The Weimarization of Europe

A decade ago the European Central Bank had built itself up to be the epitome of strict monetary policy. The European Union was founded on a constitution that assumed that printing money was the same as creating massive inflation. Therefore, the ECB was supposed to keep money supply tight and not give in to any pressure, under any circumstances. While the Federal Reserve has to consider the overall macroeconomic situation in the American economy when it makes its monetary policy decisions, the ECB was supposed to focus exclusively on keeping inflation down by means of tight money.

Today, the ECB’s accommodating policies toward Greece and Spain have basically ruined its monetarist reputation. Eurocrats are working hard to shatter whatever is left of the ECB’s status by demanding EU treasury bonds, which would obviously be purchased to a large degree by the ECB. On top of that, the ECB is making completely open-ended commitments – it is ready to print whatever amounts of money it takes to keep Europe’s debt-ridden welfare states afloat. EurActiv reports on the bank’s latest commitment:

European Central Bank chief Mario Draghi faces the most decisive moment of his presidency today (6 September) when he tries to heal divisions among policymakers and deliver on his promise to save the euro. A leaked draft reveals that the plan includes buying ‘unlimited’ quantities of government debt from troubled countries. The leaked draft, seen by financial news agency Bloomberg, revealed that the ECB president has proposed unleashing a bond buying effort that would be ‘unlimited’.

This is a frightening perspective. There are three components to it:

1. The commitment itself means that the bank promises to print whatever money is needed for “troubled countries”. For those who believe that inflation comes from money supply, this means that it is time to significantly raise inflation forecasts for the euro zone. It also means a downward adjustment on the euro exchange rates vs. the U.S. dollar, the yen, the yuan and other major currencies. Contrary to the strict quantity-theory-of-money approach,  currency depreciation is indeed a source of inflation. The euro zone does not need an uptick in inflation, especially not at this point where all major macroeconomic indicators are trending negative.

2. Who defines “troubled countries”? Given how the ECB and the EU have poured everything they have into saving just a couple of countries thus far, and given how sternly they have done so, it is not far-fetched to assume that basically anyone who claims to be in trouble will get on the list of “troubled countries”. This would add Italy to the list, below Greece and Spain. It also puts the Netherlands there, and with trouble mounting for the French economy we should not rule out that the euro area’s second largest economy ends up on the list. Down the road, this will force the ECB, in honor of its “unlimited” commitment to “troubled countries”, to print money at a rate that will begin to resemble Latin American monetary disasters.

3. This opens for a very destructive combination of two ill-designed and misguided policy strategies. On the fiscal side, the EU and the ECB are forcing Europe’s “troubled” economies to swallow very bitter austerity pills. Government spending cuts coupled with higher taxes destroy growth, increase unemployment and spread poverty around like economic manure. The tax base is eroded and the governments that try to use austerity to close the budget gap end up looking like a cat chasing its own tail. The very policies designed to close the budget deficit gap actually perpetuate it. Meanwhile, on the monetary side the ECB pledges to fund these very same deficits forever.

I have on numerous occasions compared this situation to Weimar Germany. There, austerity killed the tax base while the country had a massive restitution payment obligation toward the winners of World War I. Since the tax base was evaporating and the government thus could not use its regular, fiscal incomes to honor its debt commitments, they simply took to the central bank, printed the money they needed – and ended up destroying the currency in the meantime.

As we go back to the EurActiv story, we note that none  of this is of any consequence to the decision makers in either Frankfurt or Brussels:

The central bank would also relinquish its senior status among creditors, a measure seen as critical to encouraging private bond investors.

This only reinforces the impression that the ECB is now deadset on “saving” the euro from one disaster by creating another. By relinquishing  its senior status the ECB effectively puts itself in a position where it may have to forgive debt, and thus leave all its printed money out there to slush around in the economy.

As the EurActive article reports, tensions are already mounting over this mad policy initiative. On the one hand you have sensible central bankers who see where this is going:

Renewed ECB intervention in the eurozone’s bond markets is crucial for buying governments time to come up with a longer-term response to the bloc’s debt crisis. Germany’s Bild newspaper reported, however, that Jens Weidmann, who heads the Bundesbank and disapproves such ECB intervention, considered quitting over the disputed plan although he was dissuaded from doing so by his country’s government. His predecessor Axel Weber resigned last year over the ECB’s first bond purchase programme.

On the other hand you have frustrated economists who see no improvement in the European economy despite all the measures taken by the EU and the ECB:

“This meeting is absolutely crucial, because expectations are extremely high. If the ECB does not deliver, we will get into another bad patch,” said Gilles Moec, senior European economist at Deutsche Bank.

If you are an economist at a big bank like Deutsche Bank, you should know that austerity and monetary expansionism only make matters worse. But beyond that, Mr. Moec’s statement reflects the desperation felt in many parts of the euro zone, and the rest of the EU.

Some would point out that the ECB’s “unlimited” commitment to printing money really isn’t as unlimited as it may seem. EurActiv again:

Spanish and Italian government bond yields have fallen significantly since Draghi said on 2 August that the ECB would buy bonds issued by Madrid and Rome. However, the debt purchases – which would succeed the ECB’s Securities Markets Programme that has been dormant since March – would resume under strict conditions and only if the countries first sought help from the eurozone rescue fund.

That rescue fund puts the same old austerity policy requirements on troubled countries as the EU and the ECB have already been forcing upon Greece, Spain and Italy. As any reader of this blog knows, those policies have only made a bad situation go worse, a fact that has not changed just because the two major European institutions call their “rescue” programs something else than they did a year ago. Therefore, when a country seeks help fgrom the euro zone rescue fund and then gets freshly minted euros from the ECB, it means that the deficits will continue, that the troubled nations will continue to pile up debt and that the ECB will continue to print money ad infinitum.

It’s Weimar deja vu all over again.

The only way out is to:

a) Stop with austerity;

b) Start structurally reforming away the welfare state;

c) Put in place constitutional measures that guarantee a limited government; and

d) Break up the euro zone and return to national currencies.