The Bundesbank Hits Back

Germany's constitutional court in Karlsruhe is traditionally buried in complaints with every major new decision concerning the bailout regime and every major new policy initiative by the ECB. The court's modus operandi hitherto has been to largely adopt the position of the German government, but it will now and then add certain conditions. These conditions usually seek to ensure greater parliamentary oversight and/or attempt to ensure that government won't agree to anything on the European level that is clearly in conflict with the German constitution.

If one looks at these proceedings from outside, it seems obvious that the court wants to avoid handing down any rulings that might exacerbate the crisis. In fact, the government's arguments and briefs always stress the possibility that an uncontrollable crisis situation may result and that consequently Germany would suffer great economic damage if the court were to substantially interfere with its course.

On the other hand, the complainants are not exactly dummies. Not only do they usually wield very strong legal arguments, they are also favored by the  fact that their predictions regarding the euro have all come true. And so the court is walking a fine line – neither does it want to completely upset the European applecart, nor does it want to be seen as simply rubber-stamping the government's agenda.

 

Following Mario Draghi's OMT announcement, more complaints were filed. In June the court will decide on the legality of the ESM and as part of the exercise has also undertaken to examine the legal standing of the ECB's OMT program  – which so far exists only in announcement form.

What makes this particular decision a lot more interesting than usual is an amicus curiae brief filed by the Bundesbank. German financial newspaper 'Handelsblatt' reports that it has received a copy of the brief and its contents are quite explosive. We will summarize the Handelsblatt report below:

The Bundesbank is evidently strongly critical of the policies implemented to date in order to rescue the euro. It vehemently argues against any purchases of government bonds by the ECB.

It notes that “bonds of low credit quality are deliberately bought”, which increases the risks to the euro-system. Buying sovereign bonds might put the central bank's independence into doubt, which the BuBa considers the sine qua non for it to successfully pursue its price stability mandate.

Once monetary policy is on this slippery slope, a reversal is difficult and only possible at great cost”, according to the BuBa. Wait, it gets even better.

 

'Monetary Transmission Mechanism' Broken? Tough Luck!

The BuBa notes that it doubts that purchases of sovereign bonds under 'conditionality' will actually include strict reform demands of the countries concerned and points to Greece as a bad example that has shown that conditionality does not preclude sizable purchases in extremely dubious cases, which teds to redistribute risk across the balance sheets of the euro-system. Moreover, the BuBa has grave doubts about the justifications for the putative bond purchases. For one thing, it regards different levels of interest rates within the euro zone not as a very good reason to engage in such purchases – higher financing costs for the private sector may simply reflect higher fiscal risks in the countries concerned. That, says the BuBa, isn't a development that should be influenced by means of monetary policy, as it is a direct consequence of the fiscal policies of the countries concerned. These policies  in turn are their own responsibility.

 

In other words, the Bundesbank doesn't believe in or support the whole 'the monetary transmission mechanism is broken and must be fixed' theory forwarded by Draghi and the ECB's board.

 

'Preserving the Euro' Not Part of the ECB's Mandate

It gets even more interesting though, as the Bundesbanks also asserts that the 'preservation of the euro' is not part of the ECB's mandate.

The BuBa argues that it is simply not the ECB's job to prevent the exit of a member nation from the euro area. Verbatim: “In view of the fact that it consists of sovereign nations, the current composition of the currency union cannot be guaranteed – at least not by the central bank.”

Otherwise, the ECB could become the chief source of financing for euro area governments. A categorical guarantee for countries that they will remain members of the euro area – which is implied by the design and the justification for the secondary market purchases of sovereign bonds – means that as a last resort, financing independent of the financial markets will be entertained in order to guarantee that a country remains in the currency union.

Obviously this is a complete refutation of everything Draghi has said since his famous assertion at an investment conference in London which preceded the OMT announcement. As Draghi said on that occasion:

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro – believe me, it will be enough.” 

In order to buttress its case further, the BuBa criticizes the provision of ELA (emergency liquidity assistance) financing to banks in Greece, noting that this was an especially problematic case that highlights the fact that fiscal policy was being taken over by monetary policy. The ECB had run a great risk by providing this financing, as the exit of Athens from the currency union “could  under no circumstances be assessed to be a low probability event at every point in time.

The above is – apart from our comments –  mainly a summary of the article that was published at Handelsblatt.

However, the BuBa's brief also contains an extensive discussion of the TARGET-2 imbalances in the euro system, in which the BuBa – quite in contrast to its previous public “nothing to see here”  pronouncements on the topic –  admits that the payment system surreptitiously finances inner-European balance of payments deficits.

It specifically mentions that capital flight from the crisis countries is financed via TARGET-2, and points out that no settlement procedure exists. Long time readers know of course from our past discussions of the euro-system's payment mechanism that this is the case, it is mainly noteworthy because up to this point, the BuBa has tended to downplay the problems and risks of the TARGET imbalances in public. In its brief to the court it explains clearly what is actually happening. In addition it remarks that the recent narrowing of the imbalances may not mean much, because such phases of narrowing TARGET-2 imbalances have been seen several times before, namely whenever the crisis seemed to briefly go into hibernation. Similar to what we have always argued, the Bundesbank notes that the imbalances represent no problem as long as the currency union continues in its current form – however, in the event of a member state exiting, losses would likely have to be taken by the ECB (with the size of the losses depending on the ability and willingness of the national central bank concerned to pay up), which in the end would have to be borne by tax payers.

 


 

TARGET-2


TARGET-2 liabilities and claims between NCBs and the euro-system; data via Germany's IFO Institute – click to enlarge.

 


 

Conclusion

The Bundesbank's scathing assessment of the ECB's plans to save the euro via OMT certainly adds a new wrinkle to the upcoming deliberations of Germany's constitutional court. After all, it is not just any old expert witness condemning the ECB's policies here, but Germany's own central bank. Will the court dismiss  this brief in the name of preventing a renewed flaring up of the crisis? That may well partly depend on actual market conditions in June. The court may be bolder than usual if the markets are still fairly calm when the time comes. Previously it was forced to deliver verdicts at a time when crisis conditions were acute, and an adverse decision on the bailouts would almost certainly have made them more so.

We know however that chief judge Voßkuhle is not necessarily a pushover. He has made very critical remarks about the government's crisis related policies before and pointed out that the time may come when the court insists that any further measures will require a plebiscite. It can therefore not be ruled out that the court comes to the conclusion that the Bundesbank's assessment of the OMT program is correct. Any decision that disrupts Draghi's cunning plan to print will put the euro area back on square one – i.e., the time before the OMT announcement. 'Interesting times' would be almost certain to make a rude comeback, especially as it is well known that a number of countries continue to miss their deficit targets amid sharply worsening economic conditions.

The Bundesbank's brief can be downloaded here (pdf), note however that we have unfortunately only a German version of it available at the moment.

 

 

Charts by: IFO Institute


 

 
 

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6 Responses to “BuBa vs. ECB – Euro-System Infighting Resumes”

  • mc:

    To me this will be huge even if the ruling comes out as the supposed rubber stamp, but still insists on underlining the conditionality of an ECB/EU/IMF negotiated program. What these programs have come to mean is that countries needing bailouts are left to twist in the wind until the last hour, where Germany always takes the strongest line at the negotiating table and the results are nudged through the Bundestag with much public comment from all of the highest profile German political leadership. If someone moots easing bailout terms, eurobonds, easier money, or more lenient budget rules, it is far too often Germany that will have to rebut the issue. This is beginning to play politically like these ‘bailouts’ are acts of German sovereignty – negotiated by the German government, with the German taxpayers’ money on the line, with the defining act of democracy a bill passing the German Parliament (the bill passing the ‘bailed-out’ nation’s parliament is a forgone conclusion).

    In Germany, having the final say in practice yet much of the risk, plays with mixed results – theoretically these are discussions between the multinational IMF/EU/ECB and the distressed country, not one between two nations directly. Spain or Slovenia is equally a member of the Trioka, and the decisions are supposedly taken with the interest of all involved, but nearly all of the vitriol is directed at Germany for essentially acting with a shred of restraint. Giving it the veneer of approval, the respected Bundesbank has reined in the ECB mostly, the ruling government has not yet lost a vote on the matter, and the bailouts have not yet completely backfired. A court ruling that reinforces this dynamic will lock the eurozone into the self-destructive spiral it is in. If the German taxpayer (via referenda, elections, acts of bundestag, etc) has to say yes to every single incremental bailout, eventually it will say no and the course of the euro is unpredictable after that.

    However, in the bailed out nations, Germany’s ‘hegemony’ is completely toxic politically. Any party out of power that opposes the reforms becomes the new government, and then is forced to implement the same reforms or oversee the euro withdrawal (which would also likely destroy them politically). As bailout time frames stretch to past a decade, it seems inevitable that the ‘default on the debt’ platform will gain some political traction (Greece was close). Can Italy or Spain, moving towards bailout territory, accept any terms at all from Germany before they become completely ungovernable? If any of the other ‘fiscally responsible’ euro nations weaken their resolve, German attempts to keep them in line could easily backfire. The measure, more than anything, is the solidarity that the people of different nations feel between each other. This can quickly erode, as one side (German tax payers) feels they are footing the bill and the other side (citizens of bailed out nations) feels they have no political power, with this tension possibly destroying what is left of the euro as everyone feels wronged in the end.

  • This may be evidence the German banks have largely rid themselves of foreign debts, save for the TARGET2 levels. Now this has happened, no longer necessary for the Bundesbank to support the policy. In any case, a country can use any currency it pleases and that would include the Euro. Indirectly, the dollar is used in every country on earth.

    Why the prohibition of exit? I suspect it has to do with forcing countries to follow the dictates of the EU commission. Think what a competitive advantage countries would have if they got out from under the dictates of nonsense coming out of this communist, central planning group? They would have to get new politicians though, as most in power, this is utopia. Utopia comes with a price.

    • worldend666:

      More to the point Mannfm, why would any country wish to be part of this Faustian bargain? Living in Bulgaria I wonder what advantage there was for the mostly corrupt politicians to join. EU fraud control has made it harder to steal from the public purse and whilst there is some EU money now to pilfer It probably doesn’t make up for the extra oversight from Brussels.

      Bulgaria’s currency has been pegged to the DEM since the 90s so there is no real need to have euro here. The EU tells Bulgaria what they can and cannot do with their social policy and the European court is a way for society’s lowest to extract demands for benefits from The state.

      I was talking to a Luxembourg banker a week ago and he was saying Luxembourg is buckling under to EU pressure and from 2015 there will be automatic notification of interest to residents’ home countries’ authorities. I noted that Luxembourg used to be a farming community before they became a tax haven and asked him if he would like to go back to farming. He told me he enjoyed his garden ;)

  • rodney:

    I don’t think it will come to that. Most likely the court will keep walking it’s fine line. You said it yourself, they are not applying the law, they are playing politics:

    neither does it want to completely upset the European applecart, nor does it want to be seen as simply rubber-stamping the government’s agenda.

    So what decision would be consistent with their current policy? Since the beef of the Buba’s argument is doubts about conditionality, they will simply deliver “rules” or “guidelines” for the implementation of conditionality.

    Once again, let Draghi follow his plan, but only after the sovereign concerned has implemented budgetary reform, passed laws, etc. under the instructions of the troika.

    • rodney:

      Related to this, it is not clear to me whether Germany’s constitutional court has any legal authority over the ECB’s decisions. Perhaps someone can clarify that?

      It certainly has authority over anything that implies fiscal transfers or liabilities. A point could be made that the Target-2 imbalances ultimately create liabilities for taxpayers, but probably the court would not see that as a fact unless the Buba can prove beyond reasonable doubt that the Euro is NOT irreversible.

  • worldend666:

    Rip roaring stuff. I hope everyone took the opportunity of lower prices to stack the vaults with gold.

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