Saving the Euro Germany's Central Bank against the World
Part 2: Growing Calls for Intervention
Now the question is how long the cheering will last. Although Weidmann won a battle with his successful handling of the special drawing rights issue, he certainly hasn't won the war. Last week, as it became increasingly clear that the Italian debt crisis was coming to a head, there were growing calls for a massive intervention by the European Central Bank, and they were supported by credible arguments.
In the crisis, the ECB has proven to be the only functioning institution that can make a stand against global speculators and expect to succeed. If it pledged to buy unlimited amounts of sovereign bonds to keep the yields on those bonds low, not even the wealthiest hedge fund would dare to speculate against it.
Keeping the speculators in check is a laudable goal. The only problem, in Weidmann's opinion, is that a victory over speculators would come at too high a price. The central bankers know perfectly well that by purchasing bonds, they are serving policymakers and jeopardizing their real function of keeping prices stable.
When the ECB buys bonds today, it is still taking just as much money out of the market as it is injecting into it. Experts call this "sterilizing." The goal is to ensure that the money supply does not grow excessively, thus reducing the risk of inflation.
However, the process only remains unproblematic as long as the interventions in bond markets are kept within reasonable limits. But now that they are propping up Italy, the central bankers in Frankfurt have had to inject more and more money into the market to achieve any effect at all.
Weidmann feels that these interventions are completely unnecessary. Italy, unlike Greece, is not bankrupt, he says. On the contrary, the country is very prosperous and could easily raise money by, for example, increasing taxes.
Last week, it became apparent that the ECB's money hose can achieve little in the long term. The more the political crisis intensified, the more billions the ECB had to spend on Italian sovereign debt, because no one else wanted to invest in the bonds. Banks and other major investors, fearing that they would soon be faced with high losses, as with Greek bonds, threw their Italian bonds on the market.
Traders reported that the ECB bought up bonds worth significantly more than 10 billion ($1.37 billion) last week alone. But yields kept on climbing, despite the interventions, topping 7 percent by the middle of last week. The market for Italian government bonds is simply too big. Only when a political solution to Italy's crisis was in the works did rates fall again.
If the country doesn't get its problems under control, the ECB will have to intervene to the tune of billions. The consequences would be considerable. If monetary watchdogs are unable to reel in liquidity, the money supply will expand and, sooner or later, will lead to rising prices.
One of the biggest fears of critics of the bond-purchase programs is that they will deprive governments of any incentive to sort out their finances on their own. When the ECB decided in August to buy Italian bonds, Berlusconi, trusting in the Frankfurt-based rescuers, cut back his austerity program. As in the case of Greece, valuable time was lost without structural reforms being addressed -- and everything just got worse.
"Here in Europe, we spent a year and a half talking about irrelevant alternatives," says former Bundesbank President Axel Weber, who is currently teaching at the University of Chicago and is in a position to express inconvenient truths. "All previous ideas follow the principle: How can I use other people's money to help myself?"
Since August, the ECB's bond purchases have doubled to more than 180 billion. This is only a fraction of the amount that the American central bank, the Fed, has spent on treasury bonds since the financial crisis. But in the United States, the liability rests with the federal government and not with the individual states. In Europe, by contrast, the Germans always bear 27 percent of the risk, corresponding to their share of the ECB's capital. If the securities were downgraded as a result of a national bankruptcy, German taxpayers would have to cover the losses.
Should the ECB start generally propping up government finances, it would create deep holes in Germany's federal budget. And it would also be a clear violation of the law, since the European treaties expressly bar the ECB from financing the euro-zone countries. If Germany truly wished to allow the central bank to finance governments, constitutional law experts argue, the matter would have to be decided by the German Bundestag. In fact, a referendum might even be necessary.
It's no wonder that Weidmann's campaign is highly popular in Germany. Last week, the five members of the influential German Council of Economic Experts, which advises the government, announced their support for the Bundesbank president. Most members of Germany's banking industry also support the Weidmann line. Deutsche Bank CEO Josef Ackermann, for example, favors imposing tight restrictions on the central bank's mandate. "If we start developing the ECB into a bank that performs completely different tasks beyond maintaining price stability," he says, "we will lose people's confidence."
Michael Heise, chief economist at the insurance giant Allianz, advises "strongly against unlimited purchases of government bonds." If a country is unable to sort out its finances," he says, "we should let the markets speak." And Commerzbank chief economist Jörg Krämer warns against turning over control of the money presses to national governments. "If the virus of mistrust spreads to the ECB, it will have serious consequences," says Krämer. As a result of the bond purchases, he explains, wealth is being permanently transferred from northern to southern Europe, "without democratic legitimization and without the debt problems being solved."
The top officials of the German banking lobby also clearly oppose all plans to make the central bank largely a tool of policymakers. "Then it'll only be a short step from the use of currency reserves to firing up the money presses to pay for government debts," warns Andreas Schmitz, president of the Association of German Banks. "However, the ban on government financing by the ECB is a valuable asset that cannot be compromised."
Weidmann agrees. In his campaign, he can count on the support of the German banking industry, as well as on the Bundesbank's tradition. Its presidents have always considered resisting pressure from politicians to be their most important task.
Strong Independent Streak
Since its birth on July 26, 1957, the actions of the Bundesbank have been shaped by two genes. First, it has a strong independent streak, which it is particularly likely to demonstrate in its dealings with politicians. Second, it can be enormously combative when it is called upon to secure the stability of its own currency.
It is as if the institution had implanted these two core characteristics into its respective leaders, from the first Bundesbank president, Wilhelm Vocke, to the current president, Jens Weidmann.
The position and the responsibility have had a greater influence on the respective Bundesbank presidents than they in turn had on how the institution is run. Bundesbank presidents who were members of the center-left Social Democratic Party (SPD), like Karl Klasen and Karl Otto Pöhl, ran the central bank in much the same way as center-right Christian Democratic Union (CDU) member Hans Tietmeyer: They all did their utmost to fight inflation.
As a result, it was not uncommon for Bundesbank presidents to clash with chancellors and cabinet ministers. Their disputes were usually about interest-rate increases, which the central bank used to avert risks of inflation. The governments, on the other hand, preferred low interest rates, because they hoped that this would stimulate the economy, bring down unemployment and improve their election prospects. But the keepers of the currency routinely proved to be stubborn.
Former Chancellor Konrad Adenauer berated then-Bundesbank President Vocke as a "stale refrigerator." Former Finance Minister Hans Matthöfer dismissed his counterpart Otmar Emminger as a "miserable know-it-all." And former Chancellor Helmut Schmidt referred to Helmut Schlesinger, who had long opposed the introduction of the European Monetary Union, as a "German nationalist."
The German government does not appoint the head of the Bundesbank. It can only nominate a candidate, who must be accepted by the Bundesbank board of directors before becoming president.
- Part 1: Germany's Central Bank against the World
- Part 2: Growing Calls for Intervention
- Part 3: Keeping the Politicians Away from the Money Presses