It has been some time now since the ECB turned to monetisation to deal with its sovereign debt crisis. At the time, the Germans were out in full force attempting to stop the train of events and keep the ECB out of the political economy. They failed. And the European crisis has been changed forever since. Now the Irish promissary note exchange scheme is bringing the Germans out in full force to rail against the monetisaton of sovereigns yet again. I predict these efforts will also fail. The ECB and Europe are turning away from the German central bank model and moving to a model more in line with the one used by the major central banks in nations with sovereign currencies. The Bundesbank’s futile railing against the ECB’s promissory note deal with Ireland is the latest example of the Germans’ waning power within the ECB.
Back in May 2012, I wrote that European “policy makers remain committed to the euro. They will go to great lengths to protect it from dissolution and a catastrophic outcome.” The point here was that the European endgame was within sight and it going to involve monetisation as I had been predicting since late in 2011 during the Italian crisis. I predicted the following:
over the medium term, we are likely to see
- Monetisation via the ECB’s Securities Market Program but this will be a stop-gap only as the Europeans are not ready to give the ECB authority for backstopping sovereign debt.
- EuroTARP either for Spain in isolation or Europe-wide. Clearly the Irish and others will want equal treatment to the Spanish. Moreover, a political backlash against bank bailouts will ensue. Therefore making this Europe-wide and tethering it to the Basel III reforms makes sense.
- Growth pact via the EIB that will invest in infrastructure projects in return for medium-term fiscal consolidation and ‘growth-oriented’ market reforms.
- Target relaxation because that will be a major compromise in order to deal with the Spanish and Italian situations and to assuage French concerns about front-loaded cuts and tax increases.
- ECB backstop will come as well. Even Juergen Stark has intimated that ECB liquidity could be on offer under the right circumstances i.e. “only when important steps toward political union are made can we have common bonds,” the ECB would get a green light after the bilateral agreements to provide unlimited liquidity until Eurobonds are issued.
Over the long-term, we are likely to see more permanent structural remedies like
- Grexit as the euro zone will lose Greece as a member. It could happen over the medium-term too if the European situation is not stabilised. Portugal could also exit.
- But the rest will become more integrated as the Lisbon treaty is amended to add greater fiscal integration and penalties. The big question marks are Italy and Spain.
- Defaults in Greece and elsewhere. Portugal seems most likely, followed by Ireland.
- Eurobonds will eventually have to occur in order to keep sovereign debt from being a problem. Clearly, the fiscal compact and the penalties will have to have teeth for Eurobonds to be palatable. In practice, you could have sovereigns conduct a ‘sovereign debt swap’ whereby the ECB buys an agreed-upon portion of the existing debt from the sovereigns and then uses these funds to back the supranational debt.
All of the medium-term predictions were met by the end of 2012 in one form or another, the most important being the OMT program. I expect the longer-term predictions to also be fulfilled. Again, the point here is that European policy makers do have an economic model which they still support and this has been a contributing factor to the debt deflation in Europe’s periphery. They will not give up this world view. However, they will cede ground to the realities of the day if and when crisis threatens the euro or the EU in an existential way.
This is what we are now seeing with Ireland.
I have written again and again about the parries the Germans have made against the ECB’s new more interventionist policy on the sovereign debt crisis. The resignations of Juergen Stark and Axel Weber only weakened the Germans’ position within the ECB just as a Jens Weidmann resignation would. Now the Irish Times is reporting on yet more German opposition to the ECB’s promise to let Ireland out of its hated promissary note. I believe these protests will have no impact.
European Central Bank president Mario Draghi said today the promissory note deal was a “positive” step for Ireland, despite reservations from Germany’s Bundesbank.
The accord, which will see the promissory notes exchanged for long-term bonds held by the Central Bank, will ease Ireland’s borrowing needs by up to €20 billion over the next decade.
Speaking at a meeting of the Economic and Monetary Affairs Committee of the European Parliament this afternoon, Mr Draghi said the deal will be reviewed by the ECB in its annual assessment later this year. Mr Draghi said the disposal of the bonds in a way that ensures “compatibility with financial stability” would be “crucial” to Ireland’s restructuring.
He said the opportunity has “not necessarily” passed to object to Ireland’s deal. “We will assess the compliance with Article 123 at the proper opportunity,” Mr Draghi told European lawmakers in Brussels today, referring to a prohibition on central banks financing governments. “If it does not” comply “we will see what legal remedial action needs to be taken,” he said.
Former ECB executive Jürgen Stark has joined Bundesbank criticism of Ireland, describing the new promissory note arrangement as a clear breach of the bank’s prohibition of monetary financing. Dr Stark’s criticism follows fresh criticism from the Bundesbank in its monthly report yesterday that the deal underlines “increasingly stronger and more problematic inter-linkage between monetary and fiscal policy in the European monetary union”.
These arguments reflect a long-term fear of German monetary hawks that the ECB, in its efforts to assist in resolving the eurozone crisis, has broken its own rules, compromised its
independence and made itself beholden to politicians.
Dr Stark said yesterday the arrangement with Ireland was a further demonstration of “the ECB’s new understanding of crisis management”.
“The ECB’s contractual basis and core mandate shift further into the background,” he wrote yesterday in “Die Welt” daily.
Earlier, the Bundesbank said the involvement of the Irish Central Bank in the promissory deal is “problematic”. In its monthly report, the German central bank highlighted what it described as “the increasingly stronger and more problematic inter-linkage between monetary and fiscal policy” in the European monetary union.
“The European Stability Mechanism, which should be responsible in this regard, has been established to provide any help to individual member states in servicing debt,” it said. It highlighted what it described as “the increasingly stronger and more problematic inter-linkage” between monetary and fiscal policy in the European monetary union. “The European Stability Mechanism, which should be responsible in this regard, has been established to provide any help to individual member states in servicing debt,” it said.
Stark is no longer in a policy role. But Jens Weidmann, the Bundesbank head, is in a policy role and shares his views. He is likely of the same opinion. But these views are not going to get any hearing because the Germans have been marginalised at the ECB. Their dogmatic approach abut monetisation has been directly responsible for many problems the euro zone has suffered. Angela Merkel, in her pragmatism, has decided to move away from the Bundesbank and back the position that Mario Draghi has taken. This position mens austerity in exchange for an implicit or explicit ECB backstop. And I believe this will continue to be official policy for Europe for the forseeable future.
We should watch events in France where deficit targets are going to be missed to see how much the European mainstream policy view involving austerity will be pressed, even for core euro zone members. The word on the street is that Joerg Asmussen, a German SPD politician close to the CDU Chancellor Merkel is saying that France should not receive special treatment and must cut its deficit this year through austerity if its fiscal situation deteriorates. I have been saying that targets are going to be relaxed because France, Spain and the Netherlands all are going to have these problems. But, the support for austerity is strong in Europe. And unlike the support for the ECB’s no-monetisation clause, this support for austerity is likely to endure.