Any fair minded reading of the Bundesbank’s latest Constitutional Court deposition must lead to one of two conclusions: Either the Bundesbank has failed to recognise the existentialist threat to the Eurozone (that was placed in suspended animation during the past eight months or so), or the Bundesbank has intentionally opted for a strategy that will, sooner or later, see the disbanding of the current Eurozone. Loath to assume naiveté on the Bundesbank’s part, I opt for the latter. Here is why:
The 12th June moment
On 12th June, 2013, Germany’s constitutional court is scheduled to rule on the legality of Mr Mario Draghi’s OMT (outright monetary transactions) program. Of all the institutional interventions during the past three years of cascading Euro Crisis, OMT (together with Germany’s reluctant acceptance that Grexit was too risky) was the single most significant measure that has calmed the bond markets and allowed the euro not to fragment (beyond the recent de facto exit of Cyprus from the Eurozone).
This is not the first time that Germany’s constitutional court has heard cases against Europe’s institutional reforms the purpose of which was to calm markets and buy the Eurozone (and its political class) additional time. It was only last September that it ruled, through clenched teeth, that the ESM (the European Stability Mechanism) could go ahead, while imposing massively constrictive conditions on Germany’s participation in it (e.g. limiting Germany’s contribution to the ESM to less than €200 billion, specifying that the ESM would not be able to make a move without the Federal Parliament’s consent etc.)
While no one really expects that Germany’s Constitutional Court will dare a ruling that explicitly bans Mr Draghi’s OMT, almost everyone expects that it will attempt to weigh in regarding the form of conditionality that will accompany any bond purchases under the OMT – exactly, in other words, as it did with the ESM; i.e. give it a grudging green light while binding its operations in a manner that, effectively, renders it ineffective. Then, of course, the proof of the pie will be in the eating, both in terms of how the markets will react and, more importantly, how the ECB will act if it needs to activate OMT quickly to assist, say, Italy’s bond market (i.e. will Mr Draghi and Ms Merkel abide by the Court’s conditions or will they, quietly, sweep them under the carpet?).
The Bundesbank’s deposition
In a sense, the German Constitutional Court is doing nothing new; hedging its verdict by officially saying ‘yes’ to Berlin while piling up the conditions so that it is an effective ‘no’. Yet, this time it is different. While Karlsruhe (where the Constitutional Court is situated) will, most likely, tread a fine line between obstructionism and avoiding a public clash with Berlin and Frankfurt, what makes this hearing different is a deposition that was tabled last December at the Court by Germany’s Central Bank, the intransigent Bundesbank – a document that was only yesterday released by Handeslblatt and commented upon extensively in the financial press.
Three statemets make this is bombshell of a deposition. The first openly questions whether the ECB has a mandate to preserve the integrity of the euro; that is, to prevent the currency’s collapse. The second, in reality, questions the joint decision of Mrs Merkel and Mr Draghi to keep Greece in the Eurozone. And the third challenges Mr Draghi’s oft-stated conviction that the ECB’s broken monetary transmission mechanism should be mended as quickly as possible. Taken together, these three passages constitute an act of war against the euro as a coherent currency; especially in view of the fact that they are official depositions by the Bundesbank to the German Constitutional Court for the purpose of invoking a constitutional ban on Mr Draghi’s monetary stance. In view of the gravity of the matter, it is perhaps important that we take a look at each of these three acidic statements:
Statement 1: It is not the role of a central bank to guarantee the irreversibility of the currency
One wonders whose role it is, if it is not the Central Bank’s? As long as the democratically elected political leadership declares (for better or for worse) a cast iron determination to keep the Eurozone intact, it would be a gross violation of the ECB’s mandate not to guarantee, to the best of its abilities, the irreversibility of the currency (nb. Besides price stability the ECB’s charter specifies that the ECB is obliged to assist the European Council in the pursuit of its borader objectives). Especially in a Eurozone that, in truth, only has one substantial common institution: the ECB! By challenging this simple assumption, the Bundesbank adopted a brand new, utterly incendiary, position: The Eurozone’s salvation is not paramount, even if its political leadership thinks it is! Nothing can damage confidence in the Eurozone more than such a position-statement by the Central Bank of the monetary union’s most powerful economy.
Statement 2: The credibility of the OMT program, by which Mr Draghi tried to guarantee the euro’s irreversibility, was cast in doubt (even before OMT was announced) by Greece’s use of its own Central Bank’s ELA (from around April to December 2012).
This statement requires some unpacking. Lest we forget, Greece was cut off the troika’s loan tranches when the Papademos government lost its credibility in the early Spring and had to call for elections. The troika, citing the impossibility of coming to an agreement with a non-existent government, suspended all payments to the Greek government till further notice. It did not resume lending to the Greek state till the end of the year, well after the election in June of an acquiescent conservative administration that accepted all its terms and conditions to the full. Meanwhile, some time in the Spring of 2012, the ECB also cut Greek banks off its own refinancing operations; something it could not avoid given the clear state of insolvency of these banks. If at that point (when the state was utterly impecunious), the Greek banks had also lost access to ELA funding, they would have closed down instantly and the Greek government, whether it liked it or not, would have had to reconstitute the drachma and exit the monetary union.
Of course, this did not happen because the ECB never approved Grexit (thinking of it, correctly, as a systemically catastrophic development) and allowed the Greek Central Bank to continue providing liquidity to the bankrupt Greek banks. Moreover, and this is not unimportant, the ECB had another reason to do this: In May and in August of 2012, tranches of Greek government bonds that the ECB had purchased in 2010 (as part of the ill-fated SMP bond purchasing program) matured. Allowing Grexit would have meant taking losses on those bonds; a political and symbolic eventuality that Mr Draghi dreaded. Thus, the Greek government issued T-Bills to pay back the ECB (while keeping a few ‘peanuts’ for itself), T-Bills that only the Greek banks bought before handing them over to the Central Bank of Greece in exchange for ELA liquidity. In this manner, Greece was kept on a drip feed until the end of the year when the loan tranches from troika started flowing again and the ECB started accepting again Greek bank collateral (on the pretense that, somehow, they had become solvent again).
This is the background to Bundesbank’s charge against the ECB’s OMT. What Mr Weidmann is saying is that, in the above case, the ECB played fast and loose with its own rule book, accepting collateral that is worthless and, even when it could no longer bring itself to do this, allowing the Greek Central Bank to create euros on behalf of clearly bankrupt Eurozone entities (the Greek banks). And if the ECB played fast and loose with its rulebook on that occasion, why should we trust it not to do the same with OMT? What will stop Mr Draghi from purchasing Italian bonds even if the Rome government is less than diligent in the implementation of agreed spending cuts, tax hikes and ‘reforms’? One must admit that Mr Weidmann has a point. But, imagine what would have happened if Mr Draghi had proposed to the ECB’s Governing Council to veto the Greek Central Bank’s ELA liquidity provisions in June, in August, in September? Greece would have exited the Eurozone overnight, defaulted on the ECB’s Greek bonds (the first time that would have happened in the Eurozone’s short history), Italy would have crashed, and the euro would have been history.
Put briefly, by castigating the ECB’s handling of the Greek debacle during those crucial months in 2012, the Bundesbank is questioning whether the Eurozone ought to have been saved. In conjunction with Statement 1 above, it sends a signal that the Bundesbank thinks it preferable to let the Eurozone collapse than adopt a ‘flexible’ interpretation of insolvency or, in the case of OMT purchases, of ‘conditionality’.
Statement 3: Mr Draghi, and almost every other commentator, laments often that the interest rate transmission mechanism of the ECB has broken down; that unprecedented reductions in ECB refinancing interest rates are not passed on even to profitable and efficient firms in the hard-hit Periphery. Uniquely amongst all European financial and economic authorities, the Bundesbank told Germany’s constitutional court this: “the question arises as to whether and why such a development must be corrected”.
This statement seemingly reveals a degree of callousness that exceeds the negative expectations of the Bundesbank’s most ardent critics. But is it callousness? It would only callousness, dear reader, if the Bundesbank truly thought that it is fine for a Spanish company to be paying interest rates of 7% when a comparable (in terms of efficiency and potential profitability) German company secures loans at a mere 2%. I am, however, beginning to tilt towards the interpretation that the Bundesbank does not think that this is a defensible situation. The reason it does not want the transmission mechanism to be ‘corrected’ may be because it is more useful to the Bundesbank’s strategy while ‘broken’. Useful in what sense? Useful in the sense that, while broken, the political climate in Europe becomes increasingly amenable to the idea of a Eurozone break-up; without the Bundesbank ever having to propose such a break-up.
Conclusion: Error or stratagem?
Some readers may feel inclined to dismiss my hypothesis as too far-fetched; too conspiratorial. It is perfectly true that I have no evidence that Mr Weidmann has intentionally embraced a strategy of pushing the Eurozone toward disintegration (thus creating an inexorable dynamic that will lead to the DM’s re-introduction). However, a close reading of the Bundesbank’s constitutional court deposition leaves us with only two possible interpretations. One is that Mr Weidmann does not ‘get it’; that he cannot see that a Greek exit in 2012, or an Italian exit in 2014, would spell the end of the Eurozone; that he cannot see that Mr Draghi’s OMT announcement played a crucial role in stopping the disintegration of the common currency last year; that he has no appreciation of the catastrophe facing good, solid Spanish and Italian enterprises due to the broken down interest rate transmission mechanism. The other is my interpretation: Mr Weidman can see only too well that the above hold unequivocally but is tabling this deposition at the constitutional course knowingly and as part of a strategy that leads the euro to a death by a thousand, almost silent, cuts. You take your pick, dear reader: Do we behold a Bundesbank Grand Error or a Grand Strategy, the purpose of which is to bring about a new hard currency east of the Rhine and north of the Alps, unencumbered by the deficit countries and France? I know which interpretation I would place money on.
