Germany's Lafontaine Talks, Business Trembles

The Finance Minister is throwing his weight around

When German Chancellor Gerhard Schroder made his first policy speech on Nov. 10, it sounded more like damage control than the agenda of a brand-new government. Schroder tried to reassure Parliament and a worried business community that he and his fellow Social Democrats would continue on the path of fiscal discipline. But his words did little to soothe his listeners' fears. The very same day, the chief aide to Finance Minister Oskar Lafontaine had issued a stern warning: If Europe's central banks don't cut interest rates to spur economic growth, he warned, governments might open the spending spigots--even if that means relaxing the rules for monetary union.

The threat carries real weight. In the widening split between centrist Schroder and his Finance Minister, Lafontaine seems to wield the clout. Never in postwar Germany has a leftist activist had as much power as Lafontaine has now. His strong support from the Social Democratic rank and file gives Lafontaine, 55, enormous leverage within Gerhard Schroder's new government. He already has formed a superministry, adding to his Finance portfolio powers formerly held by the Economics Ministry, such as policy regarding Europe's new single currency.

FAUSTIAN PACT? Now, Lafontaine is taking his act global. He and French Finance Minister Dominique Strauss-Kahn plan to meet in Bonn on Nov. 16 to formulate a new European economic plan, for which they hope to gain backing all across Continental Europe. He will pitch his ideas in the U.S. on Nov. 20, when he's due to meet with U.S. Treasury Secretary Robert E. Rubin and Federal Reserve Board Chairman Alan Greenspan in Washington.

Lafontaine's aim is to move economic policy in Germany and the rest of Europe considerably toward the Keynesian left. Before he meets with Rubin and Greenspan, for instance, he hopes to forge a European consensus on the need to stabilize foreign-exchange markets after the single currency is created next year. He believes that the euro should fluctuate only within a predetermined trading range against the dollar and other major currencies.

The Finance Minister's broader views are spelled out in Don't Be Scared of Globalization, a book he published this year with his wife, Christa Muller. Many businesspeople believe Muller, an outspoken economist who favors stimulative monetary policy, has a powerful influence over her husband's decisions. Both believe that Germany and Europe must lessen their dependence on exports and do more to boost domestic demand. With European inflation running under 1%, Lafontaine sees some room to ease the tight spending that Continental governments practiced during the runup to the euro. And, as he never fails to remind central bankers, he thinks the main way Europe can promote growth is by slashing interest rates from the 3.3% with which the European Central Bank is expected to usher in the euro in January.

Business doesn't like what it's hearing. Many executives believe Schroder made a sort of Faustian pact with Lafontaine to get elected on Sept. 27. Lafontaine whipped the party into backing Schroder and then kept discipline during the campaign. Now, groans Hans-Olaf Henkel, head of the Federation of German Industries, "we find ourselves in the difficult situation of having someone who knows nothing about business, who never studied economics, telling us what we should think about business and economics."

Such fears are being fanned by Lafontaine's politicking over interest rates. He is making a play to gain leverage over the new ECB. Former Chancellor Helmut Kohl tried to insulate the bank from such pressure by giving it the same legally mandated independence as the Bundesbank. But there's a loophole: If enough of the euro zone nations agree, they can instruct the ECB on exchange-rate policy. Lafontaine and Strauss-Kahn are worried that the euro will be born too strong, potentially killing export growth. If they can win a few other governments to their side, they will theoretically have the power to push the ECB to drive the euro down by cutting rates. "That could set up a huge conflict between the ECB and the politicians," says Ralf Hoffmann, a Deutsche Bank economist in London.

Whether things will ever go that far is doubtful. FiNancial markets would likely tank at any sign that politicians are successfully pressuring the ECB. Already, many German executives are up in arms over Lafontaine's diatribes at the Bundesbank and his tepid tax-reform program. "I'm disturbed," says Siemens Chief Executive Heinrich von Pierer. "I think it would be a big mistake if the government moves onto a collision course with the elites in this country."

MASTER TACTICIAN. In Germany, such tactics could provoke a collapse in business confidence. Net investment outflows, which ballooned to $34 billion last year, fell to about $11 billion in the first half of this year as companies anticipated major tax reforms from the new government. Now, disappointed companies are slowing their domestic investments again. "The new government is promising cuts in 2002, but what about now?" frets Diether Klingelnberg, owner of a small machinery outfit near Dusseldorf. "This will cost jobs, lots of jobs." That prospect, plus aftershocks from the Asia crisis, prompted Morgan Stanley Dean Witter to slash its forecast for German economic growth next year to just 1.5%--and for the entire euro zone to just 2.1%.

The big question is whether Schroder will move to rein in his Finance Minister. MAny of Lafontaine's pet projects have little prospect of success. His exchange-rate target idea was roundly rejected at the last Group of Seven meeting and probably won't get a much better reception from Rubin and Greenspan on Nov. 20. There also are signs that Lafontaine's tactics are making Schroder jittery about his poll ratings. The Chancellor has chastised Lafontaine for lobbying publicly for interest-rate cuts rather than jawboning central bankers in private. And Schroder recently announced new measures to cut the tax burden on German companies by 50% more than planned, or about $9 billion--with most of the cuts aimed at helping small to midsize businesses.

Business is clamoring for more such moves. But Schroder may not be able to change Lafontaine's agenda. The Finance Minister is a masterful tactician. The German newsweekly Stern summed up the feeling of many observers when it ran a recent cover story on Lafontaine entitled "The Boss." That may prove to be an exaggeration. But Oskar Lafontaine could shake Europe Inc. to its foundations.

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