A leopard never changes its spots – Jens Weidmann, ECB President aspirant

Various people are vying for the key positions in the European structures (EC President, ECB head, and a range of other positions) at the moment. The presence of French and German interests typically dominate these outcomes, although as a result of the Treaty of Lisbon changes, more weight was given to the jockeying of the various political coalitions that find their way into the European Parliament. But that process has new been compromised by the decline of the traditional parties as other political forces (Greens, En Marche, Liberal Democrats etc) have gained ground. So Europe is back to its Franco-German rivalry and emerging out of that process is the unthinkable – Bundesbank President, Jens Weidmann – becoming a front-runner to take over the ECB role. He is a man with a past and his current ‘political’ statements, as he lobbies for the position he clearly covets, appear to contradict that past. A leopard never changes its spots. Beware.

Weidmann and the Emminger Doctrine

During the European Summer of 1992, the European Monetary System (EMS) was in a state of crisis.

After the Treaty of Maastricht was pushed through the nations entered the next phase – meeting the convergence criteria for euro adoption.

At the time, there were massive disparities between the prospective Member States in terms of international competitiveness (measured by the so-called ‘real effective exchange rates’) and convergence via exchange rate adjustments had become impossible due to their membership of the EMS, which began life in March 1979.

The upshot was that adjustment could only come via austerity and cost (wage) cutting. As nations struggled to meet the convergence criteria, which meant bringing their inflation rates down among other things, unemployment in many Member States skyrocketed.

Further, France had embarked on its ‘Franc Fort’ (strong franc) obsession, which meant it tried to match German inflation rates with other nations following suit.

The strains this process generated meant that the EMS endured many forced realignments as the central banks struggled to maintain the exchange rates within the narrow tolerances specified under the EMS rules. These realignments were discouraged after the signing of the Basel-Nyborg agreement in 1987 and nations were forced to rely much more on interest rate adjustments to maintain the parities.

It was a mess.

The major reason that there was any currency stability, however, was because capital controls were still in place and prevented some of the speculative movements that would have normally destabilised the nations’ exchange rates. Italy relied on capital controls extensively and only started to withdraw them in 1988.

But the Monetarists hated capital controls because they impinged on their ‘free market’ ideal, and so, they were eventually eliminated as a policy choice for all nations by the Single European Act of 1986, which stipulated that all capital controls were to be abolished by July 1, 1990. There was a slightly longer phasing out period agreed for Ireland, Greece, Portugal and Spain.

Once capital controls were eliminated, central banks became vulnerable, as they had to focus policy on defending the nominal exchange rate parities. And with the rising instability associated with the signing of the Maastricht Treaty, this vulnerability became acute.

It was heightened by the referendum failure in Denmark on June 2, 1992, which brought some reality back into European financial markets by pricking the false bubble of currency stability.

It was also obvious that all the components of the convergence agreement would not be met. For example, to maintain the exchange rates within the narrow tolerances agreed, some nations would have to increase interest rates, which would violate the undertakings with respect to maintaining narrow interest rate differentials.

The Bundesbank didn’t help matters when it pushed up interest rates on July 16, 1992 because of its concern for rising inflation associated with the reunification.

The German central bank was conflicted. It was the anchor of the mark but also dominant in the EMS. By keeping rates high, the Bundesbank forced this interest rate regime onto its neighbours at times when they faced recession and unemployment was already high.

The increasing political backlash to the high unemployment raised further doubts in the financial markets as to the commitment by policy makers to maintaining the ‘no realignment’ policy.

The crisis that emerged in mid-1992 onwards and saw the lira plunge in value, the French franc come under unsustainable pressure, and the Bundesbank resist using the mark to help stabilise the other currencies, culminated in the Black Wednesday (September 16, 1992) when the British pound was attacked.

These events saw the pound leave the EMS along with with the lira, a major devaluation of the Spanish currency.

The instability continued through the Summer and Ireland, Portugal and Spain (for the second time within a few months) were forced to devalue.

The 1992-93 crisis demonstrated that the system of fixed exchange rates or even tightly linked exchange rates between economies that were disparate in structure and performance would always fail with mobile capital.

The damaging behaviour of the Germans (failing to reduce its interest rates and use the mark to engage in symmetrical intervention) brought back memories of the famous – Emminger letter – written by the then Bank President Otmar Emminger to German Chancellor Schmidt on November 16, 1978.

The letter sought to confirm an “agreement” between the Bank and the German government such that membership of the proposed EMS would allow for an “opting out” of the Bundesbank’s responsibility to support other exchange rates if “internal monetary stability is threatened”.

Schmidt annotated the letter with a lower case ‘r’, shorthand for ‘richtig’ (correct) to signify agreement.

In other words, if the Bundesbank thought that it would be undermining its anti-inflation approach by selling marks in order to purchase weaker currencies as part of its intervention obligations under the EMS, this agreement allowed it to simply renege and let the other nations lose reserves and enter crisis.

The German government also ensured there was no formal agreement along the Emminger lines, but a ‘secret’ informal arrangement was understood.

The Emminger ‘opt out’ forced the Italians out of the ERM in 1992 when the Bundesbank vigorously opposed the devaluation. The resulting forced devaluation then turned the attention of the financial markets towards the pound and Black Wednesday was the result.

It was replayed again when the crisis re-emerged in the Summer of 1993 as recession became more entrenched and central banks around Europe were signalling a need to lower interest rates, to provide some stimulus support.

Far from learning from the mistakes, the politicians claimed that the currency crisis in 1992-93 was evidence of the need to accelerate the move to the single currency.

I cover these events in detail in my book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015).

The reason I remind readers of these events is that while the ‘Emminger Doctrine’ brought the EMS to its knees in 1992-93, the sentiment and arrogance still resonates and came out again during the GFC.

David Marsh wrote in his MarketWatch article (October 14, 2014) – Germany finds historic parallel for opting out of QE – that the Bundesbank was seeking ways in 2014 to “block full-scale European QE, which it believes would transmit wrong policy signals and expose it and German taxpayers to large capital losses.”

He notes that the Bundesbank was deeply opposed to the “ECB’s untested outright monetary transactions (OMT) bond-buying program”, which at the time (2014) was being challenged in the European Court of Justice (ECJ) by several Germans, who claimed it violated the Treaty prohibitions on “the direct financing of national governments by the ECB”.

Marsh pointed out that Jens Weidmann, the aspiring ECB President, “has been known to cite Emminger approvingly in his speeches”.

March also argued that the ‘Doctrine’ was invoked during the March 2013 Cyprus crisis when the ECB delivered an “ultimatum to Cyprus” to agree to the IMF bail-out package or go broke.

Weidmann on QE – circa 2010

When the ECB introduced its Securities Markets Program in May 2010, which saw the protest resignation of the fiscally-conservative boss of the Bundesbank, Axel Weber in early 2011 and the later (November 2011) resignation of ECB Executive Board member, German, Jürgen Stark, Weber’s successor as head of the Bundesbank, Jens Weidmann maintained the criticism in a speech given to the SUERF/Deutsche Bundesbank Conference in Berlin on November 8, 2011 – Managing macroprudential and monetary policy – a challenge for central banks.

He told the audience, at the time the ECB accelerated its SMP purchases in 2011 to quell the rising bond yields on Italian government debt, that:

One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, in colloquial terms also known as the financing of public debt via the money printing press. In conjunction with central banks’ independence, the prohibition of monetary financing, which is set forth in Article 123 of the EU Treaty, is one of the most important achievements in central banking. Specifically for Germany, it is also a key lesson from the experience of the hyperinflation after World War I. This prohibition takes account of the fact that governments may have a short-sighted incentive to use monetary policy to finance public debt, despite the substantial risk it entails. It undermines the incentives for sound public finances, creates appetite for ever more of that sweet poison and harms the credibility of the central bank in its quest for price stability. A combination of the subsequent expansion in money supply and raised inflation expectations will ultimately translate into higher inflation.

This clearly reiterated the Bundesbank’s obsession with inflation and its tendency to ignore the reality outside of Germany.

Whatever spin one wants to put on the SMP, it was unambiguously a fiscal bailout package. Weidmann was correct in that sense.

History tells us that Weidmann’s inflation fears were unfounded and reflected the fact that German economists (in the main) and economic policy makers have become locked in a time warp that centres on the 1920s.

On September 26, 2012, Weidmann explained in an interview with the Neue Zürcher Zeitung – There is no point in trying to dress up the facts – why he was the only ECB Governing Council member “to vote against the new bond purchase programme”.

He outlined his reasons:

I see a number of arguments against the programme. They include stability policy principles and the question of whether the central bank has a democratic mandate for a measure of this kind. The programme spreads liability risk among euro-area taxpayers. That is something only parliaments are allowed to do, and the rescue packages are the right tools for the job. Central bank funding must not become entrenched as a catch-all solution to all our woes. And then there’s the question of whether the programme ultimately does more harm than good. If central bank assistance eases the pressure on politicians to push ahead with reforms, that could hinder and delay the process of overcoming the crisis …

If the central bank moves into that kind of territory, it could become ensnared by its own policy and forfeit some of its credibility.

In the same interview he also challenged the justification that the ECB gave for the large-scale bond purchasing programs that it was to smooth out the “monetary policy transmission” process.

This justification was, of course, just a ruse to get around Article 123. Everyone knew the ECB was funding fiscal deficits in contravention of the Treaty but they dressed it up as a liquidity measure.

Weidmann admitted as much.

He was asked whether it was the ECBs remit to “maintain the euro area and the euro” and replied:

Our job is to maintain the euro as a stable currency within our mandate. We cannot and must not dispute political decisions regarding the composition of European monetary union …

So the fact that the ECB save many nations from insolvency during the crisis was not a justifiable intervention in Weidmann’s eyes.

For Weidmann, financial stability was less a focus and:

… price stability takes clear precedence for the ECB – it is our primary objective. Our financial stability mandate is secondary to this aim and is not a blank cheque.

In an interview on March 21, 2014, Weidmann told MNI that:

… we have to ensure that the prohibition of monetary financing is respected.

That is all on the public record.

So what now?

In the Zeit Online publication – Jens Weidmann bekennt sich zu Anleihekäufen (June 19, 2019) – we read that:

1. In lobbying for the position as President of the ECB, Jens Weidmann has said (translated from the German):

… he now considers Outright Monetary Transactions (OMT) – an instrument that has proven controversial in Germany – to be consistent with European law and that he feels obligated to uphold the policy.

So a few years ago he opposed it and thought it compromised ECB credibility, was illegal under the Treaty, and would lead to inflation – yet now it is “current policy” and is ok.

The article quoted him as saying:

My position, though, was not legally based. It was driven by the concern that monetary policy could get caught in the wake of fiscal policy. Of course, a central bank must act decisively in the worst-case scenario, but given its independence, there should be no doubt that it is acting within the framework of its mandate

So what difference does it make that the European Court of Justice rubber-stamped the ridiculous ECB justification that the program was just part of its liquidity management brief?

Even if it is ‘legal’, what about the other concerns that Weidmann expressed including his upholding of the Emminger doctrine.

So his current justification for his position change based on the fact that the ECJ has ratified the legality of the ECB’s massive bond-buying program is hardly the issue.

One would be surprised if he still continued to claim illegality in the face of the Court’s decision.

The more important point is that his projections about the program – as “more harm than good” and his claims that inflation would result and all the rest of the mainstream macroeconomic myths – raises the question of his suitability for the position.

Has he really had a ‘Paul the Apostle’ sort of conversion?

Where was Damascus for him?

Jens Weidmann should be forced to explain to all and sundry why he is a suitable ECB President given his past claims about ECB policy, which, as he admits, remains “current”, and which he would be responsible for.

The reality is that he was wrong in the first place and his predictions and resistance were reflecting the German inflation angst and the application of flawed mainstream macroeconomics.

But that doesn’t alter the point.

Conclusion

If ‘leopards do not change their spots’ and Weidmann is elevated to the ECB Presidency then we can expect instability to arise.

How will he keep the system intact without the ECB funding government deficits, something he is implacably opposed to?

His comments above suggest he thinks creating crises and financial instability to the point that a nation is forced out the currency union is acceptable as long as the ECB keeps inflation stable within its mandate.

He also should explain how the ECB is going to actually meet its price stability target given that inflation is plunging and the target has not been met for years.

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.