Chatting as he sips a morning cup of coffee in his office two miles from downtown Frankfurt, Bundesbank President Helmut Schlesinger's gestures are as spare and efficient as the decor inside the German central bank's headquarters. But as the talk turns to the growing global criticism of high German interest rates, two years after unification, Schlesinger suddenly leans forward. "Our policy is often discussed in other countries as if we were the Germany of 1989," he says, his voice tightening and his eyes narrowing behind his steel-rimmed glasses. "We are not. We are the Germany of 1992, '93, '94--and we have quite different problems."

If Germany's global partners hadn't already gotten the message that domestic concerns come first at the Bundesbank, there should be no doubt now. Its July 16 decision to squeeze domestic inflation by raising the discount rate by three-quarters of a point, to 8.75%, sent bourses and bond markets around the globe reeling, pushed the dollar's value close to a historic low of 1.45 German marks, and forced the Federal Reserve to organize an intervention campaign to prop up the greenback. Schlesinger's insistent stand on inflation may even further complicate the European Community's efforts to ratify the Maastricht Treaty on economic and monetary union. "The move was very destabilizing," says Giorgio Bodo, top economic analyst at auto maker Fiat. "If I wanted to be really nasty, I'd say that the Bundesbank doesn't mind that European unification will slow down."

For the 67-year-old Schlesinger, the markets' chaos was just the latest episode in nearly a year of living dangerously as the Bundesbank's head. Schlesinger sees himself on a crusade to vanquish inflation spawned by the high costs of unification. If nothing else, that has established the Bundesbank as the most tangible symbol yet of the assertive new Germany that many neighbors fear. Even German business leaders are concerned. With the global economy so weak, says Daimler-Benz Chairman Edzard Reuter, "there are certainly questions whether it was wise" to hike rates. "They could have waited."

`PLEADING.' More shock waves could lie ahead. High German rates will cool domestic growth, keep pressure on the dollar, and put a further damper on the economies of Europe and even Japan. Until July 16, "there was a slight chance of Japan decreasing the discount rate in a few months," says Kazuo Ogura, the Japanese Foreign Ministry's chief economic aide. But now, "we'll have to reconsider."

It's not as if Schlesinger and the 17 other members of the Bundesbank's policy-making council didn't make a stab at limiting the fallout. The council confined its increase to the largely symbolic discount rate. But traders think the bank will eventually increase its Lombard rate, too. Now at 9.75%, it sets a floor for money-market interest rates across Europe. Schlesinger, in an interview with BUSINESS WEEK, wouldn't rule out a further rate hike. "One cannot make a forecast now for lowering rates or of a need to go up once more," he says.

In trying to squeeze Germany's current 4.3% inflation rate and break the back of 9% money-supply growth that has far overshot bank targets, Schlesinger has discovered how limited his leverage really is. Since unification, Bonn's budget deficits have ballooned, and billions of marks' worth of cheap, government-subsidized loans have poured into eastern Germany. The loans, amounting to one-sixth of the new lending in all Germany, have left credit demand largely insensitive to interest rates. "I'm pleading that the federal government not extend these measures," Schlesinger says. "They make our own work more difficult."

That reality has mocked Bundesbank anti-inflation rhetoric ever since December, when the council last raised rates. Schlesinger is a longtime hard-liner who says he is devoted to "keeping the stability of our money." So until money-supply figures drift down toward the 5.5% annual growth target the bank has set for itself, the chief needs to keep sending tight-money signals or face a growing credibility gap. July's inflation figures are expected to show a drop, to an annual rate of 3.5%. Still, few expect the tension to ease, as public-sector workers prepare for wage talks this fall.

OUI OU NON? EC ministers are hoping that inflation is all that Schlesinger succeeds in killing. The central banker insists "our measures are helpful for the European Community and for acceptance of the Maastricht Treaty." But a Brussels official confides that EC finance ministers have "decided to keep their mouths shut" to avoid dramatizing the latest Bundesbank move. That may be wise. With France's crucial referendum on Maastricht scheduled for Sept. 20, French voters could easily find the Bundesbank's current domination of European monetary policy reason enough to reject a deal that will force countries to cede monetary sovereignty to a new bank run largely by Germans.

Even if France votes yes, higher German rates will certainly strain European unity by putting pressure on countries such as Italy and Britain to devalue currencies and risk a breakup of Europe's system of managed exchange rates. "The whole concept of the system was based on low inflation and low interest rates in Germany, and we've got the reverse of that," complains Ronald Cohen, chairman of the British venture-capital group Apax Partners Ltd.

For Schlesinger, the need to look over his shoulder at the impact of Bundesbank decisions on Europe has made his hot seat at the Bundesbank all the more uncomfortable. But choosing a path out of the dilemma doesn't give him pause. "There's no possibility of helping our partner countries by allowing more inflation in Germany," he says. At the risk of inflicting more pain on his allies in Europe and abroad, that's a point he'll drive home again and again.

      UNIFICATION "That requires big financial assistance. But it must be done on 
      the basis of keeping the stability of our money"
      INTEREST RATES "One cannot make a forecast now for lowering rates or of a need 
      to go up once more"
      EUROPE "Our measures are helpful for the European Community and acceptance of 
      the Maastricht Treaty"
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