Posted by: Dirk | September 4, 2012

Weidmann against the world

Last week the SPIEGEL featured an article on the euro zone crisis and an interview with Bundesbank president Jens Weidmann, which is available in English on their website. It depicts Mr Weidmann’s opinions and judgements and is very helpful to understand the reasoning of German policy makers. In my opinion, the position of Mr Weidmann is wrong on many grounds. Let me give you a rundown of some important issues.

In the preceding article, the field is prepared by looking at the world through a monetarist’s (20th century) glasses. The SPIEGEL informs us on page 68 that (my translation):

If Draghi has his way (and his proposal passes), European central bankers might lose control over monetary supply in the medium run.

What is presented here as a fact is actually a fiction. The European central bank does not control the monetary supply in the first place. Private banks create loans and by this create what we call money, that is, numbers in virtual bank accounts. Ever since the end of the Bretton Woods system there is no control of a central bank over the monetary aggregate. Even before this it was a debatable position. On the same page the story continues:

Weidmann wants crisis countries to leave the euro if monetary stability is in danger. Merkel wants to keep the eurozone at all costs, even if that means inflation or financial crashes.

This is a strange idea to have. Mr Weidmann’s proposal does not lead to either inflation (or deflation) or financial crashes while that of Mrs Merkel does. That’s obviously wrong. A “grexit” would stop German exports to Greece dead in its tracks as the Greek currency will devalue tremendously (which is the whole point of leaving the euro). This means more unemployment in Germany and will harm the German economy. Greece’s exit would not be noticed much, but imagine Spain or Italy leaving the euro zone.

On page 69, the magazine attacks the bond purchases of the ECB:

With its purchases the ECB floods the markets with money. If it doesn’t collect the additional liquidity somewhere else the amount of cash will be blown up bigger and bigger. History tells us that this impulse will sooner or later create rising prices.

That, again, is doubtful. We are in a special situation which we call liquidity trap, where additional liquidity does not translate into more lending and liquidity is hoarded by the financial sector. The money flows straight back to the ECB, which means that no inflation will result. If it would, the ECB could always sterilize the excess liquidity by selling sovereign bonds (of which it has many) and/or increasing the interest rate. In the Great Depression, inflation was not a problem. Today, our economy looks like 1929-1937 (which in includes Brüning’s deflation policy), not like 1921-1924 (Weimar hyperinflation as a result of war debt, not the printing press). Germany has no foreign debt problems, and those euro zone members that have them cannot use the printing press to solve them.

In the following interview, there are some points I would agree with. On page 76, Weidmann says:

When the central banks of the euro zone purchase the sovereign bonds of individual countries, these bonds end up on the Eurosystem’s balance sheet. Ultimately the taxpayers of all other countries have to take responsibility for this. In democracies, it’s the parliaments that should decide on such a far-reaching collectivization of risks, and not the central banks. Europe is proud of its democratic principles; they characterize European identity. That’s something else that we should bear in mind.

That point is true. However, Mr Weidmann did not issue such warnings when German banks were guaranteed for by the German government early in the crisis. Collectivizing risks hence seems to be OK to him if it happens within Germany, but not within Europe. Also, cancelling debts by popular vote would be an option if Europe would use its proud democratic principles. That is not mentioned either.

To me, the whole idea of the European periphery countries benefiting from a socialization of sovereign debt is quite strange. Spain and Greece have had high unemployment since the outbreak of the crisis and not one government got re-elected. Hence a strategy of spend&run – which fits only Greece, not Spain – would not be something which politicians are keen to repeat.

Europe’s problems are elsewhere, and the symptoms for the crisis should not be mistaken for their causes. Here is an extract from Michael Hudson’s recent article on the euro zone:

Banks have shown themselves to be irresponsible in financing the characteristic form of price inflation of today’s world: a financial bubble fueled by credit on easier and looser terms to buy real estate, stocks and bonds, to buy entire companies. Governments hardly could have been expected to fuel asset-price inflation. Their interest is in taxing away “free lunch” windfalls from the land’s rising site value and from natural resources, and to provide basic infrastructure services at subsidized prices or freely, just as they provide roads without tollbooth access charges. Banks have sought to enable mortgage debtors and corporate raiders to pay their interest by cutting taxes, leaving more land rent and corporate income “free” to be paid to bankers and bondholders rather than to the tax collector.

A political and ideological coup d’état is replacing democracy with financial oligarchy, transferring government power to banks and bondholders. The new policy is not for governments to tax the wealthy but to borrow from them – at interest, which is to be paid by taxing labor, consumers and industry all the more. To proceed down this path would reverse Europe’s Enlightenment and the past three centuries of economics. It is called classical economics – and even “free market economics” – but it is a travesty to impose this policy in the name of the patron saints of classical political economy. The Physiocrats, Adam Smith, John Stuart Mill, Wilhelm Roscher, Friedrich List and Progressive Era reformers urged just the opposite path of what now is being taken, and indeed which the world seemed to be following until World War I and for a few decades after World War II.

As I still see it, the ongoing crisis in Europe is something which is bigger than just finding “technical” solutions to an “economic” problem. It concerns the identity of Europe in the 21st century. Of course, Europe is not isolated from the rest of the world, so whatever happens here will affect people elsewhere on the planet. It is time to broaden the discussion.


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