechanical failure. The V-22 w as attempting to land at Quantico, Virginia, on 20 July 1992 when it went down in the Potomac River. The right engine failed, and that failure was followed by a failure of the interconnect drive system, which resulted in loss of drive to the propeller system from the good engine. The engine failure was caused by the ingestion of a combustible fluid that had pooled in the forward part of the right engine nacelle. As the aircraft was transitioning from wing-borne to rotor-borne flight, the fluid was drawn down through the air seals into the engine, where it caused three surges characterized by flames and backpressure. The backpressure fractured the engine housing, causing the flames to be draw n into the upper nacelle, where they ignited additional fluid pooled there. A flash fire, lasting five-to-ten seconds ensued, during which temperatures reached up to 900" Fahrenheit. During this flash lire, the right engine failed and the pylon drive shaft was damaged.

V-22 Verdict—Mechanical Failure

purely domestic German decision to finance reunification by borrowing rather than taxing, forced other European govern­ments to raise their own interest rates to convince financial spec­ulators to keep their money in the local currencies. It was well known, however, that the underlying economies were much weaker than the German economy. Governments might promise high interest, but it was not clear that they could pay it for long: where would the money come from?

Western Europe, after all, is in deep recession, and the last thing most governments want is to sop up whatever money is available—money to buy goods and services and accelerate eco­nomic activity. A very hard currency is attractive to bankers (why put your money in, say, the pound when it may lose 10% of its value against the dollar tomorrow morning?) but not to manufacturers (whose goods cost too much abroad) or to any country heavily dependent on tourists.

It could be argued, then, that German reunification was being achieved at the cost of the other European economies. The Community was already notoriously tilted in favor of French and German farmers, and its poorer members were benefiting from what amounted to direct redistribution of wealth. The rel­atively wealthy members, such as Britain, France, and Italy, were now effectively subsidizing the richest of all, Germany.

For their part, the Germans could not readily afford to aban­don the rate-setting mechanism. The German economy de­pends on foreign trade, both within and outside the European Community. An overvalued Deutsche mark would drastically hit exports outside Europe, but that could be tolerated so long as the Community itself, a huge market, was wide open to German goods. As soon as the rate mechanism collapsed, however, the other European currencies would be devalued against the mark. It would become far more difficult for the Germans to sell goods within the Community as a whole.

Worse still, the other Community members would find it far easier to export to Germany, since their goods would encounter few tarriff barriers (that was, after all, the entire point of the Community). The effect would be to increase the social cost of reunification. Germany already suffers from very heavy unem­ployment, largely because most of the firms in the East were not viable. It is proving difficult to integrate the vast number of newly-unemployed East Germans into a West German economy that, although healthy, is not growing. The resulting social un­rest is finding, unfortunately, classic channels, such as resurgent racism directed against all foreigners. Nationalism is on the rise, not only in Germany but also in other Western European coun­tries (not to mention Eastern Europe).

Within the Community as a whole, employment is largely stagnant, and growth has been quite slow for a long time. One reason is complex social laws that make it extremely difficult to fire employees after only a few months on the job. It is also very hard to close inefficient plants or, for that matter, compa­nies. While such rules seem the essence of decent treatment of workers, in fact they make it very difficult to set up new com­panies, or to expand existing ones (for fear that personnel costs will be impossible to reduce if things do not go well).

One effect of stagnation, visible to many tourists, is large numbers of long-term unemployed teenagers and young adults. Governments are well aware of their potential for mischief; the only solution to date has been very generous welfare outlays.

All of this meant that, far from being a benign abstraction, the European rate mechanism was a crucial test of just how much the governments involved rated a unified Europe above domestic issues. They had signed the Treaty of Maastricht in December, but to many of them that was probably more a sym­bolic than a meaningful act. Money was different, and it was far more important. The Germans were aware of the problem,

and in mid-September they lowered interest rates slightly, mak­ing it clear, however, that they would go no lower, and a cri­sis began. Britain and Italy both withdrew from the rate-setting mechanism (tourists were already well aware that their curren­cies were grossly overvalued).

The British pound was hit particularly hard. The British gov­ernment tried to maintain its value (nearly $2.00) by raising the interest rate to 12% and then to 15%, and by very heavy spending on foreign exchange. Then it gave up, charging that the Germans had refused to do their part. The pound promptly lost about 10% of its value compared to the dollar. As of the third week in September, it seemed likely that it would drift lower, perhaps eventually as low as $1.25.

Such figures presented the British Government with a terri­ble dilemma. The City of London, i.e., the bankers, cannot cheer­fully accept such devaluation, since it removes much of the value of money held with them, i.e., in pounds. Until now, the bankers have controlled the Cabinet, which is one reason Britain has avoided devaluation. Devaluation will also increase the cost of imports, and, to the extent that Britain has surrendered large slices of her manufacturing base to foreign suppliers, such in­creases merely increase the size of her trade deficit.

On the other hand, Britain is also an important exporter of fin­ished goods, and she has a large “invisible” export market in the form of tourists. Although there is a world recession, she can expect to do much better in both fields as the pound weakens. ■

The monetary crisis erupted just as the French were about to vote on the Maastricht Treaty. The French parties generally backed the treaty; in the past, France has been a moving spirit in the Community. A French Socialist heads the European Com­mission, the Brussels bureaucracy which actually runs the Community. The public was becoming less enthusiastic, how­ever, and some saw the referendum as a means of attacking the unpopular President, Francois Mitterand. In the end, on Sep­tember 20, the treaty won narrowly, by 50.95 to 49.05%. It i was much the same as the margin by which the Danes had voted , down the treaty a few months earlier. It seemed likely that the treaty would be withdrawn and rewritten. The exchange-rate agreement may well be dead. If reasoning this is correct, the German government will be unable to tolerate fully free trade in its absence, and the Community will begin to unravel.

These are not abstract points. For example, Britain competes j with the United States in the military export arena and Saudi Arabia, a potential customer, is a case in point. Both Britain and the United States offer a mix of military training and weaponry. The latter include British Tornado and U.S. F-15 fighters. Al­though the two airplanes are by no means equivalent, they fill much the same roles. The competition is complicated by other players, such as the Russians, who will offer far lower prices (but probably far less service). Note, incidentally, that money paid to train officers in Britain or in the United States is part of “invisible” exports, just like tourism.

Of course money is hardly the whole story. Different coun­tries place different sorts of political restrictions on exports, partly in hopes of convincing major potential buyers not to go elsewhere. A great scandal of the Iraq war, for example, was , that Germany was so export-happy that the German government would turn a blind eye to sales to Saddam Hussein. When that became public, the government had to accept a more moral ap­proach. One consequence was that it cut off Turkey, historically a major arms customer, as punishment for attacks on Kurds. That did not end the Turkish Navy’s modernization program, but it does suggest that any follow-ons to the current Track II frigate program probably will not be MEKO 200s. Visitors to the 1992 Navy League show saw a model of a possible U.S.-built candidate, designed at Newport News.