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.

Climbing Yields

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?"

Deep Holes

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.

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Eleos 11/15/2011
1. "Keep your head when all about you are losing theirs"
I have no doubt that history will see Jens Weidmann as a hero, one of the few with the courage to say that continuing to kick the can down the road will no longer do. I believe that many of his European colleagues secretly agree with him, but given the innumeracy which is today seen as a badge of honour, the gullibility of the public which has become addicted to instant hits, whether in a bar or on YouTube, and the sheer cowardice of politicians seeking to continue at the trough with smiles and insincere promises; it will be a difficult battle with many setbacks. 11/16/2011
2. Amazing
This is amazingly useful article for understanding the German attitude toward the current crisis. At the same time, it seems to me to betray a deep misunderstanding of the current crisis. It fails to distinguish between liquidity and solvency (Italy is solvent, but faces a liquidity crisis) and the difference between what is needed short term to bring down rates and what is needed long-term for fiscal health. To be sure, there is some connection. The crisis forces some decisions to be taken; simultaneously, it can make such decisions more difficult to implement, as borrowing costs go up and austerity brings negative growth, unemployment and less revenue. There must be a coordinated policy that indeed brings out the bazooka, which then will *not* need to be used (as happened here in the states). Otherwise, the Euro faces a death of a thousand cuts, which will harm Germany as well as her neighbors.
blankfiend 11/17/2011
3. Weidemann is Correct
Taken from my blog at "The overall concept would be for the ECB to morph into a FED-like role. It would become the lender of last resort to sovereigns in Europe. The Treaties establishing the ECB do NOT grant it this role with respect to sovereigns, but neither do they explicitly deny it. So, let's assume that market and political pressure lead the ECB to adopt the lender of last resort role. To begin with, if the ECB is going to take on a role like the FED's, it is worthwhile to compare the two institutions and the environments in which they operate. 1.The FED operates in a system with a federal republic and a central treasury and a single currency. The ECB operates in a monetary union with a single currency that is composed of individual sovereign nations and has no central treasury. 2.The central government in the US has the legislative authority to tax and to apportion funds. There is no such corresponding authority above the individual sovereigns within Europe. 3.The Fed loans to the US Treasury unconditionally. By "unconditionally," I mean that it is the Treasury that decides how to apportion and account for the funds, not the Fed. 4.The Fed operates in a system which issues bonds at its own level - the national level. There are no such equivalent bonds in Europe at the supranational level of the ECB. Obviously, these are critically important differences. When the Fed was established, institutions were firmly in place to arbitrate fiscal policy at the national level. National bonds were in place so that the Fed supports the sovereign on its own level, as opposed to from a level above it. The immense danger in having the ECB take on the role of the Fed derives from the fact that none of these institutions or instruments exist in Europe at the ECB's level. Hence, the ECB would not operate at the level of the countries it lends to, it would operate from a higher level, a supranational level. While the Fed's role as lender of last resort may be purely that, the ECB would have a critical vacuum to fill in a similar role. It would the ECB's decision as to who it lent to and, most critically, under what conditions. In the absence of a central fiscal authority at the European level, the ECB would be the institution to dictate conditions for receiving its funds. Those conditions could include debt/GDP targets, deficit reduction targets, enforced austerity measures, labor market measures, etc. In fact, such demands have already been made, the latest occasion being a letter from Trichet to Italy in late September demanding certain actions. Given the lack of a supranational Eurobond, the ECB would also have the power to decide whose bonds it would purchase and whose it would sell. In short, the ECB would become the central government of Europe, and an unelected and opaque one at that. The take away point: The Fed is a monetary authority, while the ECB would be both a fiscal and a monetary one. While the Fed may be the USA's lender of last resort, the ECB would be Europe's paymaster/treasurer. Whether the elected leaders of European nations will allow their citizenry to be subjugated to such a powerful unelected bureaucracy, and whether the citizens will stand for it, remains to be seen.... "Give me control of a nation's money and I care not who makes it's laws" -Mayer Amschel Bauer Rothschild "Whoever controls the volume of money in any country is absolute master of all industry and commerce." -James A. Garfield, President of the United States" The BOTTOM LINE: Is the Euro worth saving? If so, then governments need to put their taxpayers' money to work through a democratic and open process. If the taxpayers refuse, then the Euro must not be worth saving. It is not up to the unelected bureaucracy of the ECB to make such monumental, far-reaching decisions.
alfredmifsud 11/17/2011
4. A Fire engine without water
Who needs a fire engine without water? I cannot stand the false puritanism of the Bundesbank in particular and the Germans in general. They were the first to break the Stability and Growth Pact and when it suited them they had no qualms is putting aside the rule book. They are a main source of the current problem as the ECB kept interest rates low to suit German needs for integrating the East when such rates were totally unsuitable to the economic tempo especially in Ireland and Spain. The ECB closed both eyes to the asset price inflation going on in boom times in many Euro countries outside the German block and narrowly interpreted their mandate on retail price inflation rather than on the wider meaning of inflation including capital assets. Now that the Germans are benficiaries of the Euro problems as their Bund rate is down and the Euro is much weaker than where the DM would be, now the Germans want to teach a lesson to all the rest. The problem now is not inflation. The problem is a 1930's style depression if the Euro breaks up. Why do the Germans insist on fighting windmills? Yes many countries need strong political will to restructure their economies from the damage caused by the ECB through excessively low interest in the good times which permitted uncontrolled excessive borrowing. The damage caused by the Germans in throwing away the rule book when it suited them setting a bad example for the rest and removing the power of the Commission to impose discipline. However such restructuring cannot be done while the house is on fire. The ECB is the only institution that can put out the fire, but a fire - engine without water is useless. And it is simply not true that the ECB would lose authority over national governments if they slacken on their reform agenda. Simply by not buying their bonds they can impose discipline. Isn't that what Draghi did to send Berlusconi home? And it is much better for such discipline to be imposed by an autonous ECB council rather than by Chancellor Merkel dictating to other countries her political doctrine. It just looks abrasive and resentful foreign interference. If the Germans don't want to save the Euro they should start reading again the history books of the 1930's and 1940's. If they want to save the Euro than their choice is either allow the ECB to act as the true lender of last resort to countries that are successfully performing reform agendas or leave the Euro and go back to their beloved DM so they will lose their export competiveness and thus address the intra EU gross imbalances.
Eleos 11/18/2011
Zitat von jolaukat@gmail.comThis is amazingly useful article for understanding the German attitude toward the current crisis. At the same time, it seems to me to betray a deep misunderstanding of the current crisis. It fails to distinguish between liquidity and solvency (Italy is solvent, but faces a liquidity crisis) and the difference between what is needed short term to bring down rates and what is needed long-term for fiscal health. To be sure, there is some connection. The crisis forces some decisions to be taken; simultaneously, it can make such decisions more difficult to implement, as borrowing costs go up and austerity brings negative growth, unemployment and less revenue. There must be a coordinated policy that indeed brings out the bazooka, which then will *not* need to be used (as happened here in the states). Otherwise, the Euro faces a death of a thousand cuts, which will harm Germany as well as her neighbors.
Italy's problem is not liquidity. It is credibility. Markets and people do not believe that Italy will adopt sound fiscal policies unless it sees the alternative as worse. Elections in some European nations have recently become a choice between putting the left hand or the right hand into the German pocket. Only when politicians and people are seen to accept the conditions necessary to pay for the excesses of recent years will the situation alleviate. If they do not bankruptcy and departure from the Eurozone will, and should, follow.
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