By Marshall Auerback, a portfolio strategist and hedge fund manager
I’ve been in Amsterdam and met some people very well connected with the ECB. The topic de jour is the apparent split between the Germans and the ECB, especially in light of the resignation of Jürgen Stark last week from the ECB executive board. This has been a move hailed as a German protest of the errant ways of the ECB, andStark is now touting his conservative ideas around Europe in a hope to undermine the central bank’s current interventions. That’s the public line.
But the people to whom I’ve spoken here contend that Stark’s resignation does reflect the reality that the Germans are losing out as far as the ECB goes. The profound objections to what the ECB is becoming on the part of Germany is also accompanied by a realisation that it is the only supranational game in town and has little choice but to take on this quasi-fiscal function that it is now undertaking.
Stark (and Weber before him) had no desire to associate themselves with this but the resignation reflects the view that they were powerless to stop it.Most of the ‘blame the Mediterranean profligates rhetoric we’ve been hearing has been diversionary, to draw local attention away from the fact that Germany’s hardcore Bundesbankers are losing this battle. .
The pan-Europeanists are the ones who will support a coordinated response to financial issues, not coincidentally because this will be the only way to retain existing benefit levels once some sovereigns and the banks exposed to them go soft.
Stark’s replacement, Asmussen, is an SPD guy and even though he makes all of the same hawkish noises, he’s not as hard-line as Stark. It was also indicated to me that if Germany were to go for the Hans Olaf Henkel proposal of a DM bloc (to which I alluded in an earlier post), it would screw the French totally and they won’t stand for it.
Much of the German hard-line, then, is domestic posturing. Even Finance Minister Wolfgang Schauble (who always makes it a point to repeat the party line in public) quietly acknowledges that Germany will have to recant in the end. In a recent speech in Brussels, Schauble gave the chat in German and included the usual rants about the lazy Greeks, profligate Irish, etc., but right at the end of his speech, switched to Italian and quoted Galileo’s “Eppur si muove” (and yet it moves) which was said to have been uttered by the Italian scientist after being forced to recant in 1633 before the Inquisition, his belief that the Earth moves around the Sun. In effect, Schauble was effectively undercutting the public message of Germany and acknowledging the political reality that Germany would have no choice but to go along with what the ECB was doing or the euro itself would blow up.
The question arises as to what form this quasi-fiscal role on the part of the ECB will take going forward. Warren Mosler has come up with the idea of “revenue sharing” proposal on the part of the European Central Bank, and this strikes me as the most technically feasible proposal, as well as one that will be consistent with the recent strictures set out in Germany’s Constitutional Court decision brought two weeks ago.
The proposal is for the ECB to distribute trillions of euros annually to the national governments on a per capita basis. The per capita criteria means that it is neither a targeted bailout nor a reward for bad behavior. This distribution would immediately adjust national government debt ratios downward which eases credit fears without triggering additional national government spending. This serves to dramatically ease credit tensions and thereby foster normal functioning of the credit markets for the national government debt issues.
The trillions of euros distribution would not add to aggregate demand or inflation, as member nation spending and tax policy are in any case restricted by the Maastricht criteria. Furthermore, making this distribution an annual event greatly enhances enforcement of EU rules, as the penalty for non compliance can be the withholding of annual payments. This is vastly more effective than the current arrangement of fines and penalties for non compliance, which have proven themselves unenforceable as a practical matter.
Yes, it means that the ECB loses some of its “profitability” because it pays interest on reserves at the national central banks. In any case, as a short term measure, the ECB can easily manufacture ‘profits’ if it continues to buy the bonds of these distressed PIIGS and then doesn’t allow them to default, although clearly this program would stop once the revenue sharing begins.
There are no operational obstacles to the crediting of the accounts of the national governments by the ECB. What would likely be required is approval by the finance ministers. I see no reason why any would object, as this proposal serves to both reduce national debt levels of all member nations and at the same time tighten the control of the European Union over national government finances.
This looks legal to me, and still the obvious/best solution?
It also helps with their problem of enforcing the growth and stability pact which, whatever one thinks of the questionable economics underlying it, was the only way that the concept of the euro could have been sold politically in Germany. Arguably, the revenue sharing proposal would enhance the SGP and thereby help to entrench Germany’s “stability” culture in the euro zone.
I suspect that the Germans might ultimately find the revenue sharing proposal more palatable on a number of grounds. As I indicated, it doesn’t violate the “no bailout” rule (in fact, Germany is the biggest recipient of the funds if it’s done on a per capita basis). Even if you said the money credited to the national central banks could only be used to retire existing public debt (which I think is the only way you could sell it politically in Germany), you would deal effectively with the national solvency issue.
Think of it like a rights issue for a heavily indebted company: Company X has a debt to equity ratio of 200% and the markets won’t fund it because of perceived solvency concerns. Somehow, said Company X launches a 1 for 1 rights issue and gets the debt to equity down to 100%. Market concerns about bankruptcy are alleviated and the capital markets open up to the company again. Likewise if you do the revenue sharing. You don’t solve the problem of aggregate demand, but you reduce the solvency concerns and reopen the capital markets to the euro zone countries again.
And the other way you sell it to the German public is that (as Wolfgang Munchau of the FT has rightly argued), it makes the SGP more credible and enforceable because now you are providing a mechanism to ensure compliance. Rather than fining a miscreant company (try getting an EU official to go to Athens to collect a fine today for violating the SGP; he’d be lucky to get out alive), you withhold funds.
Credit the national central bank accounts to a sufficient degree to bring the ratios down to, say, 60% levels required by the SGP and then enforce it rigorously. Yes, there is no economic logic to the SGP, but it’s the only way you’d ever get the Germans to agree to this proposal and, in any case, a 3% deficit in a normalised economic environment does give you some growth. You could still cut off the “profligates” such as Greece if you thought they weren’t complying or enforcing desired “structural reforms”, but eliminate the contagion risk by continuing to credit other countries (and let’s be honest: other than the die-hard Hellenist romantics, nobody in the euro zone could care less what happens to Greece except insofar as it creates contagion threats for other members of the euro zone).
To repeat: the revenue sharing proposal would be non-inflationary. What’s inflationary with regard to monetary and fiscal policy is actual spending. These distributions would not alter the annual actual government spending and taxing as demanded by the austerity measures and ongoing growth and stability pact. They simply address the solvency issue, which has effectively cut the PIIGS off from market funding (because the markets believe they are insolvent).
Under the proposal, member nations remain bound to their current spending and taxing imperatives. Bonds get retired and replaced with reserves, which we know does not lead to inflation either because reserves aren’t lent out.
The problem with the European Financial Stability Fund (EFSF( solution is that the EFSF only has a limited life and the German Constitutional Court decision means that you cannot replace it with a permanent mechanism, such as the proposed ESM
And the EFSF is a dishonest fig leaf, since all of the money ultimately comes from the ECB anyway, as the sole creator of euros. The ECB is probably ill-suited to conduct quasi-fiscal operations over the longer term, but it’s the only game in town now. Everybody now recognizes that fact. At least the operations under the revenue sharing proposal are conducted with a clear set of consistent rules, rather than the discretionary, non-transparent manner in which the ECB is conducting its bond buying operations right now. It’s an effective interim mechanism (which won’t violate the German Constitutional Court), but provides the euro zone time to develop a fully fledged fiscal union with debt issuance power, which is ultimately what is required.
Yes, this idea seems radical, but two years ago, so too did the idea of buying sovereign debt in the secondary markets by the ECB. During the panic of May 2010, the ECB bought €16.5 billion the first week, €10 billion the second, and €8.5 billion, €6.50 billion, €4 billion, and €4 billion for each successive week, ending with €1 billion for its last real week of activity on 9 July 2010 for a total of €54.5 billion seven weeks of operation.
Since the week of 4 August, it purchased €22 billion the first week, followed by €14.3 billion, €6.6 billion, €13.3 billion, €13.9 billion and €9.8 billion last week for a total of nearly €80 billion in six weeks. This represents about €13.3 billion per week, i.e. over 71% higher than the weekly purchases begun in May 2010, as Erwan Mahe, the author of “Thaler’s Corner, has recently highlighted in his research.
Longer term, you clearly will need a fiscal union of sorts.
Let’s take my country, Canada, for a moment. Imagine that the two largest Canadian provinces, Ontario and Quebec, were independent countries. If this were the case, their debt burdens would consist of their existing debts plus their respective shares of the federal debt (about 23% for Quebec and about 40% for Ontario). Their capacity to repay those debts would be determined by their respective tax bases – i.e. each province’s nominal GDP.
How would those debt burdens look? Answer: probably not very good. In fact, as the Canadian brokerage house Brockhouse Cooper has pointed out,
Ontario and Quebec would each be more indebted than Spain (albeit slightly less than Portugal). This reflects the significant social spending responsibilities of the Canadian provinces, which are responsible for healthcare and education – the two largest government expenditure items in Canada. Naturally, these spending commitments are funded via fiscal deficits and debt issuance.
Quebec and Ontario are also somewhat similar to Spain and Portugal in that they do not control the currency in which they issue debt (the Canadian dollar, controlled by the Bank of Canada – a central bank that is, in turn, controlled by the federal government). So, given the poor fiscal fundamentals and inability to print money, surely bonds issued by Ontario and Quebec should trade in line with bonds issued by Spain and Portugal? Wrong – yields on 10-year Ontario and Quebec bonds are significantly lower than yields on Spanish or Portuguese bonds.”
So, why are Canadian provinces getting away with high debt loads and the inability to print money? Because of fiscal federalism and the pooling of risk within the Canadian monetary union. There is an implicit understanding that the federal government will rescue any Canadian province that runs into trouble in the bond market, which provides a strong indication that the monetary union is also complemented by a robust fiscal union.
If Europe did opt for this solution, the creditworthiness of each country would be aggregated into that of the broader Eurozone. This would be credit-positive for the entire region, since the overall debt burden of the Eurozone is not much higher than that of the United Kingdom or the United States. The joint-and-several guarantee, coupled with robust fiscal rules, would make Eurobonds more or less similar to the bonds issued by the most creditworthy entities within Europe.
But that’s a multi-year project. In the meantime, you need a credible plan to address the immediate market concerns of growing national insolvency perceptions in the euro zone (which are gradually spreading to the core). The ECB has to be the entity that leads this effort, much as it hates the idea and much as the Germans likely despise it. That’s the real story behind the Stark resignation and the public fury now featuring so prominently in the German press and parliament.