H.W. Sinn Chides Ms. Merkel

A friend pointed a recent editorial by German economist Hans-Werner Sinn in the FT out to us, in which Mr. Sinn – one of the staunchest opponents of stealth bailouts via central bank policy in Europe – takes Germany’s chancellor Angela Merkel to task for not doing anything to stop the latest schemes instituted by the ECB.

Specifically, Sinn points to the many ways in which the ECB has already skirted its statutory limitations, and how this trend continues and is actually getting worse with the most recent monetary policy announcements. An excerpt:

“Despite the Bundesbank’s protests, the European Central Bank is giving Europe’s banks a leg-up. To make them fit enough for the proposed banking union, the ECB proposes to relieve them of some of the potentially toxic loans they have extended to the private sector, which will be bundled into asset-backed securities and taken on to the central bank’s balance sheet. The ECB’s preference is to purchase the better tranches of these securities and leave the junk for the European Investment Bank. But since politicians are not playing along, the ECB will have to hold its nose – and complete its conversion into a bailout agency.

The ECB began as a central bank that carried out monetary policy, providing liquidity for domestic uses. But when the financial crisis hit in 2008, banks in Ireland and southern Europe faced a dearth of foreign loans, on which they had come to depend. The ECB allowed national central banks in these countries to end the drought by lending even more money against ever-weaker collateral. This exercise in money creation went beyond what was needed to ensure domestic liquidity; €1tn in central bank credit was created out of thin air to settle foreign bills. The citizens of the six countries that were indulged in this way used the money to pay off their foreign debts and to purchase foreign goods.

The ECB went on to instruct national central banks to grant crisis-afflicted states credit totaling €223bn under the so-called Securities Markets Program. Mario Draghi, the ECB president, moreover offered unlimited protection for their government bonds, formalizing his vow to do “whatever it takes” to save the euro under the rubric of “outright monetary transactions”. This lowered the interest rates at which overstretched euro zone members could obtain credit and reversed the losses of their foreign creditors, triggering another borrowing binge.”

Sinn then goes on to explain that what is being considered now, is going well beyond even these past interventions. He then chides Ms. Merkel for failing to look after the interests of German citizens as instructed by the rulings of Germany’s constitutional court over recent years, which tended to be of the “yes, but” kind: they allowed all sorts of bailout schemes to go forward, but with certain strings attached.

Contrary to Sinn’s interpretation of these rulings, we do not believe that they constrained the ECB much – rather, by making parliamentary consultations and votes on bailout proposals such as the ESM rescue fund a sine qua non, they increased the propensity of Germany’s government to leave the heavy bailout lifting to the formally independent ECB, as no parliament exercises control over it. In fact, Sinn himself suspects as much when he says:

“Yet politicians may again keep their mouths shut about the ECB’s transgressions. Eurozone governments might even be thankful that the ECB is doing by stealth something for which they would otherwise have to seek permission from tightfisted parliaments. Mr Draghi would never have dared to promise to do “whatever it takes” without the backing of the government heads of the day, and especially of German chancellor Angela Merkel. Mario Monti, Italy’s former prime minister, said as much this month.”

Sinn believes that this amounts to a dereliction of duty on the part of the political establishment, especially the German leadership, in the belief that “Germany’s government is prohibited by the rulings of the constitutional court to sit back and do nothing while the ECB oversteps its mandate.” As noted above, this is not necessarily how we are interpreting these rulings. Sinn points out that by bailing out the creditors of borrowers who have been left stranded by the burst real estate bubbles in Europe, the ECB is effectively shifting these risks onto the backs of tax payers. We would rather say: onto the backs of all users of the euro.

In the past, most of the ECB’s major initiatives to provide liquidity to banks were temporary in nature, such as e.g. its LTROs. Sure enough, the ECB was saddled with toxic loans bundled into securities by banks (and imbued with the essentially worthless “guarantees” of de facto insolvent governments), but as long as “extend and pretend” worked, these securities would eventually revert back to the banks – and this has indeed happened to a large extent, as the shrinking of the ECB’s balance sheet between mid 2012 and today attests to:

Consolidated central bank balance sheet of the euro-system (via Sober Look) – its decline mainly reflects the fact that banks have repaid LTRO funding.

Thus, Sinn is quite correct when he states that what Mr. Draghi and the ECB council have proposed to do next makes the previous measures pale in significance. The main difference is that this time, the ECB will engage in outright purchases, to the tune of several hundred billion euros (all in all, it plans to expand its balance sheet by about € 1 trillion, by a mixture of TLTROs and outright purchases of ABS and covered bonds).

Although no observer except us has commented on this to our knowledge, there is also a peculiar aspect to the outright purchase of covered bonds, as the two main types of such bonds are either backed by mortgage loans or by public sector assets. Public sector assets are mainly loans to “sub-sovereign agencies”, which is to say state-owned, and hence state-guaranteed companies. It would appear to us that the outright purchase of such bonds rather obviously oversteps the statutory prohibition on financing state debt.

We thought the same about the “SMP” though (when the ECB attempted to manipulate the bond markets of Portugal, Greece and Ireland), and it was done anyway, so we don’t think the ECB will feel constrained by such legal fine points.

German economist Hans-Werner Sinn, who looks a bit like Captain Ahab. His Moby Dick is the ECB.

(Photo © dapd)

Can the Euro be Made to Work?

The ECB has continued to find clever ways to make its various programs (whether they were merely threatened, such as the OMT, or actually implemented, such as the SMP) appear to be in keeping with its statutes and mandate.

It is in the nature of the State to use today’s vast labyrinth of complex laws mainly to its own advantage. The can be used to crush its opponents – since every citizen must be presumed guilty these days, as the impenetrable thicket of laws that is not even fully understood by legal experts anymore practically ensures that everybody is a criminal – or to justify its own illegal or legally dubious activities (as a recent example, see this article on how the NSA relies on a creative interpretation of a Reagan-era law to justify its “accidental” unconstitutional spying on US citizens).

So we should not be surprised that the ECB is getting rather creative as well when it comes to looking for ways to skirt its statutory limitations. In fact, many of the decisions made may be seen as technically legal as long as enough legal experts agree that they are, but whether they are actually in keeping with the spirit of the law is another matter entirely. The newest measures have been justified by invoking the “price stability” mandate, which apparently mandates that we must have perpetual currency debasement of around 2% per year. How to get there is not specified, so once interest rates are at zero, the door is open to experimentation.

Below is our initial reaction after reading Mr. Sinn’s editorial, and we believe it actually summarizes the problems nicely:

We agree with Messrs. Sinn and Weber (former BuBa president Axel Weber) that the ECB is becoming (or rather, has already become) a bad bank and that it is continually overstepping its mandate be relying on rather creative interpretations of its statutes.

But then, this only confirms that the euro area is unsustainable in its present form. If the ECB were acting strictly within the law, the euro would reflect many of the qualities of a gold standard. Gold however is a free market money. Its use presupposes an unhampered market economy with price and wage flexibility, not a collection of over-indebted, over-regulated socialistic welfare states employing wage and price controls, granting countless subsidies, etc.

This is why we have always stressed: if one wants the euro to succeed, one must rigorously shrink the State, with all that implies. That would however also entail that a vast political and bureaucratic class and its clientele of privileged private sector entities would lose economic and political power, namely to the same extent as “society”, or better, private individuals, would gain in economic and political power.

We believe that this is why the “austerity regimes” were so focused on raising taxes and cutting mainly that part of spending that benefits said individuals in the current welfare state arangements, while leaving the bureaucracies and the political apparatus perfectly intact. Conclusion: either there is A) radical change, or B) eventually, the euro will crash and burn. B) seems far more likely to us.

Conclusion:

We agree with most of Mr. Sinn’s points. The ECB has indeed been overstepping its statutory limitations since the 2008 crisis, even though it could perhaps be argued that what has been done was technically or formally legal. We also agree that these actions are subsidizing borrowers who have foolishly overextended themselves during the bubble era to the vast detriment of savers and tax payers, putting the vast majority of innocent bystanders at risk.

However, if the ECB were indeed hewing more strictly to the spirit of its statues, the euro area such as it is now constituted would probably soon break apart at the seams. To work smoothly, a “hard currency” regime requires an unhampered market economy with flexible wages and prices, and by inference, a far smaller government sector.

At some level, EU governments are recognizing this fact, as evidenced by the call to implement economic reform in the crisis countries and cut government spending and public debt back to the limits once imposed by the Maastricht treaty. However, they are trying to square the circle. What is not yet fully recognized is that a far more rigorous reform plan would have to be implemented. Those implementing it and the interest groups that depend on them would then have to relinquish a lot of power voluntarily (we recommend that readers take a look at Jörg-Guido Hülsmann’s monograph “Deflation and Liberty” – pdf, which explains how the inflationary regime sustains the status quo).

So at best some sort of “muddle through” compromises can be expected, which is indeed what has happened thus far. Whether that will be enough to keep the euro project intact is highly doubtful.

The ECB’s governing council (picture taken in February 2014) – a.k.a. the backdoor bailout posse.

(Photo via ecb.europa.eu)