The Bundesbank against the World: German Central Bank Opposes Euro Strategy
Part 2: Euro Bonds Through the Back Door
Schäuble's experts have recognized the threat to the central bank's independence, and are searching for solutions. They believe that it's perfectly conceivable that Italy or Spain will not have to commit themselves to reforms under the auspices of the euro-zone bailout fund in the future, but will merely make a voluntary commitment to the European Commission. The advantage of this approach is that the ECB's actions would not be dependent on decisions by the euro-zone finance ministers. The drawback is that a voluntary commitment would not be as binding as a program that formed part of a bailout agreement.
Whatever form the ECB actions take, the bond purchases are nothing but a back-door way of sharing risk. While Merkel refuses to enter into a liability union through jointly guaranteed euro bonds, she has nothing against the ECB handling this task. All members of the monetary union are liable, in proportion to their shares of ECB capital, for the risks the central bank accumulates by buying the bonds of ailing countries. Not surprisingly, Sigmar Gabriel, chairman of Germany's opposition center-left Social Democratic Party (SPD), accuses European politicians of using alternative means to introduce euro bonds.
Sobering Track Record
Economists and investors also doubt that Draghi's new program will produce the anticipated relief in the long term. The track record to date is sobering. Between May 2010 and early 2012, the ECB intervened in the so-called secondary markets, where bonds are traded after being issued, buying a total of 211 billion in Greek, Italian and Spanish sovereign debt. Its actions brought a brief respite for the ailing countries at the time, but risk premiums soon shot up again.
The new program could be similarly ineffective, warns Clemens Fuest, an Oxford-based economist who advises the Merkel administration. "If investors are convinced that a country is bankrupt, not even an intervention by the central bank would change this," he says.
Andrew Bosomworth, managing director of the German office of Pimco, the world's largest investor in government bonds, fears that the new program will mainly attract speculators rather than long-term lenders. "If interest rates for a particular country go up, they (the speculators) will bet on an ECB intervention," he says. "Investors oriented toward sustainability will not return until their confidence in the euro-zone project has been renewed." In other words, a measure designed to hinder speculators could in fact be a boon to them.
Experts warn that, in the end, the debt-ridden countries' creditors would simply offload large portions of their bond holdings to the ECB, without the affected countries being helped in the long term.
In a worst case scenario, the debtor countries could see their economies continue to shrink while poor-quality bonds, whose value is no longer linked to the real economy, pile up on the ECB's balance sheet. The possible consequences are well known from monetary history: inflation, currency reform and assets losing value.
Some Good News
According to some critics, the new ECB program is not even necessary, because key economic indicators are already improving in the crisis-ridden countries.
There is something to this. Economic imbalances in the euro zone have been reduced considerably. The current account deficits of all crisis-ridden countries are shrinking, although this news should still be viewed with caution. Ireland is already showing a surplus, which could approach the level of the German surplus in the next few years. Italy and Spain are about to balance their current accounts. Greece has cut its current account deficit by almost two-thirds.
Unit labor costs, an important barometer of a country's competitiveness, are declining in all countries except Italy, and exports are growing as a result. All of the crisis-hit countries have managed to increase exports in the last two years.
Fiscal policy indicators are also improving, now that austerity measures are taking effect. Italian Prime Minister Mario Monti plans to balance his budget next year, which would put the country on a similar level as Germany. Portugal has cut its budget deficit in half, and Spanish Prime Minister Mariano Rajoy is also making headway. The situation is easing noticeably in Ireland, so much so that the government was recently able to borrow money again on international financial markets.
Optimists say that the good news from the other countries will also have an effect on the market sooner or later. Confidence in the euro zone will then return, and countries, with the possible exception of Greece, will be able to obtain funding without being dependent on the help of the bailout funds. The condition, however, is that reform efforts continue and are not prematurely terminated -- for example because of bond buying that is theoretically supposed to ease the burden on those countries.
Shopping Without Limits
The debates on the details of the program that Europe's monetary watchdogs are currently engaged in show how great the risks are. Representatives from the south would prefer it if the ECB went shopping for bonds on the secondary markets without any limits. One idea is to establish general upper limits for interest rates on government bonds, or to artificially limit the spread between the bonds of crisis-hit countries and, say, Germany.
Central bankers from the north, however, only want to buy bonds on the markets in extreme situations, in short but energetic campaigns, such as when interest rates suddenly shoot up as they did in the week before Draghi's London announcement. Another idea that has recently been circulated is to pre-announce certain intervals for interventions by the ECB, such as for days when countries issue new bonds.
Which camp will ultimately prevail is still unclear. The proposals by the relevant task forces will be discussed in the ECB Governing Council for the first time in early September, at which point other council members will try to persuade Weidmann once again.
His fellow council members are reacting sharply to Weidmann's fundamental opposition. There is talk of a power struggle within the ECB that ignores the effects on the central bank's reputation. "We must speak to the outside world with one voice," one official says emphatically. The central bankers are faced with a dilemma: They need the confidence of investors to make their crisis management work. But ongoing criticism from within their ranks is partly responsible for the miserable results of the first bond-buying program, say central bankers.
But Germany's chief monetary watchdog refuses to defer to this logic. Weidmann believes that any purchase program is wrong, and he will not let anyone persuade him otherwise -- neither his fellow board members nor the chancellor.
Merkel and Weidmann have talked a lot in recent weeks, sometimes by telephone and sometimes in private at the Chancellery in Berlin. As a result, they have reached a sort of temporary truce.
Weidmann, who doesn't see himself as being isolated, will continue to openly voice his criticism of the Draghi program, but he will not torpedo the effort for the time being. He will implement the ECB decisions and will not file a complaint with the European Court of Justice. In return, Merkel will show an understanding for Weidmann's positions, but she will not support them.
It's a stalemate that benefits both Weidmann and Merkel. Weidmann doesn't want to overdo the conflict, given his ambitions to eventually head the ECB himself. Merkel, on the other hand, has no interest in having a fundamental dispute with the Bundesbank. As a minister in the cabinet of former Chancellor Helmut Kohl, she realized that it didn't pay off for members of the government to tangle with the central bank. When then Finance Minister Theo Waigel wanted to have the Bundesbank's gold revalued in 1997, he faced a storm of protest in the media and was forced to drop the idea.
Merkel knows that many members of the ruling coalition parties are more likely to support Weidmann than her today. "It isn't helpful to add to the problems by printing new money in Frankfurt," warns Rainer Brüderle, the floor leader of the pro-business Free Democratic Party (FDP), the junior partner in Merkel's coalition government. Bavarian Governor Horst Seehofer, leader of the CDU's Bavarian sister party, the Christian Social Union (CSU), believes that it is "fatal to keep buying up new bonds from indebted countries." CDU economic expert Michael Fuchs supports Weidmann "wholeheartedly," saying the ECB cannot become a money press.
Draghi's plan doesn't just upset the traditional division of tasks between fiscal and monetary policy; it also puts a strain on the relationship between the head of the Bundesbank and the chancellor. The conflict is manageable, as long as the euro crisis doesn't escalate and no ECB interventions are necessary. But if the central bank were to buy Southern European sovereign debt for hundreds of billions of euros once again, the truce would quickly end.
To retain his credibility, Weidmann would eventually have to oppose the program. Then Merkel would drop him -- just as she drops everyone who gets in her way.
Translated from the German by Christopher Sultan
- Part 1: German Central Bank Opposes Euro Strategy
- Part 2: Euro Bonds Through the Back Door
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