Bogenberg Declaration: Sixteen Theses on the Situation of the European Monetary Union
1. Causes of the crisis
2. Germany: The euro winner?
Germany was not able to achieve above-average growth until after the outbreak of the euro crisis in 2010 and 2011. However, that was partly because it had already survived its own euro crisis through years of restraint in terms of wages and prices accompanied by strenuous efforts on the part of businesses, and partly due to a revised assessment of foreign risks, which induced German investors to keep their money in their relatively safe home port. The economic recovery of the last two years was indeed primarily driven by investment. They enabled Germany to work its way up from eleventh to ninth place in the ranking of EU countries. So the current success is not achieved thanks to the euro, but actually despite it, and because of its crisis.
3. Just a confidence crisis?
4. Unsanctioned self-help via the printing press
The Bundesbank has by now amassed almost 500 billion euros in compensating claims (Target claims), which earn little interest and cannot be called due. If the euro area had adopted the rules of the US monetary system, the Bundesbank would have received marketable securities from the crisis-hit countries instead of mere compensation claims against the ECB. This would have significantly stemmed the tendency to resort to the money-printing press.
Aggregated over the period 2008-2010, the current account deficits of Greece and Portugal were financed practically in their entirety by the money-printing press. Only recently the printing press slowed down as the community of states finally came to the rescue with public bailout initiatives. The euro area is currently entering the fifth year of what effectively amounts to a full rescue of Greece, and to a large extent of Portugal as well. In the case of Spain, a significant share of the current account deficit has been financed with the printing press. Ireland printed a lot of fresh money to compensate for capital flight. Like the USA under the Bretton-Woods system in its day, the crisis-hit countries are effectively playing the role of reserve-currency countries, and have covered their financing deficits vis-à-vis other countries with money that they have printed themselves instead of with private loans and money inflows from other countries taken at market conditions.
The Bundesbank mopped up the inflowing liquidity through a retrenchment of refinancing credits and by borrowing from German commercial banks. It has meanwhile become a net debtor of the German banking system.
In a further development, massive capital flight from Italy and France to Germany started in the summer of 2011. German banks and insurance companies are withdrawing their loans on a large scale, while at the same time an increasing number of investors from these countries have taken a heightened interest in German assets, real estate in particular. The Italian and French central banks are compensating for the capital flight with freshly printed money, in exchange for which Germany must content itself with Bundesbank Target claims on the ECB. The printing presses in Italy and France are overheating while the inflowing money is shredded at the Bundesbank. No limits to this process have been set to date.
5. Missing proceeds
In the three years from 2008 to 2010, Germany accumulated a current account surplus of 264 billion euros vis-à-vis other Eurozone countries. But in net terms this did not translate into it acquiring titles to assets abroad, such as factories, real estate or securities. Instead, fully 255 billion euros, or 96% of the entire surplus, was “settled” with Target claims of the Bundesbank on the ECB. The meagre remaining 4% corresponded to other claims, half of which were claims derived from public rescue operations.
The private sector benefited from this inasmuch as it helped to reduce its indebtedness to the commercial banking system and the Bundesbank. Some may consider this sufficient compensation for the trade surplus. But in this process the Bundesbank exchanged domestic claims on the German banking system for foreign claims on the ECB which no one knows how to call due should the euro disintegrate and the ECB be folded. The recapitalisation of the Bundesbank through tax increases that would be necessary in such a case would probably annihilate the entire private wealth increase resulting from the trade surplus in the three years under consideration.
Trade surpluses are, of themselves, no badge of success, as politicians are wont to proclaim. They are only useful if they help it to acquire safe assets yielding market-driven interest that can in turn help to secure the standard of living in times of need, by running up current account deficits. If Germany had to write off all or part of its Target claims on the ECB, its export surplus vis-à-vis the other Eurozone countries would be for nought, mere donations that did not make the country any richer. The Germans would have then worked for nothing.
6. Overstepping the mandate
This was a clear breach of the prohibition to monetise the public debt enshrined in Article 123 of the EU Treaty. The two German representatives to the ECB Council have resigned in protest, and German President Christian Wulff has accused the ECB of circumventing the Maastricht Treaty. The new Bundesbank president, Jens Weidmann, fights a losing battle; just as his predecessor, he is always overruled in the ECB Council. German politicians should not take this sitting down.
The financial help provided by the Bundesbank is essentially of a fiscal, not monetary nature. For one thing, the effects on the money supply, as the ECB itself repeatedly emphasises, are sterilised. For another, these aid operations shift massive amounts of capital, with all the attendant risks, among the countries in the Eurozone. They should have been sanctioned by the corresponding parliaments.
The original mandate of the ECB was to follow the Bundesbank model, not to ram through its policies in opposition to the Bundesbank. It is preposterous that the ECB Council, in which Germany is underrepresented, should claim the right to allow a group of countries to solve their external funding problems by resorting, over long periods, to the money-printing press. What was originally intended as a short term transaction credit cannot be used as a permanent source of funding. Whoever tolerates or, worse, encourages this oversteps his mandate.
Therefore, one of the highest priorities for German politicians should be to change the rules governing the actions of the ECB. At the very least, Germany cannot agree to any change in the treaties that envisages an expansion of the rescue operations if no measures are agreed beforehand on limiting the self-service with the money-printing press, by adopting for instance the US rules for settling Target balances with marketable assets.
Should the ECB indeed be authorised to grant credit to the member states, be it through a systematic shifting of refinancing credit among the countries or through the purchase of government bonds, it must have a decision-making system like the one agreed for the bailout operations between countries. Under that system, the voting rights reflect the liability structures present, requiring unanimous approval for landmark decisions.
7. Gigantic liabilities
Politicians stick to the position that the guarantees associated with the rescue packages will not be drawn, that the leverage of the rescue fund will not lead to an increase in the risk for Germany, and that there won’t be any need of increasing the Bundesbank’s equity to compensate for write-off losses. This position is no longer credible. If it should indeed turn out to be so, it would only be thanks to the rescuers making it possible for the rescued, through open fiscal transfer, to service their debt. In other words, the rescuers would repay themselves the loans they granted.
The assumption of such gigantic liabilities will sow discord throughout Europe. It will force through a transfer union which entails a stealthy expropriation of German savers and undermines trust in the state.
We fear that this is but the beginning. The public debt of the crisis-hit countries (Greece, Ireland, Italy, Portugal and Spain) amounts now to 3.35 trillion euros. We consider the establishment of systems that open the way to an expansion of the liabilities irresponsible. The German government should not agree to them.
8. Monetising public debt
For one thing, the liabilities of the financially sound countries for the ordinary public debt and the Target debt of crisis-hit countries would increase even further. High burdens associated with the replenishment of the Bundesbank’s equity would be well-nigh inevitable.
For another, the Central Bank could no longer fulfil its mandate of safeguarding the stability of the currency, since the incentives to submit sound budgets in future would be further weakened. The growing debt burden, associated with the already gigantic Target liabilities, would exert growing political pressure to resort to an inflationary policy, which the ECB would ultimately be unable to resist.
The stability of the currency, however, is a basic requirement for the internal peace of a society and also for the future of the monetary union. This is precisely the reason why the EU treaties prohibit the monetization of public debt. The blatant perversion of law demanded by the European Commission undermines trust in the monetary union and the stability of its currency. Were the European Monetary Union to cave in to this demand, it would definitely lose the inherent basis for its contract.
The yields currently demanded for Italian and Spanish debt, described by some as intolerable, are within the levels that Germany itself had to pay during the 1970s and 1980s, and far below the rates that these countries had to pay before they adopted the euro. We do not share the opinion that the markets are exaggerating the risk and that, for that reason, measures to check the yields are called for. There is still a chance that the interest rates will stabilise at a high level.
Eurobonds would be inordinately expensive for Germany, since they would increase the interest burden on German public debt by many dozens of billions of euros per year. Eurobonds with joint liability were rightly prohibited by the German Constitutional Court; if Eurobonds with pro rata liability were the financial instrument preferred by the markets, they would have been long offered by private investment funds.
10. Restrictive rescue policy
Politicians are tending at the moment towards ever larger rescue packages and believe that they can preclude abuse by imposing conditions on the recipient countries that reduce the scope for decision-making of the local political instances. This provokes strife because the unpopular measures are attributed to the helping countries and not to the result of local faults. Germany and Europe are cast increasingly into the role of scapegoats and are the subject of demagogic attacks.
Better than prescribing behaviour is to restrict the rescue funds. That is the only credible middle way. It must be made possible, however, for the countries for which the restricted aid is insufficient and which would face excessive price deflation to regain competitiveness to leave the monetary union.
11. A transfer union?
If the path towards a transfer union were nevertheless to be pursued, much farther-reaching reforms must be adopted before this happens that introduce a common European, federally organised nation state and that also require significant concessions from the other member states. This requires not least the complete integration of the armed forces under a joint command, a common foreign policy and the extensive surrender of national autonomy. In the best of cases this can only be achieved in the long term. It must furthermore be ensured that the transfers go from the rich to the poor countries and not, as at present, from those who abide by the rules to those who break them.
12. Interest rate spreads and current account balances
13. Pre-programmed conflicts
This initially led to a calming of the markets, but it also meant that the risks of the excessive private and public sector consumption of the financially unsound countries have been imposed on the economically more solid countries. In the final analysis, the latter must now take the place of the existing creditors of the indebted countries and try to collect the delinquent debts. Strife and discord among the peoples of Europe are all but pre-programmed. The Federal Republic of Germany should stay as far away from this as possible.
14. Reassuring capital markets or the citizens?
A continuation of the current policy will place excessive strains on Germany and will make the country poorer, especially if it should succeed in reassuring investors by taking the toxic government bonds off their hands. This shifts the burden onto future generations of Germans and reduces their opportunities to enjoy economic prosperity and social peace.
15. Institutional debt barriers
Political barriers to indebtedness are of course not harmful. But the time for subduing over-exuberant creditors and debtors has long passed. The capital markets are no longer prepared to meet all the financing demands of countries in crisis, and thus foreign loans are primarily coming via the instruments of Community financing. In order to insist on debt discipline in such circumstances, political barriers that are co-defined by the borrowers themselves are not what is needed. Instead, placing limits on lending by the public creditors is perfectly sufficient.
A fiscal union with more effective intervention rights of the EU or intergovernmental bodies will, we fear, have the opposite effect of what the German government is intending. It will tend to facilitate, if not increase, lending between countries because it will give the deficit countries a political voice in accessing the loans from the bailout fund.
16. Too much competitiveness?
The fixation of policymakers on unit labour costs fails to recognise that the differences in unit labour costs in Europe largely came about as a result of capital movements, which, as we have explained, resulted from the interest rate convergence generated by false expectations and wrongly-conceived banking regulations. If the differences in unit labour costs are to be reduced, the crisis-hit countries must be allowed to become cheaper and the surplus countries must become more expensive, but for that to happen we must not encourage the flow of capital between countries via excessive bailouts and jointly secured funding instruments that lead back to a condition of undifferentiated interest rates, which would again shift economic vigour away from Germany to the periphery. If the goal is for Germany to import more and the southern countries less, the self-correction of the European capital market that started after the crisis, with more German savings capital being invested in Germany, must not be blocked. Whoever attempts through government measures to force capital out that would otherwise not voluntarily leave Germany will be responsible for maintaining the external imbalances in Europe.
Policy-induced wage increases will weaken German exports, but because of the weakening effect they could lead to a contraction of the German economy and a reduction of its imports, so that a reduction of the German export surplus would by no means be assured. What the other countries gain in competitiveness they could lose because of a reduction in German demand for their products.
17. An agenda
a) The ECB should again limit itself to purely monetary policy. It cannot assume the task of stabilising the European national banking systems, much less the member states themselves. This is the sole responsibility of the individual states or the Community itself. As long as the ECB is able to shift with its policies fiscal and other financial burdens between the states, it undermines and prejudices the decisions of the national parliaments.
b) Decision-adopting rules and the allocation of voting rights in the ECB Governing Council should be modified. It is not acceptable that a body in which the voting rights are completely decoupled from liability can adopt by a simple majority measures that impose on Germany liability risks amounting to hundreds of billions of euros.
c) The Target balances between the national central banks must be settled from now on once a year with marketable assets, as in the United States, to ensure that the national central banks’ money-printing presses will, in the medium term, only be used to the extent that this is necessary for the respective national money supply. A longer-term repayment plan could be arranged for the claims already accumulated. If easy access to money-printing is not blocked, the path towards Eurobonds and a transfer union is preordained.
d) Following a proposal made by the European Economic Advisory Group, a clearly defined sequence of support measures must be contractually agreed upon by the euro countries. A country that faces an acute fiscal crisis should for up to two years receive liquidity help. If, thereafter, the country still is unable to pay its maturing government securities, investors must bear the liability first. The international community can only be called on to avoid excessive risk, and even this protection should be limited to a certain proportion of GDP. Only then can the incentive to exercise caution be linked with the goal of preventing a panic in the markets in the case of a crisis.
e) The EU should help the stricken countries overcome their competitive problems and offer them opportunities for an economic recovery. These include assistance for the establishment of a tax administration and a functioning legal system as well as measures to support the respective governments in privatising state assets and enforcing reforms allowing more wage and price flexibility. Community support that goes beyond the aid described in point d), however, is not helpful since it creates a dependency on such assistance and an automatic mechanism that the donor countries can no longer escape.
f) Banks must hold sufficient capital in order not to be overstressed in cases of defaults of public and private borrowers. Otherwise, the banks can continue to de facto blackmail the governments to help them, in order to avoid the economic costs of a collapse of the banking system. Higher capital reserves reduce the incentives for speculation, and in cases of crisis they create a buffer to absorb the losses. Even government securities and loans to other banks are subject to failure and must be backed in the medium term by equity capital according to country-specific risks, following the rules that apply to the loans given to midsize companies. This makes government loans and interbank trading more expensive, but it is necessary to stabilise the banking system and the countries themselves. To the extent that the banks are unable to tap the capital markets, a mandatory recapitalisation by selling shares to the government or similar measures should be introduced, both to avoid a credit crunch and to give the state the opportunity to profit from a possible increase in the value of the banks.
g) Euro countries that are not willing or objectively unable to take the necessary measures to reduce imbalances and debt should be allowed to withdraw from the euro area and revert to the status of EU countries that are not in the Eurozone. Exiting the Eurozone should be mandatory in the case of default, and the relevant procedures should be contractually set out. Only a monetary union that remains a voluntary confederation of states with respect for the mutually agreed rules has the hope of permanency.
This declaration was published in full on the editorial pages of the Frankfurter Allgemeine Zeitung on 7 December 2011.
We use the term “money-printing press” here as a metaphor only, as the international money flows booked through the Target system are, of course, not to be interpreted as physical flows. Also, terms like “money shredding”, “overheating of the printing press” and so on are mere metaphors to provide a reasonable heuristic for complicated booking phenomena. For details see, Sinn and Wollmershäuser, “Target Loans, Current Account Balances and Capital Flows: The ECB’s Rescue Facility,” CESifo Working Paper No. 3500, June 2011, and Sinn and Wollmershäuser, “Target Loans, Current Account Balances and Capital Flows: The ECB's Rescue Facility,” NBER Working Paper No. 17626, November 2011.
A New Crisis Mechanism for the Euro Area, EEAG Report on the European Economy 2011, Munich 2011.
Note: This text is the responsibility of the writer (Julio C. Saavedra) and does not necessarily reflect the opinion of either the person(s) cited or of the CESifo Group Munich.Copyright © CESifo GmbH 2004-2011. All rights reserved.