The Bundesbank against the World: German Central Bank Opposes Euro Strategy
The European Central Bank plans to resume buying the bonds of crisis-hit countries on a large scale. Jens Weidmann, head of the German central bank, is firmly opposed to the idea, arguing that it will lead to inflation and lessen pressure on governments to carry out reforms. But he is becoming increasingly isolated within the ECB and in the political world.
Volker Bouffier has always portrayed himself as the last true conservative in Germany's center-right Christian Democratic Union (CDU). Bouffier is the governor of Hesse, the western German state where Germany's financial capital Frankfurt is located, and is known for raging against gay marriage, multiculturalism and school reforms. On questions of monetary policy, he has always been a champion of traditional German virtues. "The European Central Bank cannot become an institution that compensates for the failures of individual government budgets, such as Italy's," he said recently. "That isn't part of its mandate."
But on Monday of last week, Bouffier seemed to be a changed man. He had invited Jens Weidmann, 44, president of the German central bank, the Bundesbank, to a meeting at the Hesse state chancellery. For weeks, Weidmann had sharply opposed the ECB's plans to buy up large quantities of Italian and Spanish sovereign debt. In the meeting with Bouffier and his cabinet, Weidmann had just reiterated his position in the ongoing dispute with ECB President Mario Draghi when Bouffier, to the surprise of everyone in attendance, announced his new priorities. Apparently, the values of Southern European bonds on the balance sheets of Frankfurt banks are now more important than his conservative values.
Of course he still supported stable prices, Bouffier said, but noted that the mood in financial markets had become extremely fragile. And despite his characterization of the ECB's debt-buying plans as sinful, he said that there were no longer any alternatives to massive intervention by the central bank. "The political tools have been exhausted," Bouffier said.
The Bundesbank president is becoming increasingly isolated, and not just in provincial German politics.
'Addictive Like a Drug'
A powerful phalanx of key statesmen, from US President Barack Obama to French President François Hollande and British Prime Minister David Cameron, have long called upon Weidmann to finally abandon his resistance to the increased use of the ECB's "big bazooka." Now even some of Weidmann's former allies are turning their backs on him. Recently, Germany's powerful private banks have come out in support of Draghi, as have Weidmann's fellow ECB Governing Council member Jörg Asmussen and a majority of monetary policy experts in Northern Europe.
The head of the Bundesbank has now decided that the best form of defense is attack. In an interview with SPIEGEL, Weidmann explained why he believes the approach taken by European leaders is wrong. "We shouldn't underestimate the danger that central bank financing can become addictive like a drug," he says.
Of course, Bundesbank opposition is not expected to stand in the way of the Draghi plan. The EU treaties are being violated once again. Two years ago, during the course of the Greek crisis, European governments suspended the principle that no member of the euro zone could guarantee the debts of another member state. Now a similarly fundamental principle is up for renegotiation: the prohibition on national budgets being financed with the help of the ECB.
The risks are considerable. If Draghi's proposal prevails, Europe's central bankers could lose control over the money supply in the medium term, which in turn could lead to substantial inflation. Southern European governments could misinterpret this as a signal that they can obtain cheap money without instituting painful reforms after all. German taxpayers would be saddled with additional billions in risk without having any say in the matter.
Feelings of Desperation
But those European politicians who are determined to rescue the euro have been ignoring democratic principles for a long time. They are feeling desperate because, after 17 monetary summits, they still haven't been able to stop the crisis. And now they are pleased to see Draghi doing the work for them.
The purchase of government bonds sounds technical and harmless, and yet the weapon with which Europe's top monetary policy experts are now going into battle is essentially no different from the euro bonds that German Chancellor Angela Merkel famously said she will oppose as long as she lives. Not surprisingly, Merkel's take on the Draghi proposal is characterized by her typical doublespeak. At home, her advisers insist that it's a good thing that someone is upholding the principles of the Bundesbank. In Brussels, on the other hand, Merkel indicates that the Draghi plan enjoys her full support.
But the two positions will in reality be incompatible if the euro crisis continues to escalate. Weidmann wants the monetary union to be able to force crisis-ridden countries to withdraw from the euro zone if there is no other way to ensure monetary stability. Merkel, on the other hand, wants to preserve the monetary union at all costs, even if this means inflation and financial crashes.
Now Weidmann is even losing the chancellor as an ally, even though he served as Merkel's economic adviser for five years.
The Talking Paperclip
When Merkel appeared before the press at financial summits or to discuss monetary issues, Weidmann, as her adviser, always stood in the background, a thin, youthful-looking man with his brown briefcase wedged under his arm. As an adviser, he was exactly what she wanted: quick-witted, discreet and loyal to the point of self-denial.
Weidmann, who holds a doctorate in economics, spoke only when he was asked. And when he did state his position at length in off-the-record conversations, he had no trouble coming up with even more tedious wording than his boss. Journalists nicknamed him the "talking paperclip."
Given his nature and reputation, observers were convinced that Weidmann would prove to be even more flexible in his new position than his predecessors. Previous Bundesbank chief Axel Weber, for example, had resigned over his opposition to bond purchases, and ECB chief economist Jürgen Stark followed suit shortly after Weidmann came into office.
It was all the more surprising that the new Bundesbank president was soon openly championing Germany's positions even more staunchly than his predecessors. Whereas Weber and Stark tended to keep their criticism to themselves, Weidmann, in speeches, op-ed pieces and interviews, warned of the dangers of a misguided euro crisis policy. He was regularly outvoted in the ECB's Governing Council. Nevertheless, ECB President Draghi soon realized that it would be foolish to ignore Weidmann's most powerful weapon: the deep-seated and well-founded mistrust that always takes hold in the population when politicians push for banks to start printing money.
When Draghi talked of a possible new bond buying program a few weeks ago, Weidmann's resistance was to be predicted. In light of rising interest rates for Spanish and Italian bonds, Draghi felt the need to send a strong signal to the markets. Without consulting with his colleagues on the ECB Governing Council first, he announced, during a speech in London at the end of July, that the ECB would do everything in its power to save the euro. "And believe me, it will be enough," he added cheerfully.
Draghi explained his plans in more detail soon afterwards. Unlike earlier cases, he said, the bond purchases would be tied to conditions. Only those countries that had applied for assistance from the European bailout fund and were prepared to commit to reforms could expect assistance.
This was Draghi's way of accommodating his critics, to the delight of the government in Berlin. According to government insiders in Berlin, Merkel and German Finance Minister Wolfgang Schäuble characterized the Italian economist's plan as "important and valuable" and felt that Draghi's announcement alone had already had an effect. Indeed, since Draghi's London speech the risk premiums on Spanish and Italian government bonds have declined considerably.
With his strategy, the ECB chief is mainly buying time. Members of Merkel's and Schäuble's staffs appear to accept Weidmann's notorious opposition to Draghi with a shrug. At the Chancellery, where the young Bundesbank president used to work, there has even been malicious talk of "fundamentalists." In the Finance Ministry, too, Weidmann is increasingly regarded as a troublemaker. "Some people interpret the ECB's mandate more narrowly. Others interpret it a bit more broadly," says a senior Finance Ministry official, with a trace of fatalism in his voice.
Privately, Chancellor Merkel also has little sympathy for the intransigence of her former adviser. Merkel apparently feels that Weidmann and his staff shouldn't be making such a fuss.
It's a classic conflict over a cheap money policy. The government wants to use the medicine as quickly as possible, because it's easy to get. The Bundesbank, on the other hand, sees the risks and side effects and warns against writing the prescription in the first place. From the Bundesbank's perspective, the most important objective of a central bank is to maintain price stability. By buying up government bonds to force down their yields, they are intervening in fiscal policy, a classic role of government.
The consequences can be fatal. With its bond purchases, the ECB is flooding the markets with money. If it doesn't claw back the money elsewhere, it continues to inflate the money supply. Experience and theory have shown that the injection of funds into the markets could eventually lead to rising prices -- in other words, inflation, which central bankers are required by law to prevent.
Weidmann also suspects that the ECB indirectly contributes to funding the national budgets of crisis-ridden countries, which it is prohibited from doing under the European Union treaties. Although the ECB is not lending money directly to governments, its policy "is too close to state financing via the money press for me," says Weidmann. With his comment, he is articulating the fear that the crisis-hit countries will exploit the bond-buying program to constantly issue new debt.
In addition, the bond buying reduces pressure on governments to institute reforms. That's something that the ECB's bankers learned a year ago, when they bought large numbers of Italian government bonds, only to look on as the government of then Prime Minister Silvio Berlusconi promptly put its reform efforts on ice.
To prevent this, Draghi now wants to ensure that future bond purchases are subject to strict conditions. But this makes the ECB even more dependent on the political world, because it prevents it from intervening in the future when it sees fit. Instead, it will have to wait until politicians have created the necessary preconditions.
This raises new questions. For instance, will the ECB even have the option of refusing assistance? And how will it justify buying one country's bonds at an interest rate of 7 percent while it buys those of another at just 5 percent?
- Part 1: German Central Bank Opposes Euro Strategy
- Part 2: Euro Bonds Through the Back Door
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