Tuesday, 11 February 2014

It's the Euro, stupid

A few days ago the German constitutional court referred the question of the legality of the ECB’s Outright Monetary Transactions (OMT) to the European Court of Justice (ECJ), claiming that the ECB was straying into fiscal policy that was beyond its mandate and that OMT breached EU treaty directives outlawing monetary financing of governments.
The question of the legality of OMT has been a running sore ever since it wasfirst mooted in August 2012. The ECB has clearly stated that it regards OMT, or rather the threat of OMT, to be part of its monetary policy toolkit. It has nothing whatsoever to do with bailing out Eurozone sovereigns, although that may be an incidental effect. It’s all about the Euro.....
Read on here.


  1. I think there are two distinct ways to think about the ECB and the euro, and in this piece you have one of them spot on. To keep the euro intact, the ECB has to have all the tools a normal central bank has at its disposal, including OMT. Remove OMT, and as you say, you invite speculators to take on the euro, and if some do, others will follow.

    But I think that there is another way of thinking about this which contradicts the first, and that is to say that the Treaty that created the ECB was written by national politicians who wanted to avoid OMT, or any other form of fiscal transfer, explicit or implicit, from member state to member state, and the central supervision of national budgets that follows.

    When contradictory statements describe the same situation, the real contradiction must be in the setup itself. And it is. Without OMT the euro eventually breaks up, but with OMT you have at least implicit fiscal transfer - and fiscal transfer decided by the ECB, not by the member states.

    And I think that the origin of this contradiction is easy to spot. The member states that joined the euro wanted a common currency, but they didn't want the surrender of fiscal sovereignty that goes along with a common currency, so they went along with the pretence that they could have a common currency without fiscal transfers.

    Only time will tell if they really thought they could have one without the other, or if they were binding their own hands, knowing that in the fullness of time, OMT would arrive no matter what they claimed to want.

    1. Good point. I'm planning to write about the quasi-fiscal nature of ECB monetary operations involving sovereign debt - whether it is OMT, SMP, ELA, LTRO or good old-fashioned open market operations. Or QE, which some people are calling for. All of them in their own way involve implicit fiscal transfer and pooling of debt obligations. Am I right in thinking that the Germans actually object to all of them?

    2. Frances, glad you are bringing this up. Seems to me the outcome of OMT/non-OMT and the alphabet soup of indirect fiscal transfers is a EU and EZ political decision. The financial solvency situation will dictate timing. Despite the provocativeness of Hr. Sinn, at the end of the day the EZ core want to keep the Euro, but have different agendas as to how to control it. The French want "more Europe", i.e., the French influencing fiscal transfers and how it would most benefit their seat at the table - gladly enabling ECB with a tool chest even if it means the french taxpayer is left on the hook. The French need solvent trading partners to buy their goods and services and improve their own standing. Even eventually leading to a French-oriented centralized fiscal regime in Europe.

      The Germans, however, want something like "less of more Europe" - also to control fiscal transfers (despite taxpayers dislike) but to protect the credit risk they have as they are the largest creditors in EZ and they don't want to see the debtors ruined. But they don't seem to want to go so far as the French with a common fiscal policy - probably because they know they can go just as well without it, while the French can't. Obviously, for the Germans their agenda is a much tougher sell to the electorate than the French. I suppose Merkel doesn't have an easy job to do, but that's her job..

      So the key decision makers in this game both want to retain the Euro, but for their own different reasons. Then, the amount of actual fiscal transfers to take place is a factor of the waiting game - how long it will take (with some measure of reforms) for the debtor countries to reduce the outstanding risks and fiscal transfer amounts. This waiting game will also decide which acronyms the ECB will deploy. But that is all technical compared to the bigger picture.

      I think at the end of the day, both the French and Germans will do "whatever it takes" to protect the EZ from "OMT arbitrage" but use the OMT issue as a lever to pursue their divergent agendas.

      Being a banker myself, it would be foolish to run a position against the ECB. But all this isn't a finance or economic issue, it's a political one. Just like the the reason the Euro was founded in the first place.

  2. "Interest rates spiraling out of control in periphery countries threatened to destroy the monetary union in 2012 and could very easily do so again."

    Interest rates are just a symptom of deeper monetary imbalances IMO. If most money is created as debt through lending activities of banks then massive imbalances in areas such as housing and lending markets are likely to occur due to profit chasing. If money is allocated evenly by the central bank to the wider population then these imbalances are much less likely to occur.

  3. I cannot understand what the German gripe is or why anything to do with the Euro as a currency can be against German law. A central bank was created to manage the Euro and the Germans should know what a central bank does. The only possible question could be "was it illegal to join the Euro in the first place?" A constrained central bank is the most absurd illogical construct I have ever heard.

    The problems stem from the fact the EZ is not an optimal currency area and that the Germans never got to vote on it. To claim that a clearly (?) designed trans-national currency area could come under one nations national laws is patent nonsense. It is a matter for the ECJ and clearly their jurisdiction. I repeat it was either legal or not for Germany to join in the first place. bill40

  4. If the ECB starts OMT then things get very political. If the treaty is broken then whats to stop, Spain for example, simply instructing its central bank to buy spanish bonds. Or Nationalising a Bank and doing the same thing. It would require a new treaty perhaps.

  5. On a related subject, I'd be interested to hear your thoughts on the choices facing a (hypothetical) independent Scotland.

    - do you think Scotland could reasonably use the pound without official support from the UK?

    - assuming it was politically possible, do you think the Scottish economy would be a good fit for the Euro at the moment?

    - is creating an independent currency any safer?

    And from the UK's point of view:

    - is ruling out a currency union really the only option - or could the Bank of England somehow set up a scheme that lets both parties keep [most of] their sovereignty, and perhaps sees Scotland paying the UK a levy for the extra protection its banks would receive?

    1. Hi Alex,

      I have actually written about this before: http://coppolacomment.blogspot.co.uk/2012/01/scotlands-currency-conundrum.html

      However, I'm planning to respond to the ASI & IEA's arguments that Scotland using sterling "without permission" is a good option. I don't think it could possibly work without some kind of backdoor support from the Bank of England, simply because of the size of Scotland's banking sector (something like 12 times its gdp) and the fact that most of their assets are south of the Border.

      However, in all these discussions, no-one ever considers what the banks themselves would choose to do. I suspect the three big Scottish banks would reincorporate in England if faced with an independent Scotland and no currency union. I'll explain why in the post.

    2. And here's my new post on Scotland and the banks. It's quite long!


      I haven't considered your last point about the UK providing central bank support to Scottish banks for a fee. I guess this would be a possibility, though of course in a crisis the extent of liquidity support needed could far exceed any fees paid. Probably the Bank of England would have to provide the liquidity, then recover it in the form of penalty charges. But there is significant political risk involved in this: suppose Scotland simply refused to allow its banks to pay penalty charges for crisis liquidity already received? I can't see the UK Treasury being too happy with this. It's more moral hazard, really.

  6. The situation is not as as urgent as it seems. Still 2 years to go. No urgency involved. 2 years won and 2 years lost. OMT does not stand alone. I think it's related to the ESM.

    The Germans fear a devaluation of the EURO. If you look at historic charts USD vs. ATS, DEM, ES Peseta, IT Lira you immediately see that there are two philosophies involved - hard vs. weak.

    I use this for comparision - http://fxtop.com/en/historical-exchange-rates.php

    The EURO is no good idea at all. What happend in practice. Another 2 years won somehow or lost.

    The only currency that is very close to the USD is the French Franc. Over 50 years somehow 1:1 the USD. The EURO is somehow the French Franc in best case. It's a weak currency because Europe in general has been weakening for decades now.

    Agree. The EURO system does need a printing press. Europe does not need one. That's a difference.