Breaking Taboos Concerns Mount in Germany Over ECB Bond Buys

Axel Schmidt

By SPIEGEL ONLINE Staff

Part 2: 'We Cannot Give Way to Panic'


When it became clear that the measures were having little effect, Trichet summoned the other members of the ECB's executive board and the central bankers of euro-zone countries on Aug. 7 to join an evening conference call to debate how Spain and Italy should be helped.

Trichet sensed he would have a hard time making his case. To soften up his colleagues, he wrote a harshly worded letter to the Italian government relaying his conditions for granting support. Together with Mario Draghi, the president of Italy's central bank and his designated successor at the helm of the ECB, Trichet called on the Italian government to implement far-reaching reforms to the labor market, pensions and the deficit-ridden public health-care system. He also urged Rome to privatize state assets. Likewise, he stressed that Italy had to balance its budget by 2013, a year ahead of schedule.

Although Rome promptly signaled it would agree to such terms, Trichet still knew that the ECB's governing council would be deeply divided. Indeed, the cleft had already become apparent the previous Thursday. Bundesbank chief Weidmann had led the group arguing against anything involving the buying of government bonds. Doing so, he reasoned, would be tantamount to dissolving the border between monetary and fiscal policies. Following in the footsteps of his predecessor, Axel Weber, Weidmann urged his colleagues to keep the greatest distance possible between the central bank and the finances of individual states.

Actions Upsetting to Merkel

Weidmann's actions were deeply upsetting to Chancellor Merkel. Just a few months earlier, Weidmann had been serving as one of her economic advisers. She had called him right before the conference call on Sunday evening urging him to relent. Shortly thereafter, the members of the ECB's executive board hustled into Trichet's office to use his secure telephone line. On the call were the other 17 members of the ECB's governing council all across Europe, some of whom had been forced to cut their vacations short. In dramatic terms, Trichet pleaded with his colleagues to act. If they didn't, he warned, Italy, the world's third-largest bond market, would implode -- and no one could predict how this would affect the euro and the global economy.

Nevertheless, Weidmann, ECB Chief Economist Jürgen Stark and the representatives from Luxembourg and the Netherlands held their ground. They argued that the ECB's sole mandate was to safeguard the stability of the euro's value and that it wasn't its job to prop up heavily indebted countries or even to protect the capital markets from themselves.

The debate focused on key issues of financial and monetary policy. For the Bundesbank, it had always been taboo to finance the state by purchasing its sovereign bonds. Behind this belief was the terrifying example of its predecessor, the Reichsbank, which had printed money with abandon in the 1920s in order to support the budget of the Weimar Republic. The result was a hyperinflation that has become deeply entrenched in the collective memory of Germans.

Indeed, Axel Weber, Weidmann's predecessor, was so opposed to the idea of purchasing sovereign bonds that he prematurely retired from his position as Bundesbank president and withdrew his name as a candidate to succeed Trichet as head of the ECB. As he saw it, the fact that ECB higher-ups had even discussed breaking this still-unbroken taboo in May 2010 in response to the crisis in Greece was an unforgivable error.

'A Clear Violation of the Treaty'

This led Weber to write an impassioned e-mail on May 7, 2010 to his colleagues on the ECB's governing council. Though the contents of the letter had not been made public before, last week's developments make it particularly relevant to the current situation.

"We must not panic" he warned them. Although he believed the ECB had to respond to the crisis by making an unlimited amount of liquidity available, he vehemently argued against purchasing sovereign bonds. Doing so would be "a clear violation of the treaty" that had served as the basis for establishing the bank. He also wrote that the ECB was standing at a crossroads and that the governing council had to "resist government pressure." The risk of damaging the ECB's reputation, he argued, by far outweighs any short-term gains that might be made by buying sovereign bonds. "Let us not disappoint our people" Weber warned -- and he announced that he would go public with his opposition.

Despite the passionate appeal, Weber was only able to convince four other colleagues on the ECB governing council to join him in voting against the plan to buy up sovereign bonds. The vast majority of its members bought the argument of Trichet, who already at that point viewed the world as teetering at the edge of the abyss.

Within a few months, the ECB purchased almost €80 billion ($115 billion) in government bonds from Greece, Portugal and Ireland, which everyone was eager to unload. Together, the national central banks that are part of the euro system and shareholders in the ECB, including the Bundesbank, have been forced to make billions in writedowns.

Even with such bad experiences behind them, on Aug. 7, the majority of members on the ECB's governing council voted to support Trichet's new proposal. Weidmann and his three confederates were outvoted.

This was a bitter outcome for the Bundesbank. As a result of this decision, already last week it was forced to buy up massive amounts of Italian and Spanish sovereign bonds. This results from the fact that, within the context of the euro system, the ECB also uses the Bundesbank as a vehicle to make billions in such purchases. As one Bundesbank official put it, doing so "goes against our genes."

The ECB's Sweet Poison

Those in the Trichet camp, on the other hand, view the ECB as the last functioning institution in Europe. ECB experts argued that this is why the bank was forced to take action after interest rates on Italian bonds rose to dangerously high levels in recent weeks. In their view, failing to act threatened to dry up lending to companies and private clients.

The ECB was happy when the interest rate on Italian bonds dropped from 6 percent to 5 percent in the wake of its actions. But even if that sounds like success, Trichet knows that his strategy won't work in the long term. If, as in the case of Greece, the markets have made up their mind that a country will never pay back its debts because it is bankrupt, then there is also little the ECB can do. In fact, the central bank would be constantly pumping more money into the markets without really helping the country.

Even worse, such actions could also get politicians in the entire euro zone quickly used to the ECB's sweet poison. After all, it's much easier to fall back on ECB money than to get parliament to agree to tax increases. This has led former Bundesbank officials, including Weber, to accuse the ECB's measures of only delaying the inevitable introduction of the kind of radical reforms necessary in countries like Italy.

More than anything, buying up sovereign bonds is damaging the reputation of the ECB itself. If the ECB adds huge amounts of questionable sovereign bonds to its portfolio and that country one day becomes insolvent, it could result in considerable losses. In that case, it would be forced to write down parts of its assets and beg euro-zone governments for fresh capital. Doing so would risk damaging the central bank's reputation and independence, and the ECB could be tempted to start up the money-printing presses purely out of its own self-interest.

The ECB's questionable decision has also alienated members of the governing parties in Berlin. So far, members of parliment with the CDU/CSU and FDP have reverently accepted ECB decisions related to bailing out the euro, including the first and second bailout packages for Greece, the establishment of temporary and permanent euro-bailout funds -- the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), respectively -- and the aid programs for banks.

Opposition Grows in Berlin

Indeed, the coalition government has already made more than €140 billion available for efforts to bail out the euro. Given this generosity, politicians in the coalition parties are alarmed that the ECB's governing council has apparently now decided to routinely act against the reservations of its German members.

"The ECB cannot become an institution that can compensate for the failures of the budgets of individuals states, such as Italy, over the long term," says Volker Bouffier, governor of the western state of Hesse, where the ECB is based. "That doesn't correspond with its mandate, and that takes the pressure off the affected countries to put their budgets in order by themselves."

Stanislaw Tillich, the governor of the eastern state of Saxony, holds a similar view and believes the ECB program has to "remain an exception." To do otherwise would "only prove correct the people who were afraid at the time of the euro's introduction that the ECB would be less diligent in safeguarding monetary stability than the German Bundesbank."

Even Rainer Brüderle, the senior FDP official who recently stepped down as economics minister to become his party's parliamentary floor leader, views the ECB's policy of buying sovereign bonds to prop up troubled nations "with very mixed feelings." Things cannot be allowed "to go on like this forever," he says.

Still, the greatest resentment can be found within the ranks of the CSU. Many of its members share the fears of Thomas Silberhorn, a party expert on European affairs, who says that the ECB's "institutional independence … is gone." As he sees it, by introducing these measures, the ECB has overstepped its competencies in terms of monetary policy, and made a "shambles" of the foundations of the EU treaties.

Even Erwin Huber, former head of the CSU and finance minister of the state of Bavaria, believes the ECB's reputation has been damaged. "The Bundesbank would never have financed state debt at the expense of the currency's value," he says. "That is a serious violation of the entire euro blueprint."

By breaking this taboo, the ECB has bred mistrust in the most recent bailout measures and is giving fresh impetus to the euroskeptics within the coalition parties. About a dozen members of parliament from the FDP are considered to be euroskeptics, and more and more members of the CDU/CSU are calling for an emergency gathering to discuss the debt crisis.

To respond to this growing resentment, coalition leaders in Berlin have started making futile attempts at appeasement. CDU higher-ups hope to calm the base in coming weeks at so-called regional conferences. Economic Minister and FDP chairman Philipp Rösler has announced plans to set up a stability council at the EU level -- though the announcement took even Finance Minister Schäuble by surprise.

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