Palm Beach, FL 11/8/11 (StreetBeat) -- When Mario Draghi conducted his first ECB policy meeting press conference he ruled out an expansion of the central bank’s sovereign debt buying program, calling it “temporary” and “limited”. He did not define what he meant by those terms and it should be remembered that one person’s ceiling may be another person’s floor, but there is a lot riding on the topic, whether or not his statement turns out to be correct. On the one hand, who else is currently interested in buying Italian debt or is ready to bet that any of the other PIIGs will soon be able to fly on their own? On the other hand if the program were to persist without a clear upper boundary then how long will Germany be able to deny its own hard money instincts?The first time the euro zone shocked and awed the market with a Greek rescue plan was in May 2010. That was the EU750 billion package that among other things created the EFSF. A part of the deal was a decision of the ECB to establish a Securities Markets Program (SMP), which would buy in the secondary market the sovereign debt of the troubled member states. “The Governing Council will decide on the scope of the interventions,” said the document that was signed by then ECB boss Trichet. As of early November the ECB has bought EU183 billion in such debt.
“When the ECB was founded 13 years ago, it was meant to be a European version of Germany’s Bundesbank and the heir to its steadfast principles: The sole duty of central bankers is to maintain price stability while remaining politically independent,” explained Der Spiegel magazine in an August 2011 article called Concerns Mount in Germany Over ECB Bond Buys. “And their supreme task is to deny the government access to the money printers. Indeed, things at Europe’s central bank were supposed to go just like they did under Karl Otto Pohl and Helmut Schlesinger, the legendary pair of Bundesbank presidents who served between 1980 and 1993 and primarily solidified their reputations for being able to say ‘no’ at the crucial moment.” To the German people the Bundesbank is a key part of their national identity, says Peter Loedel in his book Deutsche Mark Politics: Germany in the European Monetary System; “To examine deutsche mark politics is to examine the quasi-independent Bundesbank, which commands a towering and lofty position within the political economy of Germany. For many Germans from all socio-economic strata, the Bundesbank guarantees the soundness, stability, and foundations not only of the currency but also of the democratic and stable political order. Without a sound and stable DM, society could easily be buffeted by undemocratic forces bent on subverting the established political order of which the Germans are so proud. The Germans learned their bitter lesson about defacing and devaluing a nation’s currency and entrusted to the Bundesbank the task of defending the stability of the currency.”
It was because its duty to the nation went beyond the merely the financial that the Bundesbank was such a tough nut to crack in the negotiations that led to the creation of the single currency; the fear being that no other central bank would share their fortitude. In particular, as Loedel explained in his book, there was concern that “if governments believed that others would view their national economy as too big to fail, and hence cover their debts rather than allow the country to default; the temptation to pursue expansionary fiscal policies would increase.” And if that was the case then it could be that the central bank may decide to buy the excess debt and at some point not be able to resist turning up the printing press in order to meet the demand.
When the idea of the ECB buying euro zone sovereign debt was first suggested as a part of the solution to the problems in Greece and the burgeoning situations elsewhere, former Bundesbank President Axel Weber was strongly opposed; he was said to be disturbed that the strategy would even be considered by the bank. According to Der Spiegel in that August article, Weber wrote “an impassioned e-mail on May 7, 2010 to his colleagues on the ECB’s governing council…’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 he would go public with his opposition.” Obviously Weber did not win the day. It is said that his failure to convince the ECB on this point, let alone that such a thing would even be considered by the bank, a strategy that is anathema to Bundesbank philosophy and was one of the specific fears that made his predecessors at the German central bank so difficult to persuade on the currency project in the first place, was the reason that he retired early from his position at the ECB when it appeared he was in line to be the next President of the institution. Bundesbank and ECB economist Jurgen Stark eventually followed Weber’s path and also resigned over the issue.
The euro zone debt situation has gone from bad to worse since May 2010. The brush fire in Athens now threatens to become a conflagration in Rome. Euro zone leaders have bounded from one summit to the next for the last year and a half, creating a series of grand solutions along the way, each successive plan with a shorter shelf life than the one that preceded it. When G20 leaders gathered in Cannes, France last week they were exasperated at the lack of progress seen in Europe’s struggle with its sovereign debt problem; half measures with ever shorter half lives. It is said that Obama and others decided it was time for Germany to rid itself of its fear of the printing press and have the ECB follow the Fed’s lead and just buy unlimited amounts of the troubled sovereigns. “The Germans pointed out feebly that the ECB operates within a completely different tradition than the Fed, and that it also pursues a different mission,” says Der Spiegel in a recent article. “But it is becoming increasingly clear to Merkel and her finance minister that, in the end, only the ECB will be able to save the euro if the crisis continues to escalate. It is the only European fiscal policy institution capable of taking action, and it also comes equipped with unlimited firepower. It can never run out of money, because it can simply print new money when needed.” There was also a full court press on Germany from their European counterparts to use German foreign reserves, their IMF “special drawing rights”, and their holdings of gold in order to more fully meet the needs of their woefully indebted currency partners. “But current Bundesbank President Weidmann was deeply troubled and made his concerns known to the chancellor,” reports Der Spiegel. “Special drawing rights, he argued, as well as gold and foreign currency, are part of the currency reserves that the Bundesbank is required by law to safeguard. The Bundesbank fears that issuing the special drawing rights would open yet another door to monetary state financing. Special drawing rights, the bank notes are akin to an artificial currency against which foreign currencies can be borrowed at the IMF. Making them available, Germany worries, would be tantamount to opening up yet another flank to the crisis.”
So there it is, the rock has come up against the hard place. “Bringing an end to the euro zone crisis would require a central bank that acts as a lender of last resort, a common European bond market and ultimately, a fiscal union with a high degree of labour and product market integration,” opined Wolfgang Munchau in the Financial Times. “However, these measures are at present inconsistent with national constitutions, European treaties and political preferences.” To print or not to print, that is the question; the other answers have missed the point. “It appears that the euro crisis is approaching its endgame”, suggest Der Spiegel. “Many promises made when the common currency was introduced have already been broken. The initial stipulation that only stable countries be allowed in, for example, quickly proved illusory once Italy and Greece were accepted. German taxpayers were also promised that they would never be held liable for the debts of other countries in the euro zone. But then came the first and second bailout packages for Greece and the European bailout fund. And now another breach of confidence is on the horizon, with the Germans being expected to accept the notion that the ECB will be available to ailing euro countries as an almost unlimited reserve fund. The question the German government now faces is whether to preserve the monetary union or have a stable currency.”
So, I ask again; was Mr. Draghi correct?
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