View from Frankfurt: The long and short of two money cultures

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The Independent Online
When interest rates move, the first reaction of most people in Britain is to consider the impact on mortgage repayments. Germans, by contrast, react by thinking about what it means for their savings accounts. This fundamental difference in the money cultures of the two lies at the heart of the dialogue that has been going on for some time now between the German Bundesbank and the British.

One argument repeated like a mantra by Bundesbank central council members is that, by focusing on short-term interest rates, people have been missing the point; they should be looking at the more important long-term rates, which have been lying comfortably below the 25-year average.

Currently around 6.75 per cent, they provide relatively favourable conditions, which do not justify the public outcry for radical cuts in short-term rates, according to the Bundesbank. These have been falling slowly, with the discount rate now at 7.25 per cent.

In the German context, the Frankfurt central bankers have a powerful argument. For even though they deliberately underplay the psychological importance of short-term rates, and the fact that many firms rely on them to finance working capital, around 85 per cent of credit in Germany is long-term. Only 15 per cent is affected by the full weight of the short-term rates, which have been the focus over the past 18 months of international opprobrium.

However, it is an argument that the British have found difficult to understand, let alone accept, for some 80 per cent of credit in Britain is linked to short-term interest rates. This phenomenon finds its most potent expression in mortgages, where repayments bob up and down with shifts in short rates, giving British monetary policy an extraordinary political sensitivity.

Fixed-rate finance

This penchant for flexible-rate mortgages is not shared by the Germans, who finance their house buying and building by taking out fixed- rate mortgages over terms of between five and ten years. The initial down payment - at least one-third of the value of the property - tends to be much higher than in Britain.

Present mortgate rates, at around 8 per cent, are comparatively low, especially if one takes into account the inflation rate of just over 4 per cent. Fuelled by a long-standing shortage, the private housing sector in western Germany continues to perform well, an exception to the recession prevailing throughout the rest of industry.

The explanation of why Germany and Britain have developed such different money cultures can be summarised in one word: inflation. Strong inflationary expectations, accompanied by a tradition of sharp anti-cyclical movements in interest rates, have bred Britain's short-term credit culture. Few people are willing to commit themselves for any length of time, on the grounds that the longer you save, the less you get at the end of the period, after inflation has done its work.

The much vaunted propensity of the Germans to save, by contrast, has everything to do with the country's record, under the stern hand of the Bundesbank, of keeping inflation relatively low, and avoiding excessive swings in interest rates. People in Germany are much more comfortable with the idea of seeing the value of their money protected over long periods of time.

This confidence also explains what outsiders see as the Germans' conservatism in money matters. There has not been the sort of inflation that generated strong pressures in the 1970s among American savers, for example, for the development of a more varied range of financial instruments. And the Bundesbank, anxious to nurture Germany's more stable long-term culture, is determined to make sure that savers remain conservative, by slowing down the pace of financial deregulation.

Big mistake

Britain's 'Big Bang' - short- termism gone wild - was a big mistake, one central council member says. It will make the attempt to recreate confidence in a long-term credit culture all the harder.

France, which lies somewhere between Germany and Britain in its spread between short and long-term credit, is seen as making a similar mistake by pushing ahead with over- hasty financial deregulation.

The acquisition of low-inflation confidence is a lengthy process. The Germans have had some 40 years to build up theirs. Hung Tran, the economist who heads Deutsche Bank Research, says it takes two business cycles for savers to lower their inflation expectations to the point where they would be happy with the sort of long-term credit culture predominating in Germany.

This 10- to 15-year period amounts to a different time scale from the one set out in the Maastricht treaty for convergence between those member states that will go on to the third and final phase of European Monetary Union. This is meant to happen by 1999 at the latest.

For those who ask what the two issues have to do with one another, the Bundesbank would reply: 'Quite a lot.' According to a member of the central bank's directorate, the difference between Britain's short-term money culture and Germany's long- term one poses a grave problem for a common monetary policy.

Strong doubts persist about the ability of those countries with weak inflation records to withstand the sort of strains that could arise from trying to force them into the narrow neck of the EMU bottle. These doubts lie behind the musings (only in private of course) by senior Bundesbank officials that it would perhaps be better if Britain and Spain did not join any monetary union, at least in the near future.