As the European Central Bank (ECB) continues to wrestle with the decision of when and how quickly to wind down its quantitative easing (QE) program while inflation remains stubbornly below the 2 percent target and likely to stay well below 2 percent for the foreseeable future, it’s worth noting that there’s a new nightmare to add to the equation: The euro has surged in value this year, a move that not only depresses exports in recovery economies like Spain and Portugal but also depresses inflation. And one of the things holding down the value of the euro is the ECB’s QE program. So if the ECB tapers off the QE too early and quickly it’s going to make an overly-strong euro even stronger while dragging inflation even lower, potentially derailing fragile recoveries in the austerity-inflicted member states.
Adding to the ECB’s challenges is that the QE program officially expires at the end of 2017. Unless it’s extended. And as the following article notes, when you look at the schedule for the ECB’s Governing Council meetings where the upcoming QE details — with a meeting on October 26th and another on December 14th — it’s entirely possible that the ECB won’t finalize its QE details until that December 14th meeting. And if that happens, markets are only going have around 10 trading days to adjust to whatever the new QE reality is going to be going forward. And those trading days at the end of year tend to be low volume and therefore potentially much more volatile. So if there’s a big surprise, and it’s a negative surprise from the market’s perspective, we could see some wild times for the eurozone’s financial markets heading into the New Year and a wild time for the eurozone economies next year. Wild unpleasant times.
But even if the ECB does manage to make it very clear what it’s planning for the QE program well in advance of that December 14th meeting, if that decision involves a premature curtailment of the QE program that could still results in an ongoing surge in the value of the euro and further flirtations with deflation. And more wild unpleasant times for the eurozone as a surging euro starts killing off the fragile export-driven recoveries of in places like Spain, Greece, and Portugal.
And as we saw in Part 6 of this series, there’s also the ongoing issue of the QE “capital keys” that determine the volume of bonds each eurozone nation’s central bank can legally purchase without breaking the ECB’s self-imposed QE rules. In the case of Germany, which has the largest round monthly bond purchases due to the large size of the German economy, there is simply a lack of enough available bonds. But for the weaker nations like Portugal and Ireland the “capital key” cap on the amount of bonds the ECB can purchase in the QE program poses a different kind of limitation: the “cap” on the the total size of that nation’s bond market (33 percent of the total national sovereign bond market) that can be bought up in the QE program is already being hit in Portugal and Ireland and it’s going to be hit in other member states the longer QE continues, potentially forcing a premature ending to QE unless whether that’s prudent or not.
Sure, the ECB simply could change the rules that limit the available bonds to get around this limitation, but that probably won’t be an option with the Bundesbank and its allies completely opposed to the idea. And that means that we are looking at a situation where:
1. The ECB clearly wants to end QE as soon as the economic situation allows for it.
2. The rising value of the euro is making ending QE a lot less feasible at the moment because ending QE is inevitably going to make the euro rise even more and that threatens the export-led recoveries of the eurozone member states that were forced to incurred massive austerity in order to cut costs and make their economies more export-oriented.
3. Even if QE is extended significantly, unless there’s a rule change to the 33 percent cap rule there’s going to be an end to QE anyway, hitting one nation at a time as they approach that cap.
And that all means we’re in a situation where the political drive to end QE shows no signs of abating while the signals from the actual economy (persistently low inflation, fragile recoveries, and a surging euro that threatens those fragile recoveries) are increasingly warning against a hasty and ill-timed QE taper. And the ECB has to decide what it’s going to do before the end of 2017, but it can’t wait too long to make that decision because markets need time to adapt without creating turmoil in the financial markets.
As is the case with so much of the ECB’s decisions since the start of the eurozone financial crisis the suspense is tinglingly terrifying:
Bloomberg Markets
ECB May Not Have Final QE Plan Ready Until December
* Officials may not finalize new bond plan until December
* Traders would only have about 10 trading days to adaptBy Paul Gordon and Lucy Meakin
September 1, 2017, 7:40 AM CDT September 1, 2017, 12:02 PM CDTThe European Central Bank has a tight timetable for deciding the future of its bond-buying program, but investors may face an even tighter one to adjust to the outcome.
The Governing Council will hold its first formal talks next week on the pace of asset purchases after December, when the current program is scheduled to expire. Yet it’s conceivable that the decision won’t be finalized until the Dec. 14 meeting, according to euro-area officials familiar with the matter. That would leave around 10 trading days, during a holiday season when volumes are typically low, for market participants to sort out their strategy for the New Year.
The ECB’s 25 policy makers have plenty to talk about: some say the euro area’s robust economic recovery warrants the winding down of bond purchases — currently running at 60 billion euros ($71 billion) a month — while others point to feeble inflation as a reason to keep stimulus going. Yet leaving a decision too late could unnerve investors and push up the euro and bond yields, undermining the efforts so far.
“We’re all aware of the reality of the clock that they face,” said Charles Diebel, head of rates at Aviva Investors in London. “But markets have got very used to being told what’s coming a long time in advance, so to chance your arm and decide to wing it at the last minute in itself is like asking for trouble.”
Possible Signals
Officials are aware of the risk of waiting too long, with two of the people saying they shouldn’t surprise investors by holding back every detail on the future of QE until the final meeting of the year. That suggests the ECB is still likely to deliver signals on the plan for asset purchases after one or both of the next two meetings. A spokesman for the central bank declined to comment.
Neither would a tapering decision at two weeks notice be unprecedented. When the U.S. Federal Reserve decided to cut its own bond purchases starting in January 2014, it made the announcement on Dec. 18, 2013.
The difference is that the Fed started formal talks on tapering at their June 2013 meeting and frequently talked in public about tapering in the following months. The New York Fed even included questions on the topic in its survey of primary dealers.
The ECB has so far explicitly avoided putting the topic of next year’s purchases on the Governing Council’s agenda. At July’s session, it agreed to start discussions in “the fall,” but even then opted not to say if that necessarily meant the Sept. 7 meeting.
The slide in the euro in reaction to the news that the full details of the asset-purchase plan may wait until until December might encourage those policy makers who expressed concern at the July meeting of a possible overshoot of the single currency.
The euro’s gain after President Mario Draghi’s speech in Portugal in June — when he spoke of “reflationary forces” — and the currency’s jump again last week when he opted not to try to talk it down in a speech in Jackson Hole, Wyoming, showed how sensitive markets are. That justifies extreme prudence, with changes to communication and policy likely to move even slower than originally expected, two of the people said.
Economic Upturn
Some policy makers are more sanguine. Bundesbank President Jens Weidmann and Estonian central-bank governor Ardo Hansson have both said recently that the euro’s strength reflects the economy’s upturn and is nothing to worry about. Austrian Governor Ewald Nowotny said on Friday that he wouldn’t “dramatize” the gain.
But Nowotny also added that policy normalization can’t be about “abruptly stepping on the brake.” It’s “sensible to see how to get off the accelerator and how to carefully initiate” the process, he said. Vice President Vitor Constancio said in a separate speech that while the euro area’s economic recovery is proving to be increasingly robust, a “strong worldwide reflationary phase that seemed likely at the beginning of the year has not materialized.”
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But for some commentators, the urgency for action is mounting because the ECB looks set to run into its self-imposed limits on how much debt it can buy from each nation, issuer and bond issue. The current schedule will take its purchases to 2.3 trillion euros, equivalent to almost a quarter of gross domestic product. The ECB’s balance sheet — fueled by free loans to banks — has soared to 4.3 trillion euros.
“Sticking your head in the sand until December and hoping the problem goes away is not a communication strategy,” said Richard Barwell, an economist at BNP Paribas Asset Management in London. “The issue limits are going to force them to exit prematurely. They cannot duck the consequences indefinitely.”
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“The Governing Council will hold its first formal talks next week on the pace of asset purchases after December, when the current program is scheduled to expire. Yet it’s conceivable that the decision won’t be finalized until the Dec. 14 meeting, according to euro-area officials familiar with the matter. That would leave around 10 trading days, during a holiday season when volumes are typically low, for market participants to sort out their strategy for the New Year.”
Yeah, the end of the year at the last minute probably isn’t the best time for the ECB to throw a surprise QE curveball. Unless it’s a very accomodative curveball that leans towards the ‘dovish’ side that’s sort of a reiteration of the ECB’s long-held stance to “do whatever it takes” to hold the financial system together, the stance ECB Chief Mario Draghi historically took in 2012 as the eurozone sovereign bond markets teetered on the edge.
But if it’s a last minute negative curveball that tightens conditions and simultaneously signifies a historic pivot away from ‘do whatever it takes’ and sets market expectations for significant further tightening over the next year, things could get rather choppy:
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“We’re all aware of the reality of the clock that they face,” said Charles Diebel, head of rates at Aviva Investors in London. “But markets have got very used to being told what’s coming a long time in advance, so to chance your arm and decide to wing it at the last minute in itself is like asking for trouble.”
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Shocking the markets out of QE complaceny does seem like asking for trouble. But sadly, we can’t entirely rule asking for trouble out. Because while Mario Draghi was reiterating his “Do whatever it takes” pledge to the markets over the past five years, we can’t forget that the Austerian wing of the eurozone https://www.dailykos.com/stories/2012/05/14/1090839/-The-Austerions. For a lot of powerful people in the eurozone’s financial power structure — notably Bundesbank chief Jens Weidmann and German finance minister Wolfgang Schaeuble — calling for trouble is their thing. For the austerians, massive trouble for the nation isn’t a problem, it’s a solution.
Really stupid economic policies like the austerity madness was the ‘solution’ inflicted on Greece to a reprehensible degree and to countries like Spain, Ireland, and Portugal to a somewhat less reprehensible degree. And the only reason that same far-right austerity agenda, an agenda that’s dominated most of the eurozone’s economic decision-making and successfully imposed austerity across Europe, hasn’t prevailed at the ECB level. And that’s because it would have imploded the entire eurozone economy and the zone itself. That’s too much trouble. But just about anything less than the implosion of the eurozone is apparently considered acceptable levels of trouble for Team Austerity. We’ve seen that over and over and there’s absolutely no indication that this has changed. Calls for trouble are very possible because they are very precedented.
Keeping the Market Uninformed isn’t the Best Policy, but Might not be as Bad as Informing the Market of Bad Policy
So hopefully the unspoken rule — the rule that national economies, but not the entire eurozone economy, can be allowed to implode — will continue ruling the day as the ECB approaches this big QE decision over the next few months. And hopefully the euro doesn’t keep surging too. But if the ECB really is going to wind down QE over the year or two it’s unclear what’s going to hold the euro down during the process. Maybe other measures will be used to hold the currency down, but the same forces that oppose QE all along have opposed all the other stimulative measures too. Will those forces be held at bay while QE unwinds? As we’re going to see, the answer to that question is “maybe?!”.
And let’s also not forget that the ECB’s need to signal to the the markets as early as possible of of its QE plans is potentially in conflict with the need to keep the value of euro down if the details of the ECB’s plans including ending QE soon too. If ending QE in 2018 really is the ECB’s plan, the euro probably has quite a bit of surging ahead of it unless something else intervenes. But the ECB can’t hold off on this decision for long. It has to finalize and release the details of its QE plans between now and its December 14th meeting at the very latest. And if those ECB plans really are plans to end QE, there’s real incentive for the ECB hold off on releasing those plans now in order to avoid the kind of euro surge that could disrupt those plans.
But waiting until the December 14th meeting also increases the odds of a bad market reaction. And the more the austerity faction wins out the worse that market reaction is going to be (worse, as in, a much higher euro). It’s a real conundrum. The ECB doesn’t just need to release its QE plan details soon. The ECB needs to release positive details that relieve the markets and avoid surging the euro. Soon (unless it’s ok with trouble, which is precedented):
CNBC
Euro zone countries could be in danger if euro continues to rise, economist says
The recent rise in the euro could put economic recovery in danger
“But if there would be an overshoot of the exchange rate then of course they’ll have a problem because with their large foreign debt they don’t have a second wheel on their machinery.”Silvia Amaro
Published 4:45 AM ET Wed, 30 Aug 2017 | Updated 5:56 AM ET Wed, 30 Aug 2017A euro that continues to rise against the U.S. dollar is now the main danger being posed to fragile euro zone economies that are still recovering after the sovereign debt crisis of 2011, one economist has told CNBC.
Ireland, Portugal and Spain have become some of the fastest growing economies in Europe after receiving help from creditors to restore their finances after the crises that begun in 2011. However, the recent rise in the euro could put their recoveries in danger, according to Daniel Gros, director of the think tank Centre for European Policy Studies, told CNBC Wednesday.
“That is of course the main danger point for them,” he said.
“As long as the euro doesn’t go much above 1.20 they should be able to continue. But if there would be an overshoot of the exchange rate then of course they’ll have a problem because with their large foreign debt they don’t have a second wheel on their machinery,” Gros said.
The euro rose above the 1.20 level against the greenback on Tuesday on growing geopolitical tensions between North Korea and the U.S. A stronger euro means that European products become more expensive in international markets, which could decrease foreign appetite for European goods and thus hurt EU economies.
Countries like Portugal and Spain owe much of their recovery to exports, exports have been higher than those of Germany, France and Italy (the biggest EU economies) since last year, according to data collected by TS Lombard.
John Hardy, head of forex trading at Saxo Bank, told CNBC Wednesday that “we have seen a near term peak of sorts triggered as the EURUSD and dollar Index breached key levels, but the pullback suggests the USD weakness has extended too far.”
The focus has started to shift towards Frankfurt where European Central Bank President Mario Draghi is due to speak next week, following a monetary policy meeting.
Investors had been hoping to get some indications about the bank’s program to exit monetary stimulus but the recent uptick in the euro raises doubts that the ECB will announce such details.
Easy monetary policy suppresses the value of a currency and the potential end of this policy in the euro zone is seen as one of the key reasons why the euro is currently rising. A strong currency also acts as a deflationary pressure at a time when the central bank wants to bring core inflation up in the region.
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In its latest forecasts, in June, the ECB projected headline inflation at 1.5 percent in 2017 and 1.3 percent in 2018. The bank’s target is to see inflation “close but below 2 percent.”
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“Easy monetary policy suppresses the value of a currency and the potential end of this policy in the euro zone is seen as one of the key reasons why the euro is currently rising. A strong currency also acts as a deflationary pressure at a time when the central bank wants to bring core inflation up in the region.”
The markets are always watching. And they see a potential end to QE but they also see that a a rising euro is a predictable consequence of exactly that policy and also exactly the kind of change in circumstance that makes ending QE a lot harder. As a consequence, a week before the ECB’s September 7th meeting the markets could already see that the ECB’s expected ambitions were actively getting thwarted, in part thwarted by the rising euro resulting for those expected ambitions:
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The focus has started to shift towards Frankfurt where European Central Bank President Mario Draghi is due to speak next week, following a monetary policy meeting.Investors had been hoping to get some indications about the bank’s program to exit monetary stimulus but the recent uptick in the euro raises doubts that the ECB will announce such details.
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So heading into the September 7th ECB meeting, the market’s were apparently expecting that the ECB wanted to announce an end QE, but the markets also recognized that attempting to an QE while the euro is surging is a highgly risky maneuver and might have to be postponed given current conditions. It’s sort of a Catch-22 situation, but not really. True Catch-22 situations don’t have an escape. In this case there is an escape — sane, sober policy — but sane, sober policy often isn’t an option for the ECB. It’s more like a synthetic Catch-22 situation created by the active decision to leave no good options.
Mario Draghi’s “No Decision Yet” September 7th Signal
What will the ECB ultimately do? Well, the ECB just met on Thursday, September 7th, and Mario Draghi did indeed give a signal. And it was quite a signal in an ironic sense: Draghi signaled that the volatility of the euro left the ECB uncertain about what to do with the QE. So he announced that they’re planning on making their decision in October, presumably at the ECB meeting on October 26th. He also signaled that inflation is expected to eventually reach 2 percent (what a bold prediction). Oh, and he noted that the QE discussions were very preliminary. And that they haven’t had any discussions at all about the “capital keys” caps on countries like Portugal that are preventing them from fully participating the QE (the countries that need it the most get thwarted). He did state that interest rates were going to remain ultra-low for an extended period, but also noted that it hadn’t been discussed yet whether or not they’ll get raised before the QE program ends.
So the signal Draghi sent to the markets was that the ECB has no idea what it’s going to do, hasn’t really talked about it, and will decide in a month and a half (hopefully). And to placate the markets he also announced that interest rates will stay low for an extended period, although they haven’t decided yet whether to raise interest rates before or after QE is ended, which is a rather mixed signal since QE could end next year. But that’s the signal Draghi had to send. In terms of calming the markets and avoiding a further surging of the euro it probably wasn’t Draghi’s best signal to the markets:
Bloomberg
Draghi Says Euro a Concern as ECB Targets October Decision on QE
* ECB cut its inflation outlook on surge in single currency
* Governors considered scenarios for recalibrating QE in 2018By Carolynn Look
September 7, 2017, 8:00 AM CDT September 7, 2017, 8:35 AM CDTMario Draghi said the European Central Bank is watching the euro’s gains as policy makers edge toward settling the future of their bond-buying program.
“The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring” for its impact on price stability, the ECB president told reporters in Frankfurt on Thursday. He said the decisions on QE are “many, complex, and always naturally one thinks about risks that may materialize in the coming weeks or months, so that is the caution behind not specifying a date — probably the bulk of these decisions will be taken in October.”.=
The single currency rose as much as 1.2 percent as Draghi spoke to break above $1.20. It was up 0.9 percent at $1.2025 at 3:23 p.m. Frankfurt time.
The signal that a decision on bond purchases is likely next month “makes it difficult for the ECB president to talk down the euro,” said Nick Kounis, an economist at ABN Amro in Amsterdam. “The currency market is telling Draghi that talk is cheap and it is putting more weight on the upcoming QE actions.”
The euro’s surge — more than 14 percent against the dollar this year and almost 6 percent on a trade-weighted basis — was reflected in a downgrade to the ECB’s inflation outlook even as Draghi said economic growth remains solid. That highlights the difficulty policy makers face as they debate the future of their QE program — which has already topped 2 trillion euros ($2.4 trillion) and is scheduled to continue at a monthly pace of 60 billion euros until the end of this year.
ECB staff now see inflation at 1.2 percent in 2018 and 1.5 percent in 2019, well below the goal of just below 2 percent.
Still, Draghi said that there was “broad satisfaction” within the Governing Council that consumer prices will eventually converge with expectations for stronger growth.
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The ECB chief described the discussion on the path of QE as “very, very preliminary” and that the Governing Council considered the “trade-offs” between various scenarios related to the pace and duration of purchases. Policy makers want to see the work of ECB’s technical committees before deciding, he said.
He said officials did not discuss the ECB’s self-imposed limits on the proportion of bond issues it can buy, not did they talk much about the risk the central bank will run out of debt to buy.
“We haven’t discussed really the scarcity issue because so far, he said. “We’ve consistently shown that we’ve been able to cope with this issue quite successfully.”
The ECB chief also reiterated that interest rates will be kept low for an extended period, and said officials did not discuss whether they could be raised before net asset purchases end.
““The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring” for its impact on price stability, the ECB president told reporters in Frankfurt on Thursday. He said the decisions on QE are “many, complex, and always naturally one thinks about risks that may materialize in the coming weeks or months, so that is the caution behind not specifying a date — probably the bulk of these decisions will be taken in October.””
The ECB punts the QE decision from its September 7th meeting to the October 26th meeting. Six weeks. And until then the signal to the markets from the ECB is likely going to be that it hasn’t decided yet. And that’s assuming the final decision really is made and announced by that October 26th meeting. And if things get pushed back to the December 14th meeting that leaves just 10 trading days before the end of the year. It’s going to be an interesting ride for the euro in the final quarter of 2017.
And don’t forget, the higher the euro goes, the closer inflation gets to that deflationary danger zone. A danger zone the eurozone is already scheduled to flirt with over the next couple of years (hence Draghi’s expectation that inflation will “eventually” converge with the 2 percent target):
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ECB staff now see inflation at 1.2 percent in 2018 and 1.5 percent in 2019, well below the goal of just below 2 percent.Still, Draghi said that there was “broad satisfaction” within the Governing Council that consumer prices will eventually converge with expectations for stronger growth.
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But also don’t forget that there are things Draghi could easily say that will bring the euro down. He could tell the markets good news that reassures it that the ECB is committed to its existing accommodative policies and a smooth landing for the QE and not some arbitrarily set deadline to placate the Ordoliberal faction’s ideological desire to end stimulative measures. Policy sanity. That would help bring down the euro. But it’s apparently not an option in this situation which is rather scary. If there’s been a saving grace for the eurozone over the last five years it’s that the ECB has been the one institution where Team Austerity didn’t always win out. If that changes we could looking at a very scary next phase of the evolution of the eurozone.
There was, however, the one thing Draghi said that should soothe markets and help hold the euro down: that interest rates would be kept low for an extended period. Although he also stated that the ECB Governing Council didn’t actually discuss whether or not rates will be raised before the end of QE. It could have been more soothing, although it could have been worse too:
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The ECB chief also reiterated that interest rates will be kept low for an extended period, and said officials did not discuss whether they could be raised before net asset purchases end.
So maybe QE will be ended next year but rates will stay low for much longer. That’s the kind of signal that should at least help keep the eurofrom surging.
But, again, if the QE program is ended soon — say, in 2018 — the question of whether or not interest rates are going to be hiked before, or only after, the QE bond buying program ends is going to be moot in a year. t’s an example of easily the ECB’s soothing words can be undermined by the rest of signaling — official and unofficial signals — which is s an important point to keep in mind because we’re entering into a potentially precarious phase of the eurozone crisis — the unwinding stimulative measures phase — and if the ECB screws this up we could be looking at more crises. One of the easiest way for the ECB to screw this up is for it to inadvertently send signals that indicate the crazy Austerity Team is taking over completely and the markets are in for a giant shock and few things are going to shock markets and spike the euro quite like a rapid pull out of the ECB’s ultra-low interest rate position. So if there’s a miscommunication on matters related to the expectations for future rate hikes that could have a significant impact on the ECB’s ability to actually unwind the QE program given how tightly intertwined the QE program is with interest rates and currency valuations.
This is seriously tricky central banker stuff going on right now in the eurozone. If the ECB tries to calm the markets it just might make matters worse. But saying nothing doesn’t help either. These are very non-ideal conditions for the end something like QE.
The 2018 Unwinding of QE to Be, According to Three Anonymous Insiders
So given the situation the ECB finds itself in — and role public signaling for the ECB, or lack thereof, is playing in the development of that situation — it’s worth noting that, according to the following report based on three anonymous people privy to ECB Governing Council thinking, the ECB has already made quite a few decisions on these matters. Mostly scary decisions. But let’s start with the pleasant part: According to these insiders, the ECB has decided whether or not it’s going to raise interest rates before the end of the QE program: no, it won’t.
And in theory that would be a relief to markets and perhaps help bring the euro down. But it turns out not be be much reassurance given the rest of what these insiders allege: that the ECB has already decided to unwind the QE program next year. Specifically, the insiders say the ECB has already planning on significant cut to the month QE bond purchases starting in January, and are only debating whether to get it by 33–66 percent. And they’re planning on ending the program entire by the fall of 2018 . So the question of whether or not those ultra-low rates rise before or after QE ends is moot in a year if what these anonymous insiders say is true. It’s the kind of report that limits the ability of Draghi to reassure markets.
Also, according to the anonymous insiders, there will be no flexibility on the national QE “capital keys” caps. They are non-negotiable and changing them (like lifting the 33 percent cap) would create legal challenges. If that’s truly the dominant position internally at the ECB at this point it’s a sign that Team Austerity — led by Wolfgang Schaeuble and Jens Weidmann — really is planning on ensuring QE effectively ends sooner rather than later whether or not there’s an officially declared end to QE. The national caps effectively put a time limit on the QE program. A limit that nations hit at different points and the nations that need it most tend to hit the caps first.
So there are now anonymous reports emanating from the ECB hinting at exactly the kind of policies that would call for a higher euro. And as we saw, if the ECB doesn’t give the final important details until its December 14th meeting that could be asking for trouble, leaving just 10 traditionally low volume market trading days before the end of the year. As we also heard from Mario Draghi, the official decision will probably come at the next meeting on October 26th. So it’s worth noting the other important policy stance indicated in the following article: the icing on the cake comes from Finland’s central bank governor and ECB board member Erkki Liikanen, who inform reporters that, while the ECB’s decision on QE might be made at the October 26th meeting, there would be a some “fine-tuning” on technical issues that prevent the final decision from happening until the December 14th meeting. And, of course, in a highly volatile environment, there could be a lot of technical issues. Especially after the ECB announces the plans these insiders are hinting at and especially if market speculation about ECBG Governing Council speculation of the markets leads the euro higher.
It’s possible this is anonymous bluster, but at a minimum it appears that Team Austerity inside the ECB, an enemy of QE all along, wants to make it look like it’s reasserting its control at the ECB level. That’s the signal the right-wing pro-austerity faction is sending to the markets via anonymous reports like the following one. And if it’s an accurate signal that means these ECB insiders just informed the markets that there’s a potentially significant shock coming up from the ECB and the shock won’t be finalized until December 14th, leaving just 10 trading days for the markets to work out at the end of the year. It’s the kind of message that’s probably not going to make Draghi’s job any easier.
It’s also important to note that these insider reports could be bluster from a minority faction. And specifically right now, this could be coming from the Berlin faction to placate the German electorate that has an election going on at the moment. Tough talk on QE is good politics in Germany’s election.
Still, the advance of the euro matters for the eurozone ‘periphery’ nation now forced to export their way out of the ‘austerity zone’. These are nations that have had one economic tragedy after another inflicted upon them in recent years and it would be a massive tragedy if the Team Austerity managed to create a euro spike that destabilized those same economies due to stupidly overreaching during the QE unwind. And even if the anonymous report isn’t real, it’s a real signal being sent through anonymous sources by Team Austerity to the public with the power to move markets by changing expectations:
Reuters
Exclusive: ECB policymakers agree on cutting stimulus — sources
Reuters Staff
September 8, 2017 / 3:57 AM / UpdatedFRANKFURT (Reuters) — European Central Bank policymakers agreed at their meeting on Thursday that their next step would be to begin reducing their monetary stimulus, three sources with direct knowledge of the discussion said.
After 2–1/2 years of massive money-printing, the ECB is taking baby-steps toward weaning the euro zone off the easy cash that has helped boost the economy but is also blamed for creating bubbles in richer countries such as Germany.
The ECB left its policies unchanged on Thursday. But President Mario Draghi suggested October would be decision time regarding the future of the 2.3 trillion euros ($2.8 trillion) bond-buying program. Policymakers debated various scenarios, he said.
The four options being considered for reducing its bond buying, according to sources who asked not to be named, include cutting its monthly buying from the current 60 billion euros to 20 or 40 billion from the start of 2018, with the scheme running for another six or nine months.
The decision was likely to come at the Oct. 26 meeting and should be backed by a broad consensus, the sources said. One suggested a compromise could be found for setting monthly purchases somewhere between 20 billion and 40 billion euros.
The sources added that much of the focus of the discussion was on the overall amount of the purchases, including the reinvestment of proceeds from maturing bonds, which will slowly rise toward 15 billion euros per month next year, the sources said.
The ECB declined to comment on the report, which pushed the euro and government bond yields in the single currency bloc higher.
INFLATION
Despite solid economic growth in the euro zone, inflation has yet to rise back to the ECB’s target of almost 2 percent and has been further curbed by a recent rise in the euro against major currencies, which makes imports cheaper and exports less attractive.
The rally in the euro was raising the chances that the ECB would opt to phase out quantitative easing only very slowly next year and may look for other ways to support the economy.
The sources said policymakers also agreed that interest rates will not be raised before the asset buys end, indicating by default that any extension of the program would also push out the first rate hike.
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LIMITS
Any extension to the bond scheme will leave the ECB exposed to the risk of running out of eligible bonds to buy under the strict conditions it has set itself to limit market disturbance and not become a blocking minority in any country.
But the sources said the so-called issuer limit, which caps any ECB buying to a third of a country’s outstanding debt, is not up for discussion because it would open the program up to a legal challenge.
Maintaining the cap and the program’s other self-imposed constraints would curtail the purchases as the ECB is already approaching its limit in several countries — notably Germany, the euro zone’s biggest economy and the ECB’s top critic.
This meant the ECB may have to deviate even farther from the national quotas adopted at the outset of the program, which determine how much debt it can buy from each country depending on its shareholding in the central bank.
Indeed, the ECB has been buying fewer German and more Italian and French bonds than it is supposed to for months, with purchases of public-sector paper issued by Germany hitting an all-time low in August.
Some technical issues may have to wait until the ECB’s last meeting of the year in December, according to Finnish governor Erkki Liikanen.
“We have a meeting in October where we will address these issues, and it could be that the fine-tuning on these issues will be made afterwards,” Liikanen told the Finnish parliament on Friday.
———-
“The ECB declined to comment on the report, which pushed the euro and government bond yields in the single currency bloc higher.”
No comment from the ECB on the “let’s end QE in 6–9 months and slash bond purchase 33–66% in January and give the markets 10 trading days to adjust” rumored plans. *Gulp* Hopefully it’s just ECB policy not to comment on anonymous reports.
Still, that wouldn’t change the fact that there’s group of people in the ECB leaking a behind-the-scenes narrative to the press that the consensus decision has already been arrived at by the ECB Governing Council to cut QE dramatically in January and end it entirely by the fall. And while markets might not have been shocked to hear such a plan back in, say, mid April, when the euro was closer to $1.05 and not $1.20 , it’s a lot more surprising to hear plans to unwind QE in the first 6–9 months of 2018 now that the euro is $1.20 with plenty of momentum to head higher as QE unwinds.
But, let’s not forget that the opponents of QE — primarily the Bundesbank and its allies- were more than happy to call for an expensive euro back in 2013 when the eurozone’s ‘periphery’ economies were far closer to imploding than they are today. So this insider report is surprising in a general sense given the obvious risks of an overvalued euro to the eurozone economies, but it’s not particularly surprising given who we’re talking about. Reckless policy s the austerity faction’s specialty.
And note how, even if there is a surprise ECB decision about QE and the other stimulus programs and the QE program is extended without big cuts to the monthly bond buying and no declared plans for shuttering the QE, the ECB’s “capital keys” cap on the QE sovereign bond buying at 33 percent of a nation’s outstanding sovereign bonds is still in place and not going anywhere according to these insiders. And that QE national cap is already forcing Portugal and Ireland to continually cut their participation in the QE program. So when we hear that the changing the rules to lift those national caps is already ruled out by these insiders, we’re hearing a signal that QE is going to be allowed to end soon one way or another: either QE will be wound down intentionally or eventually all the participating nations will eventually hit their caps and effectively end it anyway:
...
Any extension to the bond scheme will leave the ECB exposed to the risk of running out of eligible bonds to buy under the strict conditions it has set itself to limit market disturbanc and not become a blocking minority in any country.But the sources said the so-called issuer limit, which caps any ECB buying to a third of a country’s outstanding debt, is not up for discussion because it would open the program up to a legal challenge.
Maintaining the cap and the program’s other self-imposed constraints would curtail the purchases as the ECB is already approaching its limit in several countries — notably Germany, the euro zone’s biggest economy and the ECB’s top critic.
This meant the ECB may have to deviate even farther from the national quotas adopted at the outset of the program, which determine how much debt it can buy from each country depending on its shareholding in the central bank.
...
“This meant the ECB may have to deviate even farther from the national quotas adopted at the outset of the program, which determine how much debt it can buy from each country depending on its shareholding in the central bank.”
And keep in mind that this report came out on September 8th, one day after ECB chief Mario Draghi told the market that the ECB is going to need the next six weeks to wait and see and observe the situation with the rising euro to determine its QE decision. It’s a pretty strong “trouble here we come!” signal for these ECB insiders to send to the market.
The Schaueble Consensus. That’s a Thing. Uh Oh.
Although, again, it’s entirely possible that the anonymous insider report is just a story intended to placate the German electorate or disinfo for some other reason. It’s an anonymous insider report and people spread false stories for all sorts of reasons.
But unfortunately, according to the following report in the Financial Times from September 6th, German Finance Minister Wolfgang Schaeuble — arguably the most powerful person in Europe and a consistent advocate for absolutely merciless applications of austerity doctrines — has views on these matters that are more and more in line with the ECB consensus. Not entirely. Schaeuble wants an end to all ECB stimulus policies (QE and low rates and anything else) sooner than people expect, as he puts it. And while it doesn’t sound like the ECB is on board with a complete rapid reversal of all stimulus programs, it does sound like Schaeuble’s views on ending QE completely next year is increasingly the consensus on the ECB Governing Council
The Financial Times
Draghi faces another test to taper without tantrums
by: Claire Jones in Frankfurt
September 6, 2017Mario Draghi has been wrestling with a €2tn issue throughout this year — how to rein in the European Central Bank’s quantitative easing programme without alarming the markets and slowing down the eurozone’s recovery.
Now, as the hour of truth looms for the €60bn-a-month asset purchase scheme — due to be discussed at Thursday’s ECB meeting ahead of a likely decision in October — attention is shifting elsewhere: notably, to interest rates.
“The ECB thinking into next year could be that what matters more for the euro is not the size [of] QE, but keeping...interest rate expectations anchored for as long as possible,” said Marchel Alexandrovich, economist at Jefferies International, an investment bank.
QE remains an intensely polemical topic as the ECB president can attest. Germany has always been uneasy about the bond-buying programme, while eurozone countries with lower levels of growth are much more enthusiastic about its impact on reducing borrowing costs.
Wolfgang Schäuble, Germany’s finance minister, called on Wednesday for the ECB to ditch such extraordinary crisis measures because of the strength of the eurozone recovery. “Unusual monetary policy implies it is not usual or normal — we should get back to a normal monetary policy,” he said. “We have come back to a normal situation much quicker than people thought.”
But, insofar as they refer to QE, Mr Schäuble’s remarks are in line with the consensus, which is increasingly confident of a decision next month to scale back asset purchases from January, so that the scheme can wind down next year.
Since the ECB risks running out of eligible assets if it continues purchases at their current pace and Mr Draghi has declared several times that his bank has vanquished the threat of deflation, much of the rationale for QE has gone.
That is not the case, the ECB argues, for interest rates.
At 1.5 per cent compared with a target of just below 2 per cent, inflation is still weak, partly because of the strong euro. Core inflation is even more feeble, at 1.2 per cent.
There is broad agreement within the ECB’s governing council that any decision to increase rates from their current record lows could risk throttling the recovery, despite demand for higher rates from Germany and elsewhere.
At present, the main refinancing rate is zero while the deposit rate paid by banks is minus 0.4 per cent.
Despite the healthy eurozone recovery that brought growth to 2.1 per cent for the year to June, expectations of a rate rise in the medium term have dived in recent months — particularly since a conference speech Mr Draghi gave in Sintra in June.
The initial aftermath of that speech, in which the ECB president said “deflationary forces have been replaced by reflationary ones”, was a jump in the euro, as investors judged that there would be less reason in the near future to keep interest rates low.
But ECB officials hastened to say that Mr Draghi had been misunderstood, and his speech also argued that policy “needs to be persistent” because inflationary pressures were “not yet durable and self-sustaining”.
Since then, markets for futures contracts indicate that investors have gone from pricing in a 90 per cent chance of a rate rise by the end of 2018 to a 40 per cent chance — the lowest probability on record.
One central bank official close to the deliberations said the adjustment in interest rate swaps suggested “markets were finally taking our forward guidance seriously”. That is a reference to Mr Draghi’s near-constant refrain that the bank expects rates to “remain at their present levels for an extended period of time, and well past” the time when QE is finally brought to an end.
...
Bankers — particularly in Germany — are not happy about continued ultra-low interest rates. “The real economy is doing well, the market is expecting I think an increase in interest rates or a reduction in the negative nature of interest rates. Let’s start doing that,” said John Cryan, Deutsche Bank chief executive on Wednesday, referring to an issue that also concerns Mr Schäuble. “It can’t be forever that deposit taking is lossmaking?...for banks.
The markets’ struggle to interpret Mr Draghi’s remarks over the summer has also fuelled sharp rises in government borrowing costs and contributed to the euro’s rise.
The currency’s ascendancy means in turn that a new round of economic forecasts by ECB staff on Thursday will almost certainly show inflation weakening in 2018 — complicating the bank’s task of explaining why now is the time to exit, even though next to no one expects inflation to hit its target during the next couple of years.
“If you look back at what he has accomplished in the past two or three years, Mr Draghi is probably the most successful central banker there is,” said Michael O’Sullivan, chief investment officer in the international wealth management division at Credit Suisse.
“But on the euro, he hasn’t been that forthright. There is a danger that if he doesn’t feel the need to say anything on Thursday, then the currency could draw investors and appreciate further.”
Ken Wattret, economist at TS Lombard, a research firm, said: “Inflation is still rather low, so the ECB needs to make clear that the hurdle to embark on interest rate rises is much higher than the hurdle to tapering.
“What Mr Draghi should do on Thursday is put some distance between adjusting QE and raising interest rates. He ought to emphasise that policy adjustment will be very gradual. Otherwise he risks undermining the progress which it has taken such a long time to achieve.
———
“Wolfgang Schäuble, Germany’s finance minister, called on Wednesday for the ECB to ditch such extraordinary crisis measures because of the strength of the eurozone recovery. “Unusual monetary policy implies it is not usual or normal — we should get back to a normal monetary policy,” he said. “We have come back to a normal situation much quicker than people thought.””
Those were Wolfgang Schaeuble’s comments on September 6th, the day before the ECB met and Mario Draghi issued his vague statement about how the ECB needs to wait and observe the situation before making any decisions on how fast to wind down the QE program. “We have come back to a normal situation much quicker than people thought.” So we have this message from Schaeuble, a supremely powerful figure, the day before Mario Draghi gives his “we’ll wait and see” speech, and then the following day we get the above report from the anonymous insiders that more or less is in line with Schaeuble’s message.
It’s rather ominous given Schaeuble’s influence because Schaeuble’s way of thinking is the default mode for how the eurozone seems to operate on all matters involving finance, except for ECB matters in recent years because that would have imploded the entire eurozone. So if Schaeuble’s way of thinking is about to replace Draghi’s relatively ‘dovish’ reign now that the eurozone is slowly recovering we really can’t rule out the ECB following Schaeuble’s lead and “renormalizing” back to a “a normal situation much quicker than people thought” over the next couple of years. Or at least much sooner than is economically appropriate (Schaeuble is a highly ideologically driven figure so economic appropriateness is never a priority for him).
But it’s extra ominous to hear Schaueble’s “renormalize it all (at any cost)” views in a report that describe’s Schaeuble’s views on QE as truly the behind-the-scenes consensus:
...
But, insofar as they refer to QE, Mr Schäuble’s remarks are in line with the consensus, which is increasingly confident of a decision next month to scale back asset purchases from January, so that the scheme can wind down next year.
...
As we’ve seen repeatedly over the past 5+ years, ever since the eurozone crisis really got into full swing, when Wolfgang Schaeuble calls for a policy it’s a call rooted in punitive Ordoliberal ideology, not practical economics. So to hear that Schaeuble’s views are the consensus view on almost anything is a big warning sign that the ideologues are once again taking over at the ECB.
But that’s the signaling coming out of the ECB and all powerful German finance minister heading into this crucial period for the eurozone economy. Ending QE was never going to be easy, but if the Ordoliberal ideologues are calling the shots during this QE wind down phase it could be a very bumpy ride. Officially, Mario Draghi is telling the markets to vaguely not worry because he’s promising to keep interest rates ultra-low for the foreseeable future even if QE is unwound next year, and maybe the ECB won’t end QE at all next year if the euro keeps surging. That’s the official message.
But unofficially the message from anonymous ECB insiders and Wolfgang Schaeuble is that the decision has already been made to kill QE next year, with rate rises presumably to follow. And if the markets decide to listen to that unofficial message instead of the official one the euro is going to just keep going higher and higher, potentially derailing the fragile export-based economic recoveries that are being used to justify ending QE in the first place.
And as the above article pointed, we saw what happens when the markets misinterpret the ECB. Back in June, when Draghi sounded like he was shifting away from guarding against deflation to guarding against inflation, the euro did exactly what you would expct: it jumped in value, contributing to the overvalued euro situation we have today:
...
Despite the healthy eurozone recovery that brought growth to 2.1 per cent for the year to June, expectations of a rate rise in the medium term have dived in recent months — particularly since a conference speech Mr Draghi gave in Sintra in June.The initial aftermath of that speech, in which the ECB president said “deflationary forces have been replaced by reflationary ones”, was a jump in the euro, as investors judged that there would be less reason in the near future to keep interest rates low.
But ECB officials hastened to say that Mr Draghi had been misunderstood, and his speech also argued that policy “needs to be persistent” because inflationary pressures were “not yet durable and self-sustaining”.
...
But as the article also also noted, the markets have since taken the ECB’s officially messaging on interest rate guidance — don’t expect a rate rise for a while — to heart. So if there’s a decision, or market expectation, to raise interest rates soon after ending QE that could be a genuine surprise that would only send the euro higher:
...
Since then, markets for futures contracts indicate that investors have gone from pricing in a 90 per cent chance of a rate rise by the end of 2018 to a 40 per cent chance — the lowest probability on record.One central bank official close to the deliberations said the adjustment in interest rate swaps suggested “markets were finally taking our forward guidance seriously”. That is a reference to Mr Draghi’s near-constant refrain that the bank expects rates to “remain at their present levels for an extended period of time, and well past” the time when QE is finally brought to an end.
...
Yep, markets were finally taking the forward guidance on interest rates seriously. Forward guidance that Draghi reiterated during his September 7th “we’ll wait and see” speech. And note that the current relatively high valuation of the euro has already priced in the assumption that rates are going to stay very low for an extended period of time. So, again, if there’s a surprise on higher rates sooner than expected don’t be surprised by a higher euro.
And, unfortunately, that forward guidance on rates from Draghi is the same forward guidance Wolfgang Schaeuble just completely contradicted on his September 6th comments. And the three anonymous ECB insiders who hinted at a rapid winding down of QE next year (end it in the first 6–9 months of 2018) didn’t help that official guidance either because plans for end QE next year could easily be interpreted as meaning the Schaeuble/Bundesbank faction is now completely calling the shots and that faction wants rates to rise “much quicker than people thought”, as Schaeuble put it.
So if there’s a surpise announcement that a rate rise could happen as soon as, say, next fall (after QE winds down) — or surprise unofficial signalling that the market takes to heart over the officizl signalling — that means the value of the euro is poised for some further surging. And the higher the euro goes, the less justified ending QE and raising rates becomes because that really can be a serious drag on weak economies just trying to export their way back to health after all the austerity threw them down a depression-level hole. A rising euro is a real problem for those plans to wind down QE next year.
But ending QE isn’t just a problem in terms of allowing ideology to take over from sober management and potentially destabilizing markets in all sorts of ways. The rising euro — which was always going to be a consequence of ending QE — also undermines the basic economic model that all the other EU nations were supposed to adopt after all the austerity they incurred. The Berlin-based Ordoliberal ideology that dominates the EU’s economic policies countries was the basis of the austerity demands. Countries like Greece and Spain and Ireland where supposed to take on all sorts of austerity as part of the ‘medicine’ to transform their economies into mean, lean, export machines (with an emphasis on mean, apparently). If nations incur brutal austerity they will come out stronger than before. That was the implied social contract.
And that Ordoliberal exports-at-all-costs ideology has generally viewed the ECB’s extreme stimulus measures as an unnecessary crutch that doesn’t allow the market dynamics (high government borrow costs and possible national bankrupticies) to play their course and force the necessary pain required to create economies like Germany’s. That’s the insane ideology backed by Schaeuble that typically dominates EU and eurozone decision-making on all things financial and the only reason it hasn’t dominated at the ECB level over the past five years too is that it would have imploded the whole eurozone system. But it’s entirely possible the Schaeuble wing is going to take over for the Draghi wing at the ECB as the QE unwinding phase is happening and if that happens we could see the euro rise to levels that destroy any hope for countries like Spain and Portugal to turn themselves into mean, lean, export machines. The euro will be too strong for their exports. It’ll be the final insult to all the austerity they incurred: taking away the financial ‘punch bowl’ too quickly and killing the export sectors the ‘periphery’ nations created so far.
How possible is such a scenario, where the euro continues to rise, squashing weak recovery? Well, don’t forget that we’ve already seen how little the Bundesbank/austerity faction cares about an overvalued euro crushing the periphery economices. That was the case in 2013 when the value of the euro down in 2013 when the issue of an over-valued euro for the weaker economies was being debated.
And back in 2013 we didn’t have a whole array of stimulus measures set to be unwound that will mechanistically increase the value of the euro. But we do now and one of the key dangers in unwinding the ECB’s extreme measures like ultra low rates and QE has always been the danger of unwinding too fast. Stupidly fast. Ideologically stupidly fast. And that’s always been a danger Wolfgang Schaeuble and Bundesbank chief Jens Weidmann embrace.
Also don’t forget that the ECB has been careening towards a curtail-QE-at-all-cost modality all year and if the euro wasn’t surging the above plan would be very plausible. As we saw above, ending QE in 2018 — a move that just might mean 2018 is guaranteed to be an expensive euro year — is apparently the consensus view at the ECB Governing Council. It’s not the official signal, but it is the unofficial signal.
So while the ECB has officialy signaled to the world that it doesn’t know what it’s going to do yet because of the rising euro, unofficial signs are suggesting otherwise. And those unofficials signs point towards ECB plans that it can’t easily reveal to the markets because revealing those plans would spike the euro even more. And don’t forget, the longer the ECB waits to release its plans for next year the greater the odds of the final decision not being announced until the ECB’s December 14th meeting, leaving markets just 10 trading days left in December to process those plans. It’s quite a powderkeg situation that we’re seeing develop.
And that’s just the near-term risk we’re looking at over the next few months. The far greater long-term risk is the prospect that the austerity faction really is about to take over ECB policy making during this critical unwinding phase for QE and the rest of the ECB’s stimulus measures. That “renormalization” phase is the kind of phase that should take years to carefully execute and waiting for the right conditions. But as Wolfgang Schaeuble warned us, the austerity faction wants to see “renormalization” sooner than people expect. And as contemporary eurozone history warns us, folks like Wolfgang Schaeuble don’t actually care if their ideologically driven decisions end up damaging the eurozone’s weaker economies because that damage simply because an excuse for more austerity. Austerity is the ends and means here: creating a union of export powerhouses that derive their export prowess from their poorly paid workers. If ending QE too fast harms all these ‘periphery’ economies and forces them to impose even more austerity to deal with a strong euro that’s not a bug. It’s a feature.
Uncle Sam and The Swastika
Reuters has a new piece on a set of recent polls of economist about their expectations of the ECB’s plans for its quantitative easing (QE) program and other stimulus measure like ultra-low rates. While polls of economists aren’t always all that relevant, in this case these are the kinds of polls worth watching given the importance of market expectations — in particular expectations of a higher euro that could become a self-fulfilling prophecy — will play in the ease of ECB’s likely stimulus wind down starting in January.
What did the polled economist expect? Well, they expect pretty much what the three anonymous ECB insider leaked to the public the day after Mario Draghi gave his “let’s wait and see how high the euro goes over the next month and half before making any decisions” speech last week: that the ECB was going to announce a 6 month extension to QE, cut its monthly QE bond purchases significantly in January, and almost certainly wind down QE completely by the end of 2018. And the vast majority also expected the ultra-low interest rates would not be touched at all in 2018.
So if the ECB really has already decided to end QE, but not raise rates at all, it’s at least convenient if there’s already a general expectation of such a move. But there was a second poll also mentioned in the article. A poll of foreign exchange (FX) strategists asking them to predict where the value of the euro will go next and what its impact could be on the ECB’s policies. And what they expected was that the euro would keep all of its gains from this year. In other words, the pressure from the euro’s massive gains isn’t expected to recede. But even worse, according to these strategists, if the euro rises another 5 percent next year the ECB could start getting “uncomfortable”. And obviously the higher it gets the more uncomfortable the ECB is going to be and the more tempted it’s going to be to either slow down the wind down or reverse course and amp up the stimulus again.
Keep in mind that the euro has already risen 13 percent in 2017. On the one hand, if the euro has already risen that much it means some of the upward pressure on the euro expected as QE is phased out has already been released. But at the same time, it’s a sign of how much upward pressure there was at the beginning of 2017. The austerity madness of this decade necessitated quite a bit of monetary stimulus to hold something like the eurozone together. And it’s hard to believe that the formal phase out of QE, and not just expectations of a future phase out, won’t end up putting more upward pressure on the currency as the Great Unwinding of 2018 transpires.
So when you combine the expectations described in those polls it sounds like the market is expecting the ECB to end QE next year coupled with no rate next year. But the markets are also expecting that this policy is only going to require a 5 percent increase in the value of the euro before things get “uncomfortable”. And almost everything the market is expecting the ECB to do is the kind of thing that should push up the euro or, at a minimum, not push it down. It’s another reminder of how tricky the coming months are going to be for the ECB. As one of the polled economists aptly puts it, “they have to present it in a way that it is perceived by the markets as dovish instead of hawkish”:
“Asked when the ECB would close the program completely, 31 of 33 economists said by the end of next year, including six who said it could be wrapped up in the first half of 2018. The remaining two said the purchases would end sometime in 2019.”
So long QE! Probably! But the ultra-low rates are hear to stay for a while. Hopefully:
And hopefully there isn’t more than a 5 percent rise (e.g. going from the ~1.20 euro to dollar exchange to 1.26):
So that’s both optimistic and ominous, which is either optimistically ominous or ominously optimistic. And probably rather ominous when you consider the impact on the value of that euro that the presence of the austerity faction, led like Bundesbank chief Jens Weidmann and German finance minister Wolfgang Schaeuble, that is going to be sending all sorts of signals to the market that they are interested in seeing all the stimulus ended sooner than people expect, as Schaeuble put it last week.
Fortunately it sounds like the markets are mostly ok with the wind down, if these polled economists are reflective of market sentiments. And that makes sense both because QE and other stimulus measures have made some sectors of the markets a lot less profitable. There are winners and losers with QE, that’s unambiguous. It’s the kind of thing only used with the alternative is letting a financial crisis emerge and society loses.
But it also makes sense that the markets would largely be ok with the QE wind down next year since it really is a potentially good time to do it. If the eurozone’s general economic recovery continues into 2018 that would be a better time to unwind the QE than not. Especially if raising the 33 percent national caps remain non-negotiable. QE has to end sooner or later if those caps can’t be raised so during a relatively ok economic recovery is the moment to do it. Now is a ok moment to wind QE down if the national caps won’t be lifted. But it’s only an ok moment if the austerity faction doesn’t screw it up.
It was a point Jens Weidmann made last week when he argued exactly that, that now is the moment to end QE. He was right. The problem is that Weidmann is wrong on most other things due to his fascism-friendly Ordoliberal orthodoxy. Hyper-rigidity is just not a good fit for something like the eurozone. But that’s what the eurozone is based on (it’s modeled on the Bundesbank).
The other problem is that It’s a rather delicate moment for the eurozone economy at the moment that requires the kind of policies (and gentle touch) that the austerity faction leaders like Weidmann and Schaeuble have proven incapable of backing because that would violate the crazy Ordoliberal orthodoxy that justifies their far-right economic agenda that’s going to turn the eurozone into a trap for the weaker member nations. And the expectation of the Weidmann/Schaeble wing taking over policy when Mario Draghi retires in late 2019 would mean the markets can’s count on the ultra-low rates staying ultra-low for longer than 2019. What’s that going to do the euro if the markets get the impression that Jens Weidmann is going to be ECB chief in late 2019 and usher in an era of Ordoliberal orthodoxy, damn the consequences? It’s a question we have to ask since Berlin has made it clear they want Jens Weidmann to take over as ECB chief:
“Most economists say events have largely vindicated Mr. Draghi.”
Yep, don’t forget, “Most economists say events have largely vindicated Mr. Draghi,” because events largely vindicated Draghi’s policies at the expense of Jens Weidmann’s faction. That’s why it’s so distressing to see a Berlin power play on the ECB right now. It’s Team Always Wrong taking over. It’s almost the worst signal that could be sent during this critical period. Especially when the euro can’t rise too much in coming months. Weidmann is the king of misguided reasons for cutting off stimulus measures to an ill-advised degree. A “Weidmann for ECB Chief” push right now, when QE needs to be gently unwound, is like handing kittens a crocodile. It’s ill-advised unless you just don’t care about the kittens. That’s the reality despite the recent Weidmann happy talk (which is actually just understated unhappy talk):
And note that the above report was from June. Wiedmann playing the role of Bizarro Weidmann for months. A role he has to play until the ECB chief succession process plays out, which starts in earnest following teh German elections this month:
“But German Chancellor Angela Merkel and her finance minister, Wolfgang Schaeuble, are reportedly prepared to push for him, on the basis that no German has led the ECB, which is based in Frankfurt, in its near 20-year history.”
Merkel and Schaeuble want this to happen. Weidmann is playing nice-ish. The ECB is looking scary in 2020.
And it’s not like suddenly muting his non-stop opposition to virtually all of the ECB’s stimulus measures is going to make everyone forget the agenda Weidmann represents. So a big fight over Weidmann is something that might also play out as QE unwinds.
But is Weidmann’s arrival inevitable? Well, as the following article suggests, not quite. But as the following article also suggests, someone from Germany does appear to be the inevitable ECB replacement. Just maybe not Jens Weidmann. Maybe. Apparently his Mr. Nice Guy act hasn’t worked.
France and Italy just reportedly signaled to Germany that they would agree to a Berlin ECB chief after Draghi, but not Weidmann. And Berlin is like, “We have just one qualified candidate on offer, and it is Weidmann”. It’s potentially the latest psychodrama of despair for the eurozone, but the French and Italian governments totally deny the story.
Is it just bluster and disinfo? It’s not an inconceivable story. As the above article noted, Axel Weber, Weidmann’s pedecessor at the Bundesbank, was the front-runner for the head of the ECB in 2010, but pulled out when it became clear he would have to implement stimulus measures of some sort. Specifically, Weber quit the race for ECB chief over the prospect that he would have to oversee government bond buying. That was a time when the ECB was engaged in an early QE of sorts to stabilize the markets during that initial eurozone crisis, which was fundamentally a crisis of faith in the bond markets of numerous sovereign bond markets across the eurozone. It’s a hint at what kind of policy intent is behind Jens Weidmann’s somewhat less combative rhetoric.
But if the report is true, it’s a very strong sign that Berlin gets to pick the next ECB chief coming in 2019 because France and Italy are going to have a lot of pull on who takes that slot:
“Paris and Rome fear Weidmann, a long-time critic of the ECB’s quantitative easing programme, would oppose a flexible and pragmatic monetary policy in times of crisis, but Der Spiegel suggested Berlin was unlikely to agree with that view.”
Fears that inflexible, unpragmatic policies and Jens Weidmann are a package deal. Those are the fears France and Italy reportedly expressed to Germany and those are indeed reasonable fears. The problem is that they’re reasonable fears even if it’s a non-Weidmann’s alternative instead unless that non-Weidmann’s alternative has Bizarro Weidmann policies, something highly unlikely, tragically.
And what was Berlin’s reported response? “We have just one qualified candidate on offer, and it is Weidmann”:
It’s Weidmann or the highway. Oh dear.
So that’s the signal that is getting sent to the markets right now about who they can expect at the helm of the ECB in just a couple years. Jens ‘always Ordoliberal, often wrong’ Weidmann, would take over for Draghi in December 2019. it’s a problem. Especially when Berlin reportedly says Weidmann is “the one”.
And yes, there are also contrary signals being sent from Draghi and others that rates are going to stay quite low for an extended period even if QE unwinds entirely in 2018. But that extended period could be as short as a couple years if Jens Weidmann takes over the ECB in December 2019. And that’s the kind of possibility that probably isn’t going to do great things to the euro as it becomes closer and closer to Weidmann taking over. Don’t forget Wolfgang Schaeuble’s September 6th warning that things were going to have to normalize “sooner than people expect” included a normalization of interest rates too.
Also don’t forget that the race to replace Draghi hasn’t really gotten underway yet. So the full impact on market expectations for a much stronger euro during a looming Weidmann era hasn’t really been felt yet because the succession race isn’t yet underway. But it’s coming soon. Right in the middle of this critical QE unwinding period when a surging euro is exactly what the eurozone doesn’t need. Oh goodie.
Now, it’s important to point out that a rising euro doesn’t have to be such a problem for the eurozone and would actually help alleviate Germany’s egregious export surplus. There’s no economic law that says the eurozone can’t implement other policies to help blunt the impact on the weakest nations expected to export their way out of the deep depressions they were thrown into. That’s always an option. For instance, if the eurozone was set up like the US as a transfer union that allows money to just flow from the wealthy states to poorer, in perpetuity if need be, and no one makes a big deal out of it that kind of system could enable a stronger euro without the peripheral cruelty. It’s very a uniony thing to do. Super helpful in many senses. But that kind of transfer union system simply is not possible in the eurozone given the political opposition, primarily in Germany which is the nation that would be paying out the most for such a transfer union structure (while accruing plenty the immense benefits in return). So the eurozone, as it’s structured today, is not well prepared to deal with the consequences of a strong euro to the periphery nations, but it doesn’t have to be that way. It’s a consequence of bad politics associated with bad economics.
It’s also important to note that if the eurozone was ever turned into the mean, lean, export machine that the austerity policies were supposed to do (as opposed to just creating mass unemployment, mindlessly cutting useful spending, and destroying families and futures, but with a few new export sectors), having the eurozone operating with massive export surpluses like Germany is a global nightmare. It would precipitate one crisis after another. You can’t have the eurozone, which could grow, operating with massive trade surpluses indefinitely. So if there was a way for the eurozone to operate at a higher euro without throwing its weakest economies into a new round of crises that would be great.
And it’s also important to note that it’s entirely possible the euro’s rise won’t be enough to have a significant negative impact. Maybe the general eurozone recovery continues and exports to other eurozone members (which wouldn’t be as sensitive to a rising euro) is the primary driver of the recovery and it all works out. But if we do see a significant further rise in the euro with a significant negative impact to countries particularly sensitive to a rising euro the peril is that the eurozone has already demonstrated that it doesn’t have many tools other than ECB measures already employed to counteract the negative effects of a rising euro for the affected nations. The fiscal stabilizers don’t exist and can’t exist to a meaningful extent due to ideology.
It’s reflection one of the fundamental problems with the eurozone: the currency is shared but not the burdens that come with it. Because you would need a transfer union and a real union in spirit (like a real European identity that supersedes existing nationalism) for something like that to work. And right now it doesn’t exist. That’s why stuff like a the potential negative impact of the rising euro in the face of the Great QE Unnwind matters so much. The eurozone is artificially fragile due to its stupid far-right Ordoliberal ideology. Fiscal stimulus is off the table. Transfer union sharing is off the table. The ECB is the only tool. And the ascendance of Jens Weidmann as the next ECB chief signals a transition to a new phased were even the ECB’s tools are taken off the table heading into 2020. That’s why this is such a bad signal to have Weidmann jockeying to replace Draghi at this point in time. It both signals a stronger future euro and no meaningful ECB response if that stronger euro screws things up.
On the plus side, the fact that a Weidmann era would probably be one where the ECB is much less useful for containing crises than it has been under Draghi means that, while the markets might perceive a looming era of Jens Weidmann becoming ECB chief as a strong euro sign, it’s also hard to ignore the fact that if there’s one thing that could cause a reversal in this stimulus-wind down policy it’s a big economic crisis created by Weidmann’s addiction to stupid policies. A big enough crisis could force even a Weidmann-run ECB to implement appropriate levels of stimulus and if there’s one thing that can create a giant crisis it’s Jens Weidmann becoming ECB chief. It’s a catch-22 that oddly sort of helps the situation. The upward push that a Weidmann ECB era has on the euro has to be pared by the downward push of the peril a Weidmann ECB places on the real eurozone economy. Don’t forget, Mario Draghi has been proven right with his loose stimulus policies at Jens Weidmann’s expense. And Weidmann is his likely replacement. Which might help keep the euro down because expectations of a new era of open crisis isn’t going to be great for the value of the euro. The bad news is kind of good news in this context. So there’s that. Yay.
Remember the reports from last month about how France and Italy told Germany that they would be open to having a German as the next head of the ECB, just not Bundesbank chief Jens Weidmann, who has demonstrated an incapacity to support almost any stimulus policies regardless of circumstances? Well here’s Weidmann’s response to comments made by former Italian prime minister Enrico Letta about how it was be a “disaster” if Weidmann became the next head of the ECB. Weidmann’s response is worth noting because it gives us a hint about how he’s going to handle the inevitable and significant opposition as the battle over Mario Draghi’s successor gets underway: Weidmann spun Letta’s attack on him as an attempt to veto any German from taking that job. It’s a likely preview of what’s to come, which it looks like the upcoming battle over the next head of the ECB could devolve into another exercise in eurozone tribalistic dysfunction:
“In an interview broadcast by Italian state television RAI, the German central banker was asked about comments by former Italian prime minister Enrico Letta, who recently said it would be a “disaster” if Weidmann took Draghi’s job.”
And what was Weidmann’s response to Enrico Letta’s “disaster” comment? A response that conflated opposition to Jens Weidmann with opposition to Germany:
So that’s probably what we can expect from Weidmann. He’s going to portray attacks on him as an ‘attack on Germany’. And part of what complicates this is that almost any other German official likely to be nominated as ECB chief in place of Weidmann would still almost certainly be an Ordoliberal nut job with roughly the same stances as Weidmann.
It’s the kind of situation that just invites another eurozone tribalistic showdown which reflects one of the ongoing systematic challenges the eurozone faces: economic disputes naturally take on tribalistic dynamics in the eurozone because Ordoliberalism is so widely popular in Germany — it’s effectively part of the nation’s identity — and Germany is the dominant economic power with the most say on economic matters. So when Germany wants to head the ECB it becomes a massive question over the risks of having an Ordoliberal ideologue calling the shots. This is a dispute that’s probably going to come up over and over as long as the eurozone holds together.
But as Germany continues drifting right-ward, the economists it offers for these kinds of positions are only going to be increasingly Ordoliberal. It’s not a great dynamic for the European Project.
And Ordoliberalism isn’t just not a bad fit for a eurozone-style system. It’s bad for the global economy because it’s based on using austerity to create large trade surpluses and the world can’t handle an entire eurozone with massive Germany-style exports. In other words, if the Ordoliberal transformation of Europe fails it’s a series of national disasters. But if it succeeds it’s a global disaster.
Intra-eurozone conflicts over economic policies are inevitable because Ordoliberalism is a bad fit for something like the eurozone but Ordoliberal policies are going to be implemented anyway because it’s inevitable that Germany is going to get to head up the ECB pretty regularly. That’s just a perk of being the biggest economy. The fight over Weidmann is just a prelude to similar fights to come, which is why it’s rather distressing to see the current ECB succession fight already devolve into fight over whether or not the pre-emptive rejections of Jens Weidmann (because he’s a nut) is an example of unfair censoring of Germany.
It’s a perfect recipe for tribalist instincts to take over at a time when Germany is experiencing a far-right surge. And don’t forget, if Weidmann ends up losing in his quest and this becomes a big sore point in Germany, that resentment is going to be nursed by the German far right for years to come and probably drive more German voters into euroskeptic far right arms. That’s the kind of nasty politics that could easily emerge from the upcoming battle over who heads the ECB. And a whole bunch of future ones.
The bid day has finally arrived. Almost. Not until Thursday, October 26th, when the ECB meets and presumably makes a big announcement about what it’s going to do about the quantitative easing (QE) program starting in January.
But before we look at what the ECB is expected to announce, it’s worth taking a quick look at a recent analysis from Deutsche Bank that makes a couple important points about why there is so much pressure on the ECB to end QE:
1. The ECB is currently buying seven times as much sovereign debt as is being issued by eurozone governments, leading to a shortage of available government bonds to purchase to keep QE going.
2. This is due in part to the strongest economies, in particular Germany, running budget surpluses.
It’s a reminder of one of the primary challenges facing the ECB throughout this period of emergency measures to hold the eurozone markets together:
the rest of the eurozone’s emergency measures were mostly just austerity-based policies that wasted the the opportunity QE created to borrow cheaply and stimulate the economy with useful public investments in the future:
“The ECB is now buying seven times more bonds than the euro-area governments are adding to the market, according to calculations by Deutsche Bank economist Torsten Slok. To put it into perspective, Bank of Japan’s bond purchases currently outstrip new issuance by a factor of three. The demand coming from the Federal Reserve hasn’t exceeded supply since around mid-2002.”
The ECB can’t keep buying seven times more bonds than the euro-area governments are issuing forever. Those governments can either stimulate their economies by issuing more bonds or the ECB can wind down QE. And, of course, it’s the latter option. Germany, and now the Netherlands, are running surpluses, and the rest of the eurozone members are operating under the built in deficit constraints under the austerity doctrine of transforming the economies into mean, lean export machines by slashing labor costs, regulations, and public spending. So more government borrowing is apparently not an option out of the predicament:
And now, thanks to the eurozone’s Ordoliberal obsession economic growth by reducing debt and cutting costs (which is fine for families, but generally foolish at the macroeconomic level), room for further QE is running out fast:
According to Deutsch Bank, the euro area will have little more than 200 billion euros of worth of government bonds available for the ECB next year. That’s how crazy debt averse the eurozone is thanks to its steady embrace of Ordoliberalism: so debt averse it will waste one of the most useful parts of QE. Cheap borrowing. It’s just how the eurozone is set up now.
Given all that, we probably shouldn’t be too surprised if the ECB’s big QE announcement during the October 26th meeting ends up involving a pretty big cut in the QE bond purchases. Which, as the following article notes, is pretty much what economists are expecting the ECB to announce, along with an extension of the bond purchases for about 9 months. The big question at this point is whether or not the ECB is going to declare a schedule for ending QE entirely or leave that question unaddressed. According to sources it sounds like the ECB its going to signal keeping QE going at a low rate for well past September 2018, in a sort of dormant hibernation low level mode that will allow it to be reawoken if needed. So don’t expect Mario Draghi to declare the death of QE following the October 26th meeting. Expect him to announced its planned hibernation:
“With the euro zone economic recovery well into its fifth year, the time has come to cut stimulus. Yet, overly ambitious tightening could choke off the very growth Draghi has fostered, threatening to undo years of work.”
Now is clearly not the time for overly ambitious tightening that could choke off the economic recovery. A recovery that’s technically been going on fir five years but has still left wages stagnant, inflation chronically too low, and high unemployment in the most austerity-afflicted countries:
Yep, the eurozone’s recovery is still extremely tepid for the weakest economies, but QE has to end soon anyway or bond purchases need to be reduced significantly because, as we’ve already seen, issuing new bonds and ending the bond shortage via more government borrowing in a big stimulus effort isn’t an option in the eurozone.
ECB sources are hinting that the plan is to cut the 60 billion monthly purchases by 25–40 billion and extend the monthly purchases through September 2018.
And while it’s unclear if the ECB will announce a plan to finally end QE as Germany is demanding, sources indicate that the ECB is going to say it’s cutting QE now in order to extend it for the purpose of increasing it later. It’s a neat little logic loop unwinding mechanism: QE needs to be cut because there’s an inadequate supply of bonds, and so there are concerns that the markets will be unsettled by an overly aggressive QE unwinding. But due to this limited bond pool, the more the ECB cuts the monthly bond purchases, the longer it can extend the program with the promise of increasing QE in the if the need arises. It’s a pretty clever way to spin the bond purchase cuts as a positive “we’re trying to keep QE alive” signal to the markets (clever if you ignore the madness of austerity policies that are creating this bond shortage and forced QE unwinding in the first place):
“While this debate is still open, sources speaking to Reuters said it is more likely the bank would maintain the flexibility and even signal a willingness to increase asset buys if the outlook sours.”
According to the ECB sources, the official line from the ECB after the October 26th meeting is going to be: we’re cutting bond purchases significantly, but it’s for the purpose of keeping the ECB’s toe dipped in the QE pool for as long as possible, with the promise of diving back in if the need arises. Less is more. Or rather, less is longer which is maybe more if it’s needed.
And don’t forget, the fact that QE has to end soon is primarily due the ECB running out of available bonds. And in some countries, like Portugal, that’s because they are hitting their “capital keys” cap on the number of bonds they can have purchased (33 percent), And in the case of Germany there’s clearly a need to apply less QE or no QE at all. Each eurozone member has its own particular stimulus needs, and those needs vary dramatically. But only one QE policy could be chosen, instead of a more flexible approach that allows individuals nations to have more or less QE depending on their circumstances. It’s a reminder that even QE seems to suffer from the same problem we’ve seen throughout the eurozone experiment: the one size fits all approach is not working. It creates winners and losers and there’s barely any systems in place to help the losers. The ECB has one set of interest rates (too high for some, too low for others), there’s one shared value of the euro (too strong for some too weak for others), but not much sharing terms of fiscal transfers from rich to poor member states, so these tensions build up don’t get addressed and then get pointed at by the austerians as a reason to end QE.
And don’t forget, if a big fiscal stimulus policy that involved lots of government borrowing was allowed in the eurozone that would solve a lo of these QE problems, boost the economy, and create the new government bonds that keeps plenty available for the QE program avoiding a forced QE unwinding.
And it’s not like there’s a shortage of things for the eurozone to make a public investment in. Perhaps there could be massive investments in prevent the collapse of the insects. Isn’t that the kidn of thing the eurozone should be investing in while borrowing costs are extra low? Stopping the insect die off? It seems rather important.
So also don’t forget that refusing to allow for stimulus government spending on public investments towards addressing problems that only governments are going to realistically be able to address, like the die off of insects, it’s just having negative consequences on the macroeconomic environment. It also means all the problems that could and must be fixed if governments could borrow to fix them aren’t getting fixed. Like the insects dying which is going to kill us all. Wasted QE can have high opportunity costs. Costs like the future.
Could have been worse! That’s the general sentiment following the ECB’s big QE announcements following ECB chief Mario Draghi’s announcements following the October 26th meeting on Thursday. True to Draghi’s typical form, the announced QE cuts — a nine month QE bond buying extension that cuts the monthly buys by 50 percent — were framed in the most dovish manner possible, with Draghi emphasizing that QE could be extended further and increased if need be. As he put it, “This is not tapering, it’s a downsize.” All that was more or less in line with the market’s expectations, but Draghi also said it was likely the QE would be extended again when the newly announced extension expires next September. And while that’s not exactly a shocking revelation since it seemed like there would be at least one more wind-down round of tapering no matter what, it’s still pretty notable for the ECB chief to issue forward guidance in the context the rest of Draghi’s dovish comments. So the overall messaging from the ECB was, relative to expectations, moderately dovish.
And that’s part of what makes this a signature Draghi move: much of his success in managing the eurozone crisis has been rooted in his ability to surprise to the moderately dovish side at key moments, and doing this with enough frequency to carry out an overall dovish monetary policy over fierce and constant opposition from the austerity faction led by Bundesbank chief Jens Weidmann, Draghi’s likely successor in 2019. And as the following article points out, Weidmann not surprisingly called for Draghi to announce a planned end date of QE, as is consistent with his stance on pretty much all stimulus policies since the start of the crisis.
And that, right there, highlights the secret to Mario Draghi’s success as the eurozone’s central banker this far: he’s consistently managed to overcome Jens Weidmann and the austerity faction on matters related to ECB policy at key points. This is one of the only areas of eurozone policy-making where the austerity faction hasn’t dominated, which probably has a lot to do with the fact that if the austerity faction did dominate on ECB policy the financial markets would have imploded in one eurozone member after another. And let’s not forget about all the times the austerity faction has won in recent years, including in the design of “capital keys” that is limiting the ability of the countries that need the QE the most to participate. But at least at this key point in the Great QE taper, which technically started in April with the cut from 80 to 60 billion euros a month, the ECB got to once again surprise to the dovish side and do so while cutting QE significantly.
It was one of those ECB moments that emphasize how lucky Europe is that Mario Draghi, and not Jens Weidmann, has been ECB chief during the past five years because don’t forget that Weidman’s predecessor at the Bundesbank, Axel Weber, was on track to head up the ECB instead of Draghi back in 2011 before Weber pulled out of the race in protest of the ECB’s initial stimulus policies. So if things had gone a bit differently back in 2011 we could have had ECB chief Weber this whole time and things would have presumably gone quite a bit differently for the eurozone. And that’s presumably what’s going to be in store for the eurozone when Jens Weidmann likely takes over in 2019, which is part of what should be appreciated about this particular QE taper decision: It had Draghi’s dovish touch that is in stark contrast to the kinds of decisions the ECB is going to make once Weidmann or someone like him takes over in 2019.
So it was a hawkish move (cutting QE) that was successfully packaged as dovish (by hinting at reflating QE later if needed and a likely future extension) over the opposition of Weidmann’s demands (hawkish cuts and a hawkish declaration of the end of QE at a particular date) and Draghi managed to pull it off while surprising markets to the dovish side. Not bad on Draghi’s part and, more importantly, a lot better than the madness that’s likely to follow when Weidmann or someone like him takes over:
“Under the plan, the ECB will continue to buy bonds until the end of next September, but cut the pace of its purchases to €30bn ($45bn) a month from €60bn after December this year. The bank also left its key interest rates unchanged and said that rate rises remain some way off.”
A nine month extension and a 50 percent cut in size. On the dovish side of the general range predicted. But it’s the clarification that this cut didn’t signal an end of QE that made the announcement significant because a statement like that really wasn’t expected:
It’s also significant that Draghi overtly stated that this wasn’t the beginning of the end of QE because that’s exactly whawt Jens Weidmann wanted him to do and, again, that’s the kind of policy that we should expect when Weidmann, or someone like him, takes over in 2019:
“He would have been willing to support a fresh extension of quantitative easing if the program’s end had been more clearly in sight.”
Weidmann would have supported an extension to QE if Draghi had declared a QE end date. But that didn’t happen so Weidmann presumably doesn’t support the QE extension. Which, again, is the kind of leadership the eurozone is in store for in just a couple of years because all indications are Berlin really wants him in thast post.
And what reason did Weidmann give for his call to declare an end QE now? He literally cited his past opposition to QE as the reason. As Weidmann puts it in the article below, “In my view a clear end of net purchases would have been warranted, especially because I, as you probably know, have taken a particularly critical view on government bond purchases in the euro zone.” QE should be ended now due to all the reasons it should have been ended previously and never started in the first place. That’s basically what Weidmann just argued, like a true ideologue. That’s the kind of ideological leadership in store for the eurozone economies in a couple of years which is a key context for interpreting the ECB’s recent decision: it could have been worse because it’s on track to be worse in a couple years when Weidmann takes over:
“In my view a clear end of net purchases would have been warranted, especially because I, as you probably know, have taken a particularly critical view on government bond purchases in the euro zone,” he said.
Yes, Jens Weidmann has indeed taken a “particularly critical view on government bond purchases in the euro zone.” A particularly critical view that’s largely been wrong all along. Weidmann and the austerians were typically worrying about hyperinflation before it became abundantly clear deflation was the real threat. He was opposing the idea of QE up through 2013 and then Weidmann finally reached a point where he agreed that QE was necessary because outright deflation is a serious problem in April of 2014, during the run up to QE. But by November of that year he had come up with all sorts of new reasons why QE was a bad idea. He’s just hated QE at almost every turn.
Of course, given the reports that France and Italy told Germany that they’ll accept a German ECB chief as Draghi’s successor but just not Weidmann, it’s possible the next ECB chief won’t be Jens Weidmann, but it’s not like we can expect a better substitute in terms of Ordoliberal orthodoxy. And that’s what makes the relatively dovish stance by Draghi so ominous: the rigid orthodoxy of Jens Weidmann or someone like him is just a couple years away, which means Draghi basically has two years to Weidmann-proof the eurozone economy. And that’s not easy since the only feasible way to Weidmann-proof the eurozone economy is to help get it running so hot that it’s ready for a bunch of rate hikes and an end to all stimulus by the time Weidmann or someone like him takes over.
It points to one of the more interesting dynamics Draghi faces in handling the taper/downsizing of QE in the face of his own retirement as the battle to replace him gets underway: the more hawkish Draghi’s 2019 replacement, the stronger the eurozone economy needs to be by 2019 in order to be ready to deal with the self-inflicted wounds from all the hawkishness. The austerity faction of Europe that Weidmann leads in financial realm is like GOP. You just have to hope they don’t do too much damage should they obtain power. But with the ECB we know Berlin wants Weidmann to take over in 2019 so we know the austerity faction is going to get a lot more power in just a couple of years. ECB policy-makers know there’s a high probability that the ECB is going to basically go insane in a couple years under Weidmann.
So if a central banks knows it’s going to go insane in a couple years what should it do? That’s part of what the ECB policy-makers have to keep in mind as the QE taper/downsize unfolds. The clock in ticking on sanity for the ECB. What is the sane thing to do in that situation? It’s unclear but that’s part of what policy-makers have to figure out. Macroeconomics can often have a giant psychodrama feel to it but in the case of Mario Drahhi’s dilemma over what to do what Weidmann’s looming insanity as the Great QE Unwinding gets underway that psychodrama is getting remarkably personified.
Here’s some good-ish/bad-ish news about the future of leadership in key European institutions:
First, the good-ish news. It sounds like Angela Merkel is no longer keen on championing Bundesbank chief Jens Weidmann to be the next head of the ECB after Mario Draghi’s term expires in 2019. This would be fabulous news if it meant that the ECB wasn’t about to be taken over by someone with Weidmann’s hard right Ordoliberal economic philosophy. Unfortunately, it also sounds like Markel’s plan is to just get one of the other central bankers from Northern Europe who agree with Weidmann to replace Draghi instead. So the plan is basically Weidmann’s policies without all the political baggage Weidmann has cultivated as a consequence of his seemingly endless opposition to the ECB policies that have actually held the eurozone together.
But that’s not the only good-ish/bad-ish angle to this. Because the reason Angela Merkel has decided to forgo the massive prize of getting Weidmann at the helm is the ECB is because she has her eyes on an even bigger prize: The EU Commission presidency, which is also going to be vacated by Jean-Claude Juncker next year. According to EU convention, you can’t have the Germans holding can’t occupy two of Europe’s most senior posts at the same time. So Merkel had to choose, and she chose the EU commission presidency.
Specifically, Merkel appears to be getting behind Manfred Weber, the Bavarian politician who is the current head of the European People’s Party (the umbrella EU-wide center-right party in the EU parliament). Although it sounds like some in Merkel’s party would prefer the job go to Peter Altmaier, Merkel’s trusted economic advisor and the current German Finance Minister (who was preceded by the horrific Wolfgang Schaeuble). So there’s still a question of who Germany is going to put forward to lead the EU Commission, which is arguably the most powerful post in the EU, although one could make the case that the head of the ECB is actually the most powerful post but limited to the eurozone.
So as we can see, Merkel’s government has a tough decision ahead of it, but it’s a pretty nice tough decision to make: which powerful post do you want the most. And for now, it’s the EU Commission presidency that Merkel finds the most tempting. And that means Jens Weidmann, the man who would have proudly destroyed the eurozone’s economies in order to placate his Ordoliberal orthodoxy, might not become even more powerful. Someone similar will instead take that job. It’s extremely good-ish/bad-ish news for Europe:
Weber, a Bavarian who leads the largest bloc in the European Parliament, is said to be preparing a bid to replace Jean-Claude Juncker when he stands down as European Commission president next fall. The problem for Weidmann, the current Bundesbank chief, is that convention dictates Germans can’t occupy two of Europe’s most senior posts at the same time.
Which extremely powerful post do you want to fill: that’s Angela Merkel’s problem. Which has become Jens Weidmann’s problem because Merkel appears to have determined that having Manfred Weber at the head of the EU Commission is a better bet:
But Weber himself isn’t a sure bet for Merkel. Some in her party would would prefer someone else: Peter Altmaier, Merkel’s long-time economic adviser who is now Germany’s finance minister. It’s another pleasant conundrum for Merkel:
And note how the choice to prefer Weber or Altmaier would suggest a shift on Merkel’s part to backing much stricter refugee policies:
Keep in mind that Weber created a bit scandal for himself back in January when he called for 2018 to be the year when Europe finds a “final solution” to the refugee crisis during a radio show. So when the article says Weber and Altmaier “differ in tone” on the refugee policy it’s an understatement. And he’s the current leader of the EPP, the ruling party of the EU parliament. Although, in fairness, as the leader of the EPP, which is largely tasked with implementing Angela Merkel’s refugee policies, Weber’s rhetoric on the refugee issue is policy issue is generally directed at redirecting anger away form asylum seekers and more toward illegal immigration, which was the argument he was making that “final solution” argument.
At the same time, keep in mind that the EPP includes parties like in Viktor Orban’s Fidez Party. Its support was needed to give the EPP a majority. Also, while Weber himself is forced to damper his anti-refugee/immigrant center due to being the floor leader of the center-right EPP, he’s also reportedly considering letting Poland’s virulently anti-refugee/xenophobic PiS party into the EPP, indicating an upcoming abandonment of Merkel’s refugee policy and a rightward shift for the EPP. In other words, we probably shouldn’t be surprised if Weber, as EU Commission President, experiences a significant uptick in “final solution”-style gaffes as he attempts to co-opt the surging far right by moving the EPP far right.
And the refugee crisis and the central role it’s playing in Europe’s existential far right crisis is just one of many areas where we might expect a shift in both tone and policy as the EPP’s strategy of co-opting the far right plays out.
Additionally, there’s one of massive issue where having Weber at the head of the EU Commission could have major ramifications: on the Brexit negotiations. Back in June of 2017, three months after Britain triggered Article 50 of the Lisbon Treaty to formally leave the EU, Weber called for no extension of the two year Brexit talks. He also demanded that Britain lose its voting EU rights in March of 2019 whether or not an agreement has been reached. So if the Brexit talks are still going on when Juncker retires (in November 2019), and Weber takes over, the EU Commission could be getting ready get nasty and make an example out of Britain (like what the Troika did to Greece, but as punishment for leaving).
And since the EPP will still need the support of other parties to get either Weber or Altmaier the votes they need, it’s still possible Germany won’t get the EU Commission presidency. In which case Jens Weidmann will presumably become the next head of the ECB:
But assuming Weidmann doesn’t become ECB chief, that still means someone of Weidmann’s temperment. And that’s part of what’s so ominous of this news: it’s going to be a hawk at the helm of the ECB no matter what. Don’t forget that the hawkish ECB policies have been a proven failure throughout the eurozone crisis. That’s what’s in store for the eurozone (and the world) again in 2019. The decision appears to have been made already:
And you have to love the spin on Weidmann at the end: he ““ticks all the boxes” — except that he’s German and has opposed the ECB’s asset-buying program to protect the euro.”. He’s a perfect candidate, except for being unwilling to protect the euro. And it’s true, if he wasn’t nuts he’s the perfect candidate on paper:
And while it’s true that his being German restricts him from getting the job if Weber gets to become EU Commission President because of that convention, the fact that he’s been “opposed the ECB’s asset-buying program to protect the euro” is a pretty big reason to oppose giving Weidmann even more power. He’s been consistently wrong throughout the eurozone crisis and would have made it far worse if he got his way. So while Weidmann will probably lose out on becoming head of hte ECB because of a technicality about Germany having two senior posts at once, it’s going to be important to keep in mind that he really shouldn’t have be given that position based on his performance as an emergency crisis manager throughout the eurozone crisis. Ordoliberal dogma would have probably fragmented the eurozone by now.
Fortunately, a lot of people in Europe do keep this in mind about Weidmann, which is why Merkel now favors getting someone from another country, like Finland, who is going to have Weidmann-like policies but not Weidmann’s track record of calling for brutally hawkish policies for years just on principal. That’s the style of economics Weidmann represent. Brutally hawkish policies. And it’s going to be someone else of a similar persuasion instead.
So it’s looking like 2019 is going to bring us a Weidmann-like hawkish ECB banker who will be willing to inflict economically destructive policies based on orthodoxy. And Manfred Weber will probably be EU Commission president. That’s what’s in store for the EU’s big leadership rotation in 2019. Whoopie.
It’s worth keeping in mind that the ECB is bound to take a more hawkish stance and more aggressively unwind its stimulus sooner or later. But with a Wedimann-like ECB chief coming up in 2019, that delicate unwinding process is guaranteed to be extra dangerous and stupid. That’s the cost of having an ECB chief who is willing to impose right-wing central bank policies and an austerity agenda. You could do a lot worse than Mario Draghi and the ECB policy is scheduled to get a lot worse next year. And this rightward And it sounds like Angela Merkel has decided on that which means it’s probably going to happen.
Also keep in mind that if Weidmann doesn’t become ECB chief in 2019, that means Germany will have an even stronger claim on the position the next time, which happens in 2027. And Weidmann is young enough to be in position to be that 2027 German candidate. But if it’s not him, it’s likely to be another German Ordoliberal. So we really could be looking at 16 years of Weidmann-like ECB leadership coming up in 2019.
So the good-ish news that Weidmann probably won’t get the position in 2019 is actually very bad news. And that makes the news of Merkel’s plans for the EU and ECB pretty much bad news all around. Enjoy Mario Draghi’s relative willingness to be a responsible central banker. His tenure consisted of largely opposing Jens Weidmann and eventually winning at the last minute at the height of crisis. It could have been worse but it’s about to get worse in a little over a year. The twilight months of relative ECB sanity are getting frittered away as 16 years of Weidmann-like insanity looms ahead. A major global financial institution is about to get stuck on stupid for the next 16 years.
So at least any financial bets that assumed ill-advised hawkish policies from the ECB will be easier bets to make. That will presumably create some nice market opportunities for financial traders. Interesting new financial arbitrage opportunities. It’s as close as we get to actual good-ish news in this story.
It’s that time again. Time to seriously fret about the prospect of Bundesbank chief Jens Weidmann becoming the next head of the European Central Bank (ECB) later this year at the end of Mario Draghi’s term. That’s one of the consequences of what appears to be the dwindling prospects for Germany’s push to make Manfred Weber the head of the European Commission. Recall how the way the EU system selects people for top jobs necessitated that Germany basically choose between pushing for having a German as the European Commission President or have a German at the helm of the ECB, but not both. And last year it had appeared that Angela Merkel’s government settled on the push for Weber to become the next European Commission president and leaving the ECB position for a non-German.
Well, the EU parliamentary elections are just days away and it appears that the prospects for Manfred Weber becoming the next EU Commission President are looking a lot less certain, an ominous sign given that it signals a last minute far right surge and the prospects of Hungary’s Viktor Orban playing a ‘king-maker’ role in deciding who fills that role. Given those expected difficulties for Weber, Angela Merkel is reportedly looking for a Plan B for personnel decisions and Plan B appears to be returning to the drive to make Jens Weidmann the head of the ECB. Weidmann is also engaged in a ‘charm offensive’ so he’s on board with the ida.
Although it’s possible the dusting off of Plan B is actually part of Plan A because, as the following article also notes, Merkel might simply be bringing about these renewed plans for Weidmann as a kind of bargaining chip in the broader negotiations over who gets which positions. It’s a plausible scenario given the extreme resistance Weidmann could face from the eurozone members who were ravaged by exactly the kind of austerity-focused Ordoliberal economic ideology championed by Weidmann. The idea of Germany pushing for him to now head the ECB when so many eurozone economies remain exceptionally fragile really is a potent threat Merkel can use in these negotiations because giving someone like Weidmann that kind of power is like an economic death sentence for a lot of these eurozone members.
So we’ll see if Weidmann’s ECB ambitions end up coming to fruition this year or if he’s just being used as threat in the negotiations over Manfred Weber’s European Commission bid. The results of the upcoming elections will shape which scenario plays out. Let’s hope this is just a threat to gain leverage because a Weidmann-run ECB is more or less asking for economic disaster if a crisis breaks out. But the fact that the mere threat of a Weidmann-era at the ECB is potentially a negotiating bargaining chip for Merkel in the battle over the next European Commissions president underscores the fact the very idea of Weidmann heading the ECB is not a popular idea with a lot of Europe. That’s why it’s leverage:
“Berlin’s priority is to ensure a German becomes president of the European Commission, and Germany’s chancellor Angela Merkel has thrown her weight behind Manfred Weber’s bid for the job. But officials in Berlin know that Mr Weber — a Bavarian MEP with no government experience, who is the lead candidate of the European People’s party in this weekend’s European elections — faces a struggle to secure the post.”
The worse it looks for Manfred Weber’s EU Commission President prospects the better it looks for Jens Weidmann’s ECB chief prospects. And right now it’s looking pretty good for Weidmann, which is bad news for the eurozone and reason Weidmann’s bid may be Berlin’s bargaining chip over Weber’s nomination:
And note how one of the dynamics at work here is the fact that there’s disagreement in the EU over whether or not it should adhere to the “Spitzenkandidat” system for selecting an EU Commission president. That’s the system where each of the parties puts forward a candidate to be EU Commission president before the elections and whichever party wins the most MPs has their candidate become EU Commission president. But the “Spitzenkandidat” system is more of a formal agreement, not a hard rule, so it can be changed whenever EU governments decide to change it and right now France’s government is strongly pushing for changing it and switching to a system where the EU Commission president is determined by a majority vote instead. And thanks to far right parties peeling off MPs from Weber’s European People’s party (EPP) it could end up being difficult for Weber to actually get a majority of the votes:
And that’s why it’s suspected that Weidmann’s renewed bid for ECB chief could be part of a attempt by Berlin to gain additional leverage in the ensuing battle over who becomes EU Commission president. The same member states that oppose Weber also oppose Weidmann, especially France:
“It is their hope that a German head of the ECB would finally end the low interest rate policy of the current bank chief, the loose monetary policy which has devalued German savings and life insurance,” Der Spiegel said. And their hopes aren’t unfounded given Weidmann’s track record. Which is, again, why even threatening to push for Weidmann at the ECB is such potent leverage for Berlin in the upcoming post-election negotiations.
So while we still have to see how the EU parliamentary elections turn out it sounds like the potential for a real fight over Weber as EU Commission president is almost guaranteed unless the EPP somehow manages to get a majority of the seats and that doesn’t look likely.
Plus, as the following article notes, Weber’s prospects took a new sudden hit in recent day: it turns out the scandal that just collapsed the Austrian government hit Weber’s EU Commission ambitions too. This is the scandal caused by a 2017 video that was just showing the leader of far right Freedom Party, Heinz-Christian Strache, proposing to offer government contracts to a woman he thought was a Russian oligarch’s niece as part of a quid pro quo. It turns out this woman wasn’t actually a Russian oligarch’s niece and the entire thing appeared to be some sort of sting arranged by a still unknown party. But the video was enough to trigger the resignation of all of the Freedom Party members in the Austrian government, leading to a collapse of the current government and new elections.
So how did this scandal impact Weber? Well, since it was already a highly controversial decision for Austria’s center-right party to agree to go into a coalition with the far right Freedom Party in the first place, the fact that this coalition has already imploded due to the corruption of the far right has done serious political damage Austrian Chancellor Sebastian Kurz. And as the following article describes, Kurz was seen as a rising star in the EPP and Weber hasn’t missed a chance to campaign alongside him. And that’s just the latest factor that has even Weber’s backers feeling like the tide might be turning against him:
“The final hours of Weber’s campaign as Spitzenkandidat of the European People’s Party (EPP) were supposed to be the moment when he sealed the deal. Instead, the EPP nominee to be the next president of the European Commission found himself fighting a rearguard action.”
Being on the defensive days before an election is never great situation for a politician. And in Weber’s case it was defense on multiple fronts: Emmanuel Macron is indicating that he wants the EU to use a majority vote to choose the next EU Commission president and drop the current Spitzenkandidat system that would automatically give the EPP the EU Commission presidency as long as it win a plurality. Then dozens of German YouTube stars waged a video campaign accusing Weber’s CDU (and the SPD and AfD) of ignoring climate change and economic inequality (so it was effectively a pro-Green Party campaign). And that’s on top of Austria’s Chancellor and rising star in Weber’s EPP, Sebastian Kurz, watching his political fortunes evaporate in the wake of the Freedom Party’s corruption video scandal. It was an exceptionally bad week for Weber and the fact that this was the last week of the campaign only made it worse:
““It’s not looking good,” said one junior Weber-helper who was draped in a football-style scarf emblazoned with Weber’s visage and the slogan “to the top of Europe.””
The pessimistic junior Weber-helper is right. It is indeed not looking good for Weber. Still, it could be worse. He remains the front-runner for the position and Berlin has a track record of winning these kinds of fights. And then there’s the ‘Weidmann threat’ backing him. That’s part of what’s going to be fascinating to watch play out in the coming days as the results of the EU elections translate into political power plays. A lot is at stake which makes this exactly the kind of time when we should expect all sorts questionable negotiating tactics. Questionable tactics like threatening the nomination of Jens Weidmann to head the ECB.
It all underscores one of the grim consequences of the disastrous and brutal austerity policies of the last decade successfully demanded by Berlin: That track record of austerity policy disaster, which was cheerleaded by Weidmann every step of the way, has conferred onto Berlin a potent political power during these kinds of negotiations in the form of a credible threat of leading Europe down that disastrous path again.
It’s quite a parting gift: In what appears to be the last major decision of Mardio Draghi’s tenure at the ECB, a new round of monetary stimulus was announced this week by the ECB. It was more than what the markets were expecting. Significantly, the new bond purchases are open ended in terms of duration. So when Christine Lagarde takes over later this year she’s going to be inheriting an existing stimulus policy framework without a set end date. Given the endless battles within the ECB over the last decade over whether or not to engage in monetary stimulus at all, there has been enormous uncertainty over what to expect from the ECB once Draghi is no longer the ECB’s chief. the fact that Lagarde is going to start off with stimulus measure without a set end date is the kind of scenario that should significantly address that uncertainty.
Still, as the following article notes, this new stimulus wasn’t unanimously backed by the eurozone member states. Notably, France joined Germany and the other anti-stimulus ECB members in opposing these new measures. It’s a really big deal in terms of the internal politics of the ECB board given that France has usually been the largest eurozone economy that favored the stimulus measures. So while Lagarde is going to be inheriting an unprecedented open-ended stimulus policy framework, she’s also inheriting exceptionally weak institutional support for those open-ended policies. Still, you have to give Draghi credit for at least trying to end his term on a positive note. Interestingly, when Draghi announced these new measures, he noted one area where there was area of policy where there was unanimity within the ECB board, but it was unfortunately policy the ECB can only call for and has no control over: the need for fiscal stimulus from eurozone governments because monetary stimulus is not enough on its own:
“Draghi faced faced pushback from the representatives of Germany and France as well as at least one of his own board members when he pushed for resuming the ECB’s bond-buying program, three sources told Reuters.”
It was such a historic decision that even the backlash was historic. France joined the anti-stimulus crowd. It’s also worth noting one of way this could backfire on the eurozone economy if the anti-stimulus crowd wins out in future stimulus decisions: while the new bond purchases don’t have a precise expiration date, they are set to expire “shortly before” the ECB raises rates. So the opposition to these QE bond purchases could be channeled into drives for raising rates prematurely:
But at least it sounds like there was unanimity at the ECB on one key policy area: the need for fiscal policy because monetary policy can’t stimulate the eurozone economy on its own:
It just happens to unfortunately be unanimity in an area of policy they have no control over. Eurozone member state governments will be the ones to decide whether or not there’s a fiscal stimulus. And thanks to the EU budget rules, members states aren’t allowed to run the spending deficits needed for a meaningful fiscal stimulus unless their debt-to-GDP ratios are below 60% (a totally arbitrary cutoff). So almost no eurozone member states are allowed to engage in fiscal stimulus with Germany being the big exception. But the only reason Germany is in a position to do so is because it’s been running budget surpluses for years, despite the depression-level economic conditions of its eurozone neighbors, and is only now about to get its debt-to-GDP below 60%. It’s been a grim example of budget surpluses can ironically be grossly irresponsible budget surplus under the wrong circumstances. But Germany has run those grossly irresponsible surpluses nonetheless and as a result it no longer has the 60% rule as an excuse for not running a fiscal stimulus. So will Germany reconsider that stance now that Draghi announced that the ECB unanimously endorses more fiscal stimulus? Well, if Angela Merkel’s comments two days earlier are any indication, no Berlin has not changed its mind and continues to hold to the position expressed back in August that it’s ready and willing to engage in fiscal stimulus policies...but only if the economy gets much worse. In other words, there will be no meaningful fiscal stimulus from Germany until its already too late to avoid economic disaster. That’s what Merkel just doubled down on:
““As a federal government, we take seriously the responsibility for a solid budget policy,” Merkel told an event organized by the German taxpayers’ federation. “And I can assure you that we are sticking to the goal of a balanced budget.””
The German economy may be dramatically slowing with eurozone continuing to teeter towards recession, but nothing has changed regarding Berlin’s obsession with running surpluses. That was the answer Merkel preemptively gave two days before the ECB’s calls for fiscal stimulus. And note how Merkel routinely cites Germany’s demographics and aging population as a reason for these massive surpluses. It’s the promotion of an economic model that’s predicated on the idea that the only way a country with an aging population can pay for itself is through very low national debt levels achieved through budget surpluses which are only feasible for a country running consistent large trade surpluses like Germany. It’s an economic model that mathematically can’t work for most of the world simultaneously. That’s the kind of economic paradigm being championed here and all indications are Berlin’s conservatives are fully committed to this for the long-run:
It all sounds rather bleak. Or at least almost all of it. There is this one interesting proposal being floated around in Berlin: creating new independent public agencies that, due to their independence, can take on debt in ways that don’t count against the national spending rules that strictly limit Germany’s fiscal policy:
Could that work? If Berlin was given a path to fiscal stimulus that allowed it to still technically stick to its budget rules would Germany’s politicians accept that? We’ll see, but it sounds like it’s under seriously consideration. The idea is to create a “shadow budget”, where the debt taken on by these new independent agencies wouldn’t be counted as federal spending under Germany’s debt rules. The spending would still be counted under the EU’s Stability and Growth Pact debt rules, but because those rules are less strict than Germany’s own rules that would free up space for more fiscal stimulus.
Keep in mind that the EU’s Stability and Growth pact is actually a horribly constraining rule that has been used to justify the kind of destructive austerity we’ve seen over the last decade. If a country’s spending deficit exceeds 3% of GDP the country is legally obligated to cut spending. It’s one of the many horrible budget rules that plagues the future of the EU. And yet it’s less strict than Germany’s budget rules. Under the EU’s fiscal rules laid out by the EU Stability and Growth Pact, member states can run a deficit of up to 1% of GDP as long as their debt-to-GDP ratio is significantly below 60%, a threshold Germany is only now crossing after years of irresponsible budget surpluses. But Germany’s constitution only allows for a federal budget deficit of up to 0.35% of GDP. So by using this “shadow budget” trickery, Germany might be able to run a deficit up to 1% instead of 0.35%. That’s the extent of the potential stimulus we appear to be looking at. Currently, under the German constitution’s 0.35% cap, only about 12 billion euros would be available for stimulus spending but due to slowing growth rates and other factors that would be reduced to 5 billion euros. Under the EU Stability and Growth Pact 1% cap, it would be about 35 billion. That’s the most that could be spent by these independent agencies if this scheme gets underway.
We’re also told by Economy Minister Peter Altmaier that the government is considering privatizing the stimulus instead to get around the rules. The government would create a non-profit and inject it with 5 billion euros for spending on addressing climate change, with a maximum investment of 50 billion euros. This is how difficult it legally is for Germany to to run fiscal stimulus programs thanks to its constitutional spending constraints. Privatization gimmicks are potential required. The biggest economy in Europe operates under these lunatic rules. It’s actually a huge problem.
That’s how messed up the situation is: At a time when interest rates are negative, Germany is considering a budget gimmick that will free it up from its own extra-idiotically strict budget rules so it can instead operate by the less-idiotically strict EU Growth and Stability Pact budget rules and might run a privatized stimulus scheme to get around those rules instead:
“Under the “shadow budget” plan being considered by government officials, new debt taken on by the public investment agencies would not be accounted for under the federal budget, said the sources, who declined to be named.”
A “shadow budget”. Berlin needs to hide its stimulus from itself. Those are the rules enshrined in the constitution. Using a “shadow budget” of independent agencies, Germany can instead operate under the slightly less insane EU Stability and Growth Pact rules. This is at a time when Berlin is literally paid to borrow with negative interest rates:
And if the independent agency option doesn’t pan out, there’s the privatized stimulus scheme that the Economy Ministry is looking into: Create a private foundation that’s focused on a particular area of interest and grant a limited amount of money to it. In this case, it would be 5 billion euros injected into a non-profit foundation working on reducing German carbon emmissions. Up to 50 billion euros could be spent under the scheme the Economy Ministry is considering. Which, again, is a drop in the bucket compared to what the Berlin should be spending at this point given the fact that the eurozone growth is stalling and Germany has massive fiscal space to spend:
But a 50 billion euro climate change private investment foundation is at least better than nothing. And that’s the alternative. Nothing. Or almost nothing. And Germany is the only large eurozone economy with low enough debt to even consider a stimulus. This is why the eurozone, and the broader EU, remain economically in peril: they are built on fundamentally idiotic economic theories that sound responsible if you don’t think too much about them. Massive budget and trade surpluses can’t possibly be the primary path to economic security. That’s a recipe for global financial turmoil. And yet that’s the model at the heart of the dogma that’s behind Germany’s constitutional spending brakes and the dogma that led to things like the Stability and Growth Pact being passed in the first place.
So that’s all part of why Draghi’s parting gift to Christine Lagarde was potentially so significant. The one thing the eurozone economy, and larger European economy, desperately needs — a big public fiscal stimulus that involves spending like investing in clean energy and mitigating climate change — is effectively off the table. The austerity lobby continues to dominate Europe, leaving the ECB’s policy the only thing realistically on the table and the same forces that are limiting fiscal stimulus want to limit monetary stimulus too. And yet the ECB can’t fix Europe’s economic funk on its own. Especially when rates already in negative territory. The only thing the ECB can do at this point is not significantly disrupt the eurozone financial markets and buy time for the governments of the EU, and especially the eurozone, to get their sh*t together and actually adopt modern economic knowledge into the budget rules. Mario Draghi bought Christine Lagarde time and made this clear to the markets. That was the greatest of his parting gifts to Lagarde. It probably won’t be enough time because Europe’s austerity coalition, which is larger than just Germany, has demonstrated no sign of learning anything from the past decade of economic crisis and no sign of changing their minds to allow for the real fiscal stimulus. But the changing of the minds of enough of the austerity coalition to is what needs to happen for Europe to really draw itself out of its economic funk and allow for a normalization of monetary policy. That’s what the ECB is buying time for: waiting for sanity at the EU government level on fiscal spending.
All Lagarde can do this point is maintain or expand the extreme monetary easing and QE policies to hold things together in the hopes the politicians advocating austerity are either swept out of office or change their mind. That’s the only realistic hope for the eurozone even though it’s hard to imagine the austerity crowd relenting and allowing for the required changes in fiscal policy that needs to happen. But holding the eurozone’s financial markets together while hoping for that policy change is all all Draghi could do and all Lagarde can really do too. Because the ECB can’t do this alone. Central banks are supposed to work in coordination with government to help finance fiscal spending. Buying time and hoping that fiscal spending is allowed to happen is all Lagarde can do. She’s nominated for an eight year term so that’s how long she’s going to be walking this tightrope act. And it’s entirely possible the ECB won’t raise rates for another eight years, especially if we experience a global recession soon and it’s nasty. So Draghi’s new QE bond buy program, which could be in place until rates are set to rise, could potentially be in play for Lagarde’s entire eight year if we’re looking at an extended nasty global bust. And with economic storm clouds like Trump’s trade war antics with China and fallout from Brexit continuing to rain down on Europe’s economies, it’s hard to see why we shouldn’t expect a recession to erupt in Europe over the next year or so. Europe’s trade surpluses make it extra sensitive to global slowdowns and we seem to be settling into a global slowdown. If that does happen, Draghi’s parting QE gift is going to remain one of Christine Lagarde’s handier tools for years to come.
Convincing European governments to spend more money is one of the European Central Bank chief’s top priorities if the ECB’s stimulus policies are going to work in the long-run and convincing those governments to spend more is a seemingly impossible task. Strange times.
Here’s another reminder that the advocates of the brutal austerity that almost tore the eurozone apart have learned nothing and continue to advocate those same policies after Christine Lagarde takes over as ECB chief: a group of former ECB officials known for their hawkish views just publicly issued a memo decrying the latest round of monetary easing implemented by Mario Draghi. Recall how the new policies unveiled by Draghi last month represent his final major policy decision as ECB and were open-ended enough to ease a continuation of the existing quantitive easing (QE) policies if Lagarde chooses to do so after she takes over. It was the kind of final act that was guaranteed to elicit a response from the monetary hawks. This is that response.
But what makes the open memo just issued by a group of hawks so notable, and ominous for Europe’s economy, is the fact that the letter was issued by many of the exact same former ECB officials who presided over the policy blunders that fueled and deepened the eurozone crisis in the first place. Official like former ECB chief economist and former head of the Bundesbank Jürgen Stark. Stark announced his retirement from the ECB in 2011 in protest over the initial bond-buying measures taken by the ECB to help contain the growing eurozone financial crisis. At the time, he wrote an article proclaiming that cutting government spending was the only possible solution to the financial crisis. In other words, he’s in the “austerity fixes everything” camp. And nothing that’s happened since appears to have changed his views on the matter.
Stark is one of three Germany ECB officials who have announce a surprise retirement in protest of ECB stimulus measures. Former Bundesbank chief Alex Weber preceded Stark in stepping down from the ECB’s governing council in early 2011 in protest of those same ECB bond buying programs that Stark resigned over. Stark, then the head of the Bundesbank, was at that point considered the top candidate to become the next ECB chief. Draghi got the job instead
Sabine Lautenschläger, who currently sits on the ECB’s the bank’s six-member executive board, announced her surprise retirement a couple of weeks ago in response to Draghi’s latest stimulus measures. The retirement of German officials in protest of new stimulus measures is becoming expected at this point.
Another signer of the memo is Otmar Issing. Issing, another former Bundesbank member, was the ECB’s first chief economist until 2006. He joined Stark in protesting the early (and highly limited and inadequate) ECB bond-buying program in 2011. In 2016, Issing gave an interview where he predicted that the eurozone is doomed because governments don’t stick to the strict deficit limits the whole thing is a house of cards that’s going to collapse someday. This is the kind of hawkish/austerity-only Ordoliberal views held by the signers of this memo. They claim some more moderate former officials endorse the sentiment, but the signers are representative of the same austerity-centric policy that created the depression-level crises across the eurozone that is truly dooming the monetary union.
The memo echos German legal arguments that the QE bond-buying programs are in violation of the Maastricht Treaty because they help finance the government spending of the heavily indebted eurozone members. And that’s undoubtedly true. that’s half the point of the QE program: lowering borrowing costs overall and removing the interest rate spreads between the strong and weak members to help stabilize public and private debt markets and ease the cost of borrowing for governments and business. The fact that these kinds of emergency central bank moves are arguably in violation of the Maastricht Treaty is a demonstration of how wildly screwed up the rules are that govern the eurozone.
Another part of what’s so ominous about the letter is that it appears to critique the idea that deflation is something that the ECB should work to avoid. And it makes this critique in a most curious way: by arguing that there hasn’t actually ever been a real threat of a deflationary-spiral and therefore the ECB’s policies that were justified, in part, on avoiding deflation weren’t justified. They also argue that this lack of a risk of deflationary-spiral is also a reason the ECB shouldn’t even try to hit its 2 percent inflation target, which it hasn’t hit for years. It’s part of the argue often heard by the Ordoliberal hawks that letting deflation take hold is find and just part of the corrective process. It’s the kind of assertion that is almost Trumpian in how doggedly divorced from reality it is no matter what happens because it’s fundamentally about maintaining a narrative, reality be damned. Countries like Greece and Spain fell into deep deflationary spirals thanks to the overly hawkish ECB policies advocated by this same group in the early years of the crisis combined with the massive austerity. And there’s every reason to assumed that could happen again precisely because the powerful Ordoliberal austerity faction has learned nothing. The fact that these hawks show in this memo that they’ve learned nothing is precisely how we know the threat of deflationary-spirals continue to exist. The stupidity won’t stop because it can’t stop because it’s ideological. They’ll do it again because that’s what ideologues do.
Plus, the overall deflation across the eurozone is also only barely hovering above the danger zone and remains highly at risk of falling into deflation, which has been the case for years. Even the Bundesbank was warming to QE in 2014 due to fears of deflation (but only after it was feared that Germany was slipping into deflation). Germany officially fell into deflation in 2015 and the risk of deflation continued to dominate throughout 2016. And while it’s true that Draghi declared deflation vanquished in 2017 multiple times, it’s also the case that the a slowing eurozone (and global) economy has kept those deflationary fears in place. It was the threat of deflation that the ECB cited in its reasoning for the most recent QE measure that these former officials wrote the memo to criticize, which is undoubtedly why this group is now attacking the idea that a deflationary-spiral is a threat at all. Maintaining an orthodox Ordoliberal narrative that drove those hawkish austerity policies in the first place is the primary goal of this memo and that Ordoliberalism narrative includes welcoming deflation as safe and healthy for an economy when combined with austerity (to make exports more competitive). The authors of this memo are the pro-deflation and austerity crowd.
So in case it wasn’t already obvious that the same forces that made the eurozone crisis a depression will jump at the chance to play that same role during the next crisis, this group of former officials who helped implement that disastrous policy the last time made clear they’re very ready to do it again:
“The rare public attack on the ECB underlines how Christine Lagarde could have a fight on her hands after she takes over from Mario Draghi as president of the bank at the end of this month, if — as expected — she decides to loosen monetary policy further in the face of the eurozone’s mounting economic slowdown.”
The stupidity never stops. Yes, even if the eurozone economy keeps slowing down, Lagarde is going to have a fight on her hands if she, as expected, decides to loosen ECB monetary policy further at some point in response to that slowdown. We already knew that would be the case but these hawkish former ECB officials had to remind everyone that their dedication to orthodox Ordoliberalism remains unwavering. Austerity forever.
And then they argue there was never a risk of a deflationary-spiral. That’s the argument they make...as the eurozone claws its way out of a depression and remains barely out of the deflationary danger zone. That’s some dark humor. And dark policy:
And then they have to point out that the QE bond buying programs are in violation of the Maastricht Treaty which because anything that facilitates government spending is strictly prohibited, which highlights how screwed up that treaty is and is another reason to fear a deflationary spiral:
And then they pull out the “won’t someone think of the youth”, arguing that young savers are being robbed of decently earning interest rates. This is the same group that doesn’t mind deflation and doesn’t mind austerity policies that cut public investments and have brought about historically high youth unemployment rates in countries likes Greece, Spain, and Italy. Again, there’s a lot of some dark humor in this memo:
Keep in mind that, while this faction isn’t currently calling the shots, it’s just a matter of time before they are because it’s just a matter of time before Berlin gets to choose the next ECB chief. So it’s just a matter of time before the ECB chief is beholden to this ideology.
Also keep in mind that it’s entirely possible this is going to be the dominant decision-making faction during Lagarde’s 8 year term despite her dovish reputation. And being a former head of the IMF, another institution guilty of embracing austerity madness, isn’t exactly a dovish resume item. So it’s possible Lagarde will simply choose to side with the hawks. Or maybe she’ll get outnumbered. So this memo might be a prelude of what’s to come sooner than expected.
On the plus side, at least it doesn’t look like there will be too many surprises in terms of what we’re going to see from the eurozone austerity hawks during Lagarde’s term. It’s going to be the same old stupid we’ve seen all along. It’s bad, but it’s a familiar bad. Like an old familiar blanker that keeps trying to smother you so you know it’s coming. It could be worse. Although not much worse.
As the COVID-19 virus and the global response to it continues to impose a New Normal on the world there’s going to be no shortage of retrospectives looking back on the many missed opportunities as the crisis unfolded. But here’s a pair of article that point towards one opportunity that doesn’t look like it’s going to be missed: The opportunity for the ECB to make a bad situation worse.
First, here’s an article about some comments made by ECB chief Christine Lagarde last Thursday that single-handedly sent the eurozone sovereign bond market into tumult. What did Lagarde say? Well, she basically retracted the historic pledge made by former ECB chief Mario Draghi back in July of 2012 when he famously declared that the ECB will “Do whatever it takes” to hold the eurozone sovereign bond markets together in the midst yawning spreads between the rates demanded for Italian and other Southern European bonds compared to their Northern European counterparts that reflected a crisis of confidence in the entire eurozone system. It was a significant moment simply because at that time it wasn’t really clear if the ECB was even willing to consider the kind of unorthodox monetary policies (like outright buying sovereign bonds) that would be required to avoid the eurozone bond market from imploding. By declaring that the ECB would do “whatever it takes”, Draghi signalled to the markets that, yes, the ECB is indeed willing to go down a path of unorthodox emergency measures.
That brings us to last week, which was arguably Lagarde’s “do whatever it takes” opportunity, with the growing spread between Italian and Germany sovereign bond yields reflecting a renewed crisis of confidence. But Lagarde didn’t repeat or even allude to Draghi’s “do whatever it takes” stance. Instead, she declared explicitly the exact opposite stance that, “We are not here to close [bond] spreads, there are other tools and other actors to deal with these issues.” Yep, the ECB decided to signal to the markest that it’s actually not going to do whatever it takes right in the middle of the coronavirus financial meltdown.
Lagarde later tried to backtrack that statement, asserting in a later interviews but the damage was done. The ECB also signaled that it’s planning on a new round of “targeted longer-term refinancing operation” (TLTROs) that in theory should encourage banks to lend to businesses. TLTROs will probably help somewhat but don’t forget that, as we’ve seen, the stimulus generated by TLTROs can be underwhelming.
And in fairness, Lagarde’s statement about bond spreads not being the job of the ECB was part of a larger message about how eurozone governments themselves can’t depend on monetary policy to save them and really do need to engage in a substantial fiscal stimulus. As Lagarde put it, “An ambitious and coordinated fiscal stance is now needed in view of the weakened outlook and to safeguard against the further materialisation of downside risks.” And that’s a very valid point she made. It’s just making that very valid point in no way excused undoing Draghi’s “do whatever it takes” stance. Still, as easy as it is to criticize the ECB, we can’t forget that it’s also one of the ONLY eurozone institutions that’s actually done anything to hold the zone together thanks in large part to the hawkish politicians in Germany and Northern Europe that appear to want the eurozone to embrace mass austerity instead, in keeping with Germany’s Orodoliberal economic ideology as an economic cure-all.
Also in fairness, it sounds like Lagarde made her “We are not here to close [bond] spreads, there are other tools and other actors to deal with these issues” comments in response to calls for the ECB to cut rates further (they’re already negative) lower bond yields. And she was correct that there are other tools that are better at addressing spiking bond yields like the quantitative easing (QE) program where the ECB straight up buys eurozone sovereign bonds. But it was still an extremely poor choice of words to say that “we are not here to close [bond] spreads” because that it exactly what the ECB should do and needs to do and say something like that was guaranteed to freak out the markets. At the same time, half the point of supporting the sovereign bond markets is to facilitate government debt spending and fiscal stimulus. It’s a group effort. Or at least it’s supposed to be.
There was some additional positive news out of the ECB (that was swamped by the retraction of the “Do whatever it takes” stance): The ECB also pledged to buy an additional 120 billion euros in bonds as part of its quantitative easing (QE) program until the end of the year. That translates into an additional 15 billion euros of QE bond purchases a month on top of the existing QE program that was buying 20 billion euros a month. But as we’ll see in the second article below, it’s not actually clear that the additional bond purchases will apply to the countries that need it most. Why? Well, recall how the ECB’s QE program included a “capital keys” formula that limited the total amount of sovereign bonds the ECB could purchase for a given country to 33 percent of its total sovereign bond issuance. As we’ve seen, that “capital keys” limit was already forcing the ECB to cut back its QE monthly purchases of Portugal’s bonds back in 2016. And as we’ll see in the second article below, it sounds like the hawks on the ECB want to keep those rules in place. These are all the caveats and catches that made it all the more difficult for the ECB to undo the damage done by Lagarde’s statement.
But as we’ll see in the second article below, all of that happy talk from the ECB to undo Lagarde’s gaffe was probably completely undone by the recent statements from Austria’s central bank governor — and ECB council member — Robert Holzmann, who plainly stated that investors were correct to assume that the ECB won’t be intervening to shore up the sovereign bond markets. Holzmann went on to assert that the upcoming financial turmoil might have a positive cleansing effect on the ECB economy. Yep, Holzmann basically told the world that having a large number of businesses go out of business would actually be good for the economy and actually suggested the ECB should encourage that by not lending to troubled businesses. It sounded like some sort of Darwinian ECB intervention. Only lend to the strongest businesses.
As we’ll also see in the second article below, Holzmann’s comments early Wednesday were so damage to the bond markets that the ECB unveiled a surprise 750 billion bond buying package late Wednesday night. This package wasn’t expected and is seen in part as damage control over Holzmann’s comments. Notably, the package includes Greek Bonds. As we’ve seen, Greece has perversely been excluded from the QE program thus far over thanks to the hawks.
So the ECB had a big opportunity to demonstrate that the era of Christine Lagarde would avoid the kind of insanity created by the hawks that defined the Draghi-era. Don’t forget that Draghi’s “do whatever it takes” statement was powerful in large part because it was a refutation of the ECB hawks. A refutation that was just refuted and triggered a financial debacle. That was last week. Then, Wednesday morning, Robert Holzmann terrified the markets with his “cleansing” comments and the ECB responds with a significant 750 billion euro stimulus pledge. So the ECB eventually made a significant stimulus pledged but only as part of damage control over the pro-austerity comments from one of its hawks, thus ensuring the impact of that new stimulus program will be blunted. It was the kind of debacle that was no doubt quite pleasing to the hawks in the ECB governing council.
We’ll see how Lagarde responds as this crisis continues to unfold. But the fact that the yield on 10-year Italian bonds jumped from 1.3% to 1.8% within minutes of her comments last week was no doubt a powerful lesson. Hopefully she learns that lesson, along with the lesson that the ECB hawks are going to do what they can to ensure she fails while they call that failure a success:
“Referring to calls for the ECB to go further and cut interest rates to ease borrowing costs for highly indebted eurozone countries, Lagarde said: “We are not here to close [bond] spreads, there are other tools and other actors to deal with these issues.””
Oops. It wasn’t the best choice of words, as was evident within minutes of her statement when 10-year Italian bond yields spiked 0.5% (a huge jump for sovereign bonds) and European financial markets continued their near record drops:
And while Lagarde tried to undo the damage in later interview, the damage was done. It points towards one of the most delicate aspects of this situation: faith that the ECB really does want to avoid financial and economic turmoil really has been a critical part of what has held the eurozone financial markets together since the outbreak of the eurozone crisis. It’s why the worlds of central bank chiefs have to be chosen carefully. The words they say can have an even bigger impact than the policies. It’s a faith that Mario Draghi managed to cultivate in spite of the endless push by the hawks like Bundesbank chief Jens Weidmann to stop the ECB’s emergency measures and just allow economic turmoil to play out under the Orodoliberal ideological view that economic damage is actually helpful. That’s why attempting to backtrack on Lagarde’s ill-advised comments is so hard to do...it’s hard to backtrack on broken faith:
But the ECB still pledges to roll out additional measures like a new TLTRO program to boost business lending or expanding the existing QE program through the end of the year. But without faith in that the ECB is really committed to “doing whatever it takes”, those are the kinds of measures that are going to be more as half-measures by the market:
But despite this debacle, it’s important to note that Lagarde was completely correct with the underlying point she was making with that unfortunate comment. There really are much better ways to address the spiking Italian bond yields than lower rates. And that includes the general need for a meaningful eurozone fiscal stimulus policy, something the hawks in Germany and Northern Europe have consistently oppose. The ECB can buy time, but that’s about it. Governments really do need to start spending, as has been the case for years now:
And that brings us to the big new 750 billion euro bond buying pledge made the ECB on Wednesday in response to the comments made by Austria’s central banker Robert Holzmann when he suggested during an interview that markets really were correct in interpreting Lagarde’s comments as a signal that the ECB really isn’t going to be “doing whatever it takes”. Holzmann went on to suggest that allowing companies to go out of business was actually a good thing that might “cleanse” the economy. It’s kind of the most unhelpful thing he could have said, but that’s how the austerity hawks operate! Saying and doing really unhelpful things and then telling us it’s actually helpful:
“The unexpected move, unveiled late Wednesday, signals the bank’s determination to defend southern European governments whose debt has come under pressure from investors. But it is likely to raise fresh concerns in the region’s largest economy, Germany, where senior officials have long criticized the ECB’s bond purchases.”
A surprise announcement of 750 billion euros in bond buying, including Greek debt (finally). It would have actually be a very effective move by the ECB had it not been in response to the damaging comments by Austria’s Robert Holzmann and if it wasn’t obvious that Germany would be opposing it. But it was better than nothing given the emergency Holzmann created on Wednesday morning:
And when you read why Holzmann was saying earlier Wednesday, it’s not actually that surprising the ECB pulled this surprising stimulus package out of its hat hours later. In addition to saying that investors were actually correct in interpreting Lagarde’s statements last week as a signal that the ECB was going to allow things to just spiral out of control, Holzmann went on to suggest that the upcoming recession — which is looking like a mega-recession in the making — might have a positive effect by cleansing the economy but only if the ECB is sure not to support the weakest businesses. It was quite possibly the most unhelpful thing he could have said. Which, again, is actually helpful according to the logic of the austerity crowd. Economic pain and turmoil is good. That’s literally the ideology and Holzmann decided to be very overt about promoting that ideology at this crucial time:
And note how the situation was basically spiraling out of control in Italy’s bond markets again following Holzmann’s comments. We saw how Italy’s 10-year bond yields jumped 0.5% from 1.3% to 1.8% following Lagarde’s comments last week. Well, after drifting up to around 2.5% over the following days, Holzmann’s comments Wednesday morning cause another ~0.5% spike putting the yields above 3%. It’s just another example of the ECB’s emergency measures are often done not to make the situation better but instead to limit the damage being done by the hawks:
Also note how the ECB is considering raising its 33% “capital keys” limit on the QE bond buying it can do for an individual country, something that has been obviously needed since 2016 to ensure the QE program actually helped the countries that need it. But then we hear that, while the ECB might favor purchases of Southern European bonds in the short run, it will even it out over time. That’s basically a way of them saying that the QE program is going to get a final jolt and then get wound down via the purchase of a whole bunch of German bonds at the same time purchases of Italian and other Southern European bonds are tapered off...a move that would exacerbate the sovereign bond spread that triggered this current crisis in the first place. Because that’s how the ECB rolls:
And just to make it clear how dire the situation is looking, Lagarde herself said the shutdown of businesses in response to the COVID-19 outbreak was set to induce a 1.3% economic retraction this year if businesses are just shut down for a month. But if the shutdown is 3 months we’re looking at a 5% contraction, something not seen since the 2008 financial crisis. And this shutdown could easily last longer than three months. So the eurozone is heading into a situation that looks potentially worse than the financial crisis and we already have the hawks openly sabotaging the eurozone economy. It’s a multifaceted crisis:
Finally, we have to underscore how this crisis in Italian bond markets isn’t due to some sort of random Italian profligacy. The country is literally Europe’s epicenter for the COVID-19 outbreak with a collapsing health system and all expectations are that it’s going to have to spend much more just to keep people alive. And Italy’s just the start. All of the eurozone is going to be forced to spend on both health care and unemployed workers. So allowing the bond markets to blow up at a time like this really is a kind of mass murder. That’s only barely exaggeration:
So as we wait and see how this COVID-19 global emergency is playing out, keep in mind that the hawks at that ECB are doing what they can to ensure that emergency is as economically destructive as possible in the eurozone. As Austria’s central banker described it, allowing a wave of commercial bankruptcies might actually be a good thing. Just as allowing the cost of borrowing for the most impacted countries might also be a good thing. That’s how the hawks see it. A wave of economic destruction is actually good and healthy under the hawks’ Ordoliberal socioeconomic Darwinian logic. Economic destruction that’s inevitably going to translate into the destruction of lives as this public health crisis plays out. It remains to be seen how successful Christine Lagarde is at keeping the hawks at bay. She had one helluva stumble last week but she’s still relatively new on the job and hopefully learned a valuable lesson about the forces she’s dealing with. But it’s pretty clear now that exacerbating the COVID-19 crisis to achieve their austerity goals is now seen as largely fine and helpful by the ECB’s hawks.
We’re used to bad financial and economic news emanating from the ECB, but it looks like we can add catastrophically bad epidemiological news to that list. It’s an awful list.
Here’s a pair of updates on the latest German legal challenges to the ECB’s quantitative easing program that is shaping up to be a potentially eurozone-destroying battle of the constitutional courts. First, here’s an article from a few weeks ago about the ruling by Germany’s Constitutional Court that the ECB’s QE bond purchases overstepped its mandate. The court gave the Bundesbank three months to explain the necessity for the QE program and if that didn’t happen the Bundesbank would be forced to leave the QE program and end its share of the bond purchases.
The Court of Justice of the European Union (CJEU) that gave the legal approval for the current QC program in the 2018 is asserting that it has the sole legal authority to determine whether or not the bond buying program was constitutional, stating “In order to ensure that EU law is applied uniformly, the Court of Justice alone – which was created for that purpose by the member states – has jurisdiction to rule that an act of an EU institution is contrary to EU law.” So beyond the question of whether or not the QE program was constitutional, there’s a broader question of whether or not the question can even be asked in the first place after the CJEU made its ruling. So there’s a real constitutional power struggle playing out right now in that extends beyond monetary policy and gets at the question of whether or not member states have an effective legal veto power via their own constitutional courts:
“Germany’s Constitutional Court ruled that the ECB had overstepped its mandate with bond purchases and that the Bundesbank must quit the scheme within three months unless the ECB can prove its necessity.”
The Bundesbank must unilaterally quit the ECB’s QE program in three months unless the court can be convinced of the necessity of the program. Keep in mind that the Bundesbank has been a leading opponent of the QE programs all along so asking the Bundesbank to justify this program is kind of a big request. And according to the CJEU it’s an unconstitutional request because the CJEU alone is supposed to be making these decisions. If every member state’s constitutional court gets to weigh in on these issues you’re going to create a situation where the courts become active participants in ‘negotiating’ these pan-EU policies:
Will the negotiation of EU-level policies end up becoming a circus of competing constitutional court battles? That’s the precedent the CJEU is fearing will be set if Germany’s constitutional court is allowed to make this demand of the Bundesbank which is why the CJEU was asked if it was considering legal action against the German constitutional court. In other words, the EU-level constitutional court just might need to take Germany’s constitutional court to court to fight over whether or not the constitutional courts of Germany or any of the other member states can take EU-level laws to court after the CJEU makes its rulings. So this legal battle over the constitutionality of the ECB’s QE program is turning into a significant question about the nature of EU federalism.
So what does all of this mean more immediately for the ECB’s QE program? With the coronavirus pandemic still ravaging the eurozone’s economy the timing for this legal battle almost couldn’t be worse. So what happens if the Bundesbank ends up just pulling out of the QE program in a couple of months? Well, according to the following article, while the ECB is officially suggesting this isn’t a likely scenario, it’s still seriously planning for that possibility. Plans that include having the ECB sue the Bundesbank into rejoining the QE program.
But there’s a catch if the Bundesbank does pull Germany out of the QE program that’s specific to Germany: Because the goal of QE bond buying program is to bring down borrow costs and because Germany’s bond rates represent the de facto euro zone benchmark for private investors for the eurozone region you can’t have the Bundesbank pull out of the QE program without breaking it for everyone because if the Bundesbank stops its bond purchases and the interest rates on German bonds rise that’s inevitably going to raise the interest rates of all of the rest of the eurozone’s bonds, undermining the entire point of the QE program. So how is the ECB planning on addressing this complication? By planning on having the rest of the eurozone central banks buy Germany bonds in place of the Bundesbank. Yep. If Germany pulls out of the QE program the rest of the eurozone will continue subsidizing German bonds anyway:
“The moves would likely mark a moment of truth for the euro, testing Germany’s commitment to a currency it played the biggest role in creating and forcing it to tackle some deep-seated reservations within the country about ECB policies.”
A moment of truth for the euro. That’s a good way to characterize this legal battle, except it’s not really just limited to the eurozone. This is a battle of basic questions about EU-level federalism and whether or not the CJEU really is has the final word on these issues of constitutionality. As the article notes, if the ECB ends up taking the Bundesbank to European Court of Justice (which is part of the CJEU) it would be the first such case since the euro was created in 1999. This really is a precedent-setting legal battle over where the final word is made on EU-level matters: at the federal level or member-state level:
And as the battle of QE makes clear, part of the logic of putting the final word on these legal matters into the hands of the federal-level CJEU is that a lot of programs simply wouldn’t work if it was up to each member state to decide whether or not it wants to implement them. Like QE, which would break without the purchases of the German bonds. That’s why the emergency QE plans involve having other central banks buying German bonds if the Bundesbank stops: it’s required just for the QE policy to work.
And note having other central banks buying German bonds would ironically break the “no risk sharing” principle, which has been one of the core complaints from Germany about nearly all of the various rescue programs proposed or implemented over the last decade for dealing with the fallout of the eurozone crises: fears that the rescue programs would violate the “no risk sharing” principle that could make Germany disproportionately on the hook for the cost of financing the programs and now we face the prospect of having all of the other central banks break that rule in order to subsidize German borrowing costs:
So as with nearly all of the previous eurozone-related crises, the current crisis comes down to the question of whether or not the eurozone is really a union in any meaningful sense or if it’s just a confederation of rival neighboring rival states who don’t really trust each other but all share a currency. Because to a large extent this question of who has the final say on these matters — the CJEU or national courts — is a question of whether or not the eurozone states are willing to really trust their fates in each other’s hands.
Thus far with the way the EU and eurozone is structured and the unending battles — whether its battles over the legality of QE or bails vs austerity — the answer is clearly that EU and eurozone members states really don’t trust their fates in each others hands at all. It’s more like an LLC than a union and a deep lack of trust has long been at the root of this structure which is why pooled risk sharing — something that really is win-win and one of the great values in forming a union — is viewed as an existential threat by Germany and the other wealthy Northern European member states. As a result, the most efficacious policies get systematically taken off the table or mired in endless legal battles over whether or not they should even be allowed to exist. That’s the question looming over the future of the union. The eurozone, and larger EU, is potentially dooming itself by an unwillingness to create a shared fate. It’s kind of amazing. A bad kind of amazing but amazing.
And that’s why this legal battle that’s going to be playing out in coming months really is much bigger than just the fate the QE program and stability of eurozone financial markets. Few stories involve monetary policy have this level of existential angst associated with it: the fight over QE is shaping up to be a precedent-setting legal battle over whether or not EU and eurozone member states are part of a meaningful ‘we’re all in this together’-style union or something more a giant long-term business relationship. A giant long-term business relationship on the verge of bankruptcy and liquidation if it’s that kind of union.
Here’s a set of articles pointing to an unfortunate rerun of the eurozone’s ‘greatest hits’ of the last decade. Hits like imposing austerity and hiking borrowing costs in the middle of a recession. Only this time with a pandemic thrown in:
First, it looks like the eurozone just technically fell into another recession thanks to its struggling vaccination rates and new COVID lockdowns. Making it the second recession recorded since the start of the COVID pandemic. It’s double-dip time for the eurozone.
But as we’ll see, the news of a double-dip recession is following reports of much higher expected growth for eurozone areas going forward. This is what economic prognosticating looks like thanks to COVID and its on-again-off-again lockdowns.
So the question of what actions eurozone officials might take to address the double-dip recession are taking place at the same time there’s growing talk once again about paring back the eurozone’s stimulus and economic support programs, in particular the ECB’s bond-buy program that’s keeping a lid on sovereign bond rates and borrowing costs. And all expectations are that borrowing costs are going to rise significantly for the eurozone’s economically weakest members should the ECB pull back on its bond-buying too quickly.
Are we in store for another eurozone sovereign bond crisis? We’ll see, but don’t forget if we’re going to see another eurozone sovereign bond crisis we’re probably also going to see a new round of fiscal austerity being imposed on the crisis-hit states. Because that’s how the eurozone rolls. And yes, Bundesbank chief Jens Weidmann is already calling for a pull back on ECB stimulus programs in order to impose ‘market discipline’ on member states, so the familiar tune of austerity talk has begun playing once again, just in time for the eurozone’s double-dip recession:
“The decline came after a 0.7% drop in the fourth quarter of 2020, when the strong rebound seen over the summer – with third-quarter growth of 12.5% – faded as a new wave of Covid-19 hit Europe.”
It’s been quite the roller coaster of economic performance. A lockdown pandemic recession. Then 12.5% growth over the summer. Followed by a new wave, new lockdowns, and now a double-dip recession. But at least a large EU-level fiscal stimulus package is going to be coming into effect. Of course, given he eurozone’s general right-wing structure when it comes to budget policies, debt-levels, and, crucially, bans on fiscal transfers from economic strong to weak members states, a fiscal stimulus package that ends up increasing the national debts of those weaker member states could end up planting the seeds for the next debt/austerity crisis. Especially if the costs of financing that debt increases too much for those countries to handle, which makes the ECB’s bond-buying program that’s holding rates down all the more crucial during this period. And that’s why so many observers of the eurozone sovereign bond markets are wonder what kind of disaster is going to happen if the ECB pulls back on its bond-buying program. Especially since policy-makers are increasingly talking of doing exactly that:
““It’s very difficult to see something anything other than fiscal austerity,” said M&G’s Lonergan. “I don’t know when it will strike but I think you’re getting very, very good odds if you look at a lot of the more vulnerable parts of the European bond market now.””
“It’s very difficult to see something anything other than fiscal austerity.” That was the ominous prediction from at least one eurozone bond market observer. And it’s hard to argue with that sentiment given the eurozone’s track-record on these issues. The fiscal austerity could come in the form of the EU re-imposing fiscal rules that were lifted during the pandemic. Or maybe the ECB will pull back its bond-buying support causing a spike in borrowing costs. It’s not clear how the austerity will be forced but it’s also very unclear what could avoid that kind of situation as long as the eurozone sticks to the rules it wrote for itself:
And just note how bad the eurozone allowed the situation to get a decade ago during the height of the sovereign debt crisis in Greece: 10 year yield’s on Greek debt hit 40%. It was a powerful lesson to the world. The lesson that the ECB just might allow for these kinds of crises to spiral out of control on principle. Now, the ECB did spend much of the following decade making up for that decision by allowing the doves to ultimately win the battles for greater leniency, but it was often only after the creation of a new crisis that the ECB ended up doing the right thing. It’s this Jekyll and Hyde ECB legacy that is shaping how the market is digesting the current situation when it comes to the risks of the eurozone sovereign bond markets:
So are there ECB officials who want to see a return to some sort of sovereign debt crisis and the imposition of austerity? Of course. Jens Weidmann is still the head of the Bundesbank:
““We central bankers must clearly say that we will rein in monetary policy again when the price outlook demands it,” the Bundesbank president said in an interview with Berliner Zeitung published Friday. “And irrespective of whether the financing costs for governments rise.””
The ECB should reign in its bond buying irrespective of whether the financing costs for governments rise. That was Weidmann’s way of telling the markets what to expect. At least what to expect from him in the event of an upcoming crisis. Not that the markets needed a reminder that Jens Weidmann would keep doing exactly what he’s always done.
And note the reason behind Weidmann’s demand that the ECB cut back on bond buying and just allow borrow costs to spike: he’s concerned that the ECB is becoming too entangled with fiscal policy, a concern not shared by fellow ECB board member Isabel Schnabel. And while we’ve heard grumblings about the ECB’s influence on fiscal policy from conservative ECB members for years, the primary reason we’ve long heard for why the ECB needs to pull back its stimulus programs is to avoid creating too much price inflation. And yet Weidmann has recently come out and said he doesn’t see the current increase in the money supply (created by the ECB’s policies) as leading to persistently elevated price gains (i.e. higher inflation). So Weidmann is calling for the ECB to pull back on its stimulus policies in the middle of a double-dip recession despite not seeing the threat of inflation because he’s worried about the eurozone economies getting addicted to ultra-low rates. Like a true austerity addict:
Even with not inflation threat on the horizon he’s still calling for austerity. At least he’s consistent. But while consistency is potentially a virtue, that doesn’t really count for things like consistently calling for austerity. That’s not even being ideologically consistent. Maybe it could be viewed as being consistently anti-debt, but hiking borrowing costs and imposing economically destructive austerity sure didn’t help Greece’s debt situation as we saw a decade ago when the ECB was following the whims of figures like Weidmann. There’s a mysterious, ineffable quality to Jens Weidmann’s consistent malpractice. Like any good grift.