How Goethe’s masterpiece is shaping Europe

From the wreck of the sovereign debt crisis Germany has unquestionably emerged as Europe’s pre-eminent power. And a central tenet of the German solution to the crisis – for it is primarily a German solution – is that other eurozone members must be recast in their mould of fiscal orthodoxy and financial conservatism. Debt is to be regarded as immoral; current account surpluses are de rigueur; all but marginal budget deficits will be punished; and financial innovation is to be throttled by regulation. What, fellow Europeans might ask, is the wellspring of this providentialism and homespun finance?

The usual explanation emphasises the traumatic experience of the 1920s Weimar inflation, which lingers in the German memory more than the slump that brought Hitler to power. There are nonetheless deeper factors at work, not the least the etymological link between debt and guilt in the German word schuld. The fear of currency debasement was entrenched long before the 20th century. Frederick the Great in the Seven Years War debauched the currency several times to fund the fighting. Note, too, that Goethe’s Faust Part II brilliantly describes the perils of inflation. Mephistopheles urges the emperor to use undiscovered gold beneath his lands as putative collateral for promissory notes to pay the army. When the emperor and his court find they can print money without restraint, their wild spending leads to an inflationary spiral and civil chaos.

This, from the man who served as privy councillor at the court in Weimar, was more than prescient, given that Germany had yet to acquire a note-issuing bank when the work was written. Goethe probably drew on experiences of revolutionary France. The National Assembly’s issue of assignats – certificates supposedly backed by the value of church properties confiscated in 1790 – ballooned out of control. Goethe’s masterpiece no doubt helped embed the anti-inflationary mentality in Germany’s educated class. It took the horrors of the first world war and its aftermath to induce the temporary lapse of memory under the Weimar Republic.

Meanwhile, mercantilism and the fear of sophisticated finance have historically gone hand in hand in Germany and other parts of northern Europe. In the 15th century the cities of the Hanseatic League were profoundly suspicious of credit. They largely excluded foreign bankers. Merchants tried to balance trade bilaterally, relying partly on barter while making some use of coin. The economic historian Raymond de Roover reckoned the League’s credit institutions were about two centuries behind the Italians in 1500.

As the 16th century progressed, southern Germans such as the Fugger family became more competitive vis-à-vis the Italians. They developed a system of financial intermediation involving borrowing from wealth-owners everywhere and lending to monarchs. Yet they still mistrusted innovation deeply.

Then the big innovators were the Genoese, who developed the equivalent of interest rate swaps in lending to Spain’s government. In a form of securitisation they also used inflows of silver to Spain to finance the delivery of gold to pay Spanish troops in the Low Countries. According to the historian Fernand Braudel, the horrified Fuggers thought this an unworkable sleight of hand. So the Genoese were able to erode the Fuggers’ share of business with the Spanish treasury.

German banking continued to lag behind in the 19th century, while in the 20th big German banks were slow to respond to the importance of plastic cards, securitisation and derivatives markets. Does this conservatism matter? The Germans are superb manufacturers, while the Americans and British happen to have bigger financial sectors. Globalisation and the law of comparative advantage are all about specialisation. Yet the cultural bias is arguably a disadvantage. A shortage of equity in both banking and the non-financial corporate sector leaves Germany’s economy vulnerable to shocks.

The apparent lack of understanding of the reciprocal relationship between debtors and creditors is more damaging. No one can run persistent current account surpluses without somebody else running up deficits. There are also double standards here. The German military was long exempt from financial discipline: the motto of its general staff in the first world war was Geld spielt keine Rolle – loosely, hang the cost. Germany was the first in the European monetary union to break the stability and growth pact rules on deficits and debt.