Prospects for a single European currency, already threatened by growing political divisiveness, face another huge danger: hidden liabilities for state pensions that dwarf conventional governmental debts.
Sources said senior government officials in Germany and Great Britain are aware of the massive liabilities from state pay-as-you-go plans and are worried they could buoy inflation. That could devalue a single European currency and jack up interest rates for European Union countries, adding substantially to the cost of government borrowing.
In effect, countries with smaller state pension liabilities or sounder financial standing - such as Great Britain, the Netherlands and Germany - would be penalized for colossal state pension debts in countries such as France, Italy, Spain and Greece.
Failure to consider the pension debts in adopting European monetary union is akin to buying contaminated property without considering the environmental liability, said Ann Robinson, director general of The National Association of Pension Funds Ltd., London.
Dick Taverne, president of Prima Europe, a consulting firm in London, and compiler of an oft-cited Federal Trust report on European pensions, said: "Unless action is taken in due course, the hidden liabilities for pension commitments could upset the whole of Maastricht."
Awareness of the pension imbroglio might have played a role in recent comments by senior German officials that roiled financial markets, one source said. First, German comments seeking tighter financial controls on member states that participate in a single currency upset other European officials. Later, German Finance Minister Theo Waigel said Italy and Belgium were unlikely to meet financial criteria by 1999 to enter the European monetary union, causing weaker European currencies to plunge.
German Chancellor Helmut Kohl sought to repair relations, particularly with Italy, but the comments overhung a recent two-day summit meeting in Majorca. Germany remains in a delicate balance: while Mr. Kohl is a champion of European political union, the majority of Germans oppose surrendering their prized mark.
(In fact, fearing monetary integration, German domestic investors have been fleeing deutsche mark-denominated securities accounts, switching to ones based in more solid Swiss francs. Switzerland is not a member of the EU.)
Nor are the fears of an unhinged monetary policy likely to fade away. Many EU states are struggling to meet the Maastricht Treaty's financial criteria for participation in a single currency by 1999, the first round cutoff date.
While perhaps half of the EU's 15 member states might get their budget deficits below the allowable ceiling of 3% of gross domestic product, it will be far tougher for many states to get their public debt levels below the 60% of GDP threshold. Now, Germany and Luxembourg are the only countries that comply. Failure to include France in monetary union would spell its failure; some experts believe the future of the EU itself hangs in the balance.
Pension debts ignored
But the maximum for public debt fails to take into account the huge state pension debts many EU countries hold. A 1993 study by Jonathan Hoffman, director-economics at CS First Boston Ltd., London, found inclusion of pension obligations more than doubled the size of state debt in most EU countries.
As of 1990, "true" debt in Belgium, for example, jumps to 218% of GDP when pension debt is included from 128% without pension debt; Italy's debt soars to 245% from 98%; and Greece's jumps to 253% from 96%. In fact, the United Kingdom, with its relatively low state pension benefits, is the only country likely to meet the 60% criterion by 1999, Mr. Hoffman wrote.
A more recent study by the Organization for Economic Co-operation and Development, Paris, found some countries will see soaring public debts because of changing demographics and rising pension costs. Germany, with net debt now at 46% of GDP, will see it climb to 80% to 105% of GDP by 2030. Similarly, France's net debt will soar to 75% to 105% of GDP by 2030 from 36% now.
Italy, whose net debt is expected to fall between 80% and 100% in 2015 from 120% now, will be hit by rapid increases in pension expenditures. The OECD projects Italian net debt will rise to 125% to 175% of GDP by 2030.
Great Britain, with its small pension debt, actually may experience a 9% net credit in 35 years under one OECD scenario.
That projection tends to feed the argument of a growing number of U.K. financial experts who oppose European monetary union. The issue has split the reigning Tory Party, although Prime Minister John Major now is leaning against monetary union. (Only Britain and Denmark can opt out of a single currency under EU rules.)
As participants in a single currency, "We will end up having to share the burden for countries who haven't advance funded" their state pensions, explained Richard Malone, European policy director for Sedgwick Noble Lowndes Ltd., Croydon, England.
"One could argue it is one of the most compelling cases for the U.K. to withdraw from the EU or not to participate in mandatory economic union," he added.
CS First Boston's Mr. Hoffman said taking state pension liabilities into account is "absolutely crucial, because if you form a single currency, you are taking risks that a single currency will be subject to inflation" - not just from stated budget deficits and debts but from hidden ones as well.
"Pension liabilities will have an inflationary effect for the currency as a whole," he added.
The biggest problem, experts said, is not in terms of meeting the Maastricht treaty criteria for entry into a single currency, but ensuring participating member states stay on track after monetary union occurs.
EU states could address the pension problem by raising taxes, curtailing benefits, boosting retirement ages or borrowing money to finance pension benefits.
But raising taxes would boost unemployment, still high in Europe; cutting benefits or raising the retirement age is politically unpopular; and borrowing money would cause EU countries to encounter further problems in meeting the Maastricht treaty criteria.
"So we will pay through higher interest rates," Ms. Robinson said.
An EU tax policy?
The natural leap, some argue, is that an integrated monetary policy will lead to a Europeanwide fiscal policy - including the possibility of an EU-level tax policy.
"If those Maastricht criteria are expected to be maintained," explained Jane Platt, chief operating officer of BZW Asset Management, London, that "has implications for how economies are managed and for taxation (policies)."
Other experts, however, note EU member states strongly oppose ceding authority to raise taxes to the EU, and doubt whether that will ever happen. Surrendering sovereignty in that area could blow the EU apart, experts believe.
"I think it's a real Pandora's box," Mr. Hoffman said. "In order to solve it, you have to take the power to tax away" from countries.
Others question whether state pension debts should be included in total public debt. There are many assumptions that go into calculating pension liabilities that make those figures unreliable, they argue. Plus, pension obligations are very long term, and governments can pare back benefits in the meantime.
Some also argue that, in some EU states, the employer bears the burden for paying the benefits, although others respond the state ultimately guarantees the benefit.
The irony is that a single currency actually could help advance-funded pension plans. A single currency would eliminate many foreign exchange charges and currency risk.
The long-term solution, many pension experts argue, is to create private funded retirement systems in countries that lack them, while paring back state benefits. Countries are starting to do that, but too slowly for some.