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On May 7 2012, Jens Weidmann, the president of the Deutsche Bundesbank published an article in the Financial Times titled “Monetary policy is no panacea for Europe’s ills“. From the title one might expect to read a series of well-documented arguments forwarding the thesis point of the article. However in Mr Weidmann article this is not the case. Instead it is a text replete with misleading remarks and quasi-moralistic demands. His suggestions are in fact used to present in a good light the policy of his institution -the Bundesbank- and the overall approach of the German government to the crisis.
I could comment upon each and every paragraph of his article, at the risk of frustrating the reader, but instead of doing so I will only focus on the following pontification of Mr Weidmann, which is enough to destroy his case. As an introductory remark, allow me to say that in truth his article has nothing to do with monetary policy. It rather is a litany of normative statements arguing how prudent central banks have been, how important their independence is and why governments ought to implement austerity measures (emphasis on the quote is mine):
…[T]he funding of banks that are not financially sound or against inadequate collateral would shift substantial risks between national taxpayers. Such implicit transfers are therefore beyond the mandate of the eurozone’s central banks. Rescuing banks using taxpayers’ money is something that can only be decided by national parliaments.
There is much that is wrong with this statement. Above all it reproduces the erroneous rhetoric of “transfers”, implicit or not, with a clear intention to practically suggest that German taxpayers are in one way or another bailing out the banks of the GIIPS. Nothing could be further from the truth. The word “transfers” either implicit or explicit, direct or indirect, is an imposter term when speaking about the operations of the monetary system. What Mr Weidmann, and the other devoted “ordoliberals”, call “transfers” are just the normal, daily operations of any currency union operating under a fiat monetary system.
Refuting the misleading arguments of transfers
One of the necessary elements of a monetary union, such as the eurozone, is that its currency, the euro, must always have the same value regardless of the country in which it is circulating. This means that a 100 euro deposited in a Greek bank must always have the exact same value with an equal amount of euro in a German bank. Though on the face of it this might sound obvious, in fact this is not at all a “natural” feature of the currency. On the contrary there is a very sophisticated payment mechanism in place allowing for the smooth, automatic extension of credit between banks to create this effect. This is what Mr Weidmann falsely calls “implicit transfers”.
To understand why this is the case, one has to realize how a currency is evaluated. We shall consider two simple examples. At first assume that Greece and Germany have their national currencies. Then let’s imagine that in present time 100 drachmas are equal to 100 deutschmarks and we allow the economy to work on its own over time, without any intervention whatsoever. Under these absolute free market conditions the value of each currency is a function of a complex, interweaving web of causes. Some of these are the amount of money in circulation, the demand for it, the conditions in the economy, future expectations, the prevailing interest rates and so on. In short, the value of each currency would ultimately be determined on the market. Understandably if the market considered the deutschmark as a safer currency, because the German economy is more reliable than the Greek, then the deutschmark would be appreciated with respect to the drachma. Hence the initial 100 drachma = 100 deutschmark rate could easily become 200 drachma = 100 deutschmarks. The only way through which their mutual valuation could remain fixed at all times, would be for the central banks of each country to intervene and adapt accordingly to all those factors, by fine tuning their operations. Otherwise the market will scarcely ever treat these currencies as of having an equal value.
The same applies in the eurozone, even though each country uses the same currency. If we were to assume that no interventions from central banks exist, and that the eurozone uses only euro, we would eventually see that a German euro coin would have more (expected) value than a Greek euro coin, exactly because the forces of the market would favor the former rather than the latter, for obvious reasons. For the euro to be of equal value all across the eurozone, the National Central Banks and the ECB need to constantly extend credit to one another to counter the forces of the market and create this equilibrated effect of fixed currency evaluations.
These operations are handled by the TARGET2 payment system. In doing so they ensure that a euro in Greece will always be equal to a euro in Germany, regardless of market conditions.
This payment system becomes even more important and necessary during periods of severe financial stress such as today’s, where banks, operating under the modern fractional reserve banking system, find their selves short of credit because of a dearth in savings, continuous capital flight and due to their inability to access the capital markets at any reasonable price. Their only means of functioning is by resorting to the payment system as outlined above, to finance their daily activities and keep their ATM’s active. The process would thus go as follows: the local bank needs money to carry out a transaction » it contacts its national central bank, asking for the creation of the respective amount » the national central bank creates the money necessary for the transaction and sends a claim, through TARGET 2, to the eurosystem.
Such a process is automatic and has nothing to do with transfers of any “real” money, certainly not of taxes. It is a common feature of our modern fiat monetary system, where central banks create money out of thin air (whether that is desirable or not is another issue). As for the actual claims and the potential risk they bear, this can only make sense if the eurozone was to collapse altogether, since member-states are partially exposed to one another via this system. Thus the point of Mr Weidmann, fallacious as it undoubtedly is, seems to be grounded on the assumption that there is a high chance for the eurozone to collapse any time soon. Even though such a possibility can never be ruled out over the medium to long term, the chances of it happening in the short run are minimal.
If we strip away all the technicalities of the above analysis we realize that from a money point of view a monetary union can never be treated as an amalgamation of nation-states, with “transfers” between them.
It is therefore clear that no transfers whatsoever take place in the sense that Mr Weidmann purports to show: as taxes of Germans channeled into (quasi-)bankrupt peripheral banks. To present a regular function of a capitalist, fiat monetary union as “implicit transfers” is flatly wrong and insistence on this terminology is pernicious. There is no particular criterion to base this misleading remark beyond that of short-sighted nationalistic politics.
German banks are among the greatest beneficiaries
Yet this is not the end of Mr Weidmann’s problem, for the above quote also includes another dubious assertion. Namely that “rescuing banks using taxpayers’ money is something that can only be decided by national parliaments”. By presenting this alleged truism, Mr Weidmann fails to realize that if it were to be taken as a universal axiom it would ultimately be to the detriment of the Bundesbank and the German economy.
We know well that German banks are heavily exposed to the eurozone’s periphery. When the ECB used its SMP programme to buy government bonds of peripheral countries, or when it pumped €1 trillion into the european banking system through the two tranches of its LTRO loans, German banks were among the beneficiaries. Either because the governments that owed them money, found the cash to pay them back; or other domestic private banks tried to cover their own liabilities to them, such as Spanish banks who are heavily exposed to the property bubble and who are interwoven with German capital; or the German banks themselves gained direct access to these funds. After all, as the Financial Times reported, more than half of the 800 banks that received the second tranche of the LTRO were German banks, while Deutsche Bank, one of the world’s most leveraged banks, recently capped almost €10 billion from the ECB. In case Mr Weimann did not realized it, all this was never approved by any national parliament, but only by the governing board of the ECB, without any parliamentary scrutiny.
Given that the large German banks are among the ones with the highest leverage ratios in the eurozone, it is natural to expect that they welcome the cheap money from the ECB to raise capital, so as to meet the capital adequacy criteria, by June 30, 2012; or to make some easy profit in the meantime. I really do not think that Mr Weidmann would like this money-printing bonanza to pass from any parliament, because then, German banks could risk running short of funds, with whatever implications this would have on their stability and their sustainability.
By the way allow me to use the words of Mr Weidmann to pose a rhetorical question: does this “funding of banks that are not financially sound or against inadequate collateral” really “shift substantial risks between national taxpayers”? If yes, then the distinction between monetary and fiscal policy is completely obliterated and so the much-vaunted independence of any central bank becomes absurd and meaningless…
Mr Weidmann propounds a series of self-serving arguments, perhaps very useful for the cheerleaders of pseudo-nationalistic yellow papers such as Bild, who are enamored with such oratory and who will delight their selves with “analyzing” the “oracular wisdom” of their Bundesbanker. In truth Mr Weidmann’s article seems as if it was written by the spokesperson of Madame Merkel and not by the president of the Bundesbank, who cares so much about the “independence” of central banks.
I believe it is high time we abandon this hypocritical, polarizing palaver. It serves no one to play the game of “the good, the bad and the ugly” during these times of crisis, where dogmatism can only lead to unpleasant outcomes.
Image credit: L’express