Reading the FT: The European Central Bank Is Not the Central Bank of Europe

A couple interesting pieces in yesterday’s Financial Times, related to last year’s debates about the role of the ECB in the European crisis.

First, this article on proposals to scrap higher-denomination bills (to combat money laundering) notes in passing that “the Central Bank of Luxembourg is a particularly prolific producer of high-denomination notes … Luxembourg issued notes equivalent to 194 percent of its GDP in 2013, compare with 16 percent in Germany, 9 percent in Italy and 4 percent in France.” This is a nice reminder that the printing of banknotes is not centralized in Europe, but — like almost all the day-to-day activity of central banking — remains the responsibility of the various central banks, with little oversight from the center. This little story is also a reminder of how — as I’ve pointed out before — the eurosystem is not like the gold standard. The exceptionally large cash issues in Luxembourg are an issue for law enforcement or financial regulators, but they are not a macroeconomic issue. No one suggests that large cash issues could ever cause the Bank of Luxembourg to exhaust its reserves, in the way that equivalent “internal drains” occasionally threatened the Bank of England in the 19th century.  I wish in retrospect than I’d written something during the Greek crisis mentioning that physical euros are in fact already printed in Greece. Not that I think this operational detail is very important in itself, but it crystallizes the continued role, (and potential autonomy) of the national central banks in a way that more abstract arguments don’t.

Second, on the op-ed page there is Wolfgang Munchau suggesting that one of the main reasons for the revival of the German economy in the early years of Nazi rule was the accomodative policy followed by Hjalmar Schacht at the Reichbank, which included not only conventional expansionary policy — enabled by effective exit from the gold standard — but “unilateral restructuring of private debt owed by German companies to foreigners.” (Schacht’s memoir My First 76 Years is fascinating reading.) The recovery of output and employment in Germany ahead of the rest of Western Europe, Munchau writes, was “one reason for Hitler’s initial popularity,” and, more to the point, is evidence for “what an unorthodox central banker can do if he or she has the political support to break with the prevailing orthodoxy.” The relevance for today is obvious:

The current policy orthodoxy in Brussels and Frankfurt, which is shared across northern Europe, has some parallels to the deflationary mindset that prevailed in the 1930s. Today’s politicians and central bankers are fixated with fiscal targets and debt reduction. As in the early 1930s, policy orthodoxy has pathological qualities. Whenever they run out of things to say, today’s central bankers refer to “structural reforms”, although they never say what precisely such reforms would achieve.

In principle, the eurozone’s economic problems are not hard to solve: the European Central Bank could hand each citizen a cheque for €10,000. The inflation problem would be solved within days. Or the ECB could issue its own IOUs — which is what Schacht did. Or else the EU could issue debt and the ECB would buy it up. There are lots of ways to print money. They are all magnificent — and illegal.

There are no Nazi parties in the eurozone today, except in Greece. But France and Italy have populist parties on the right that are clearly outside the current policy consensus. Imagine a scenario in which Beppe Grillo, leader of Italy’s Five Star Movement, were to win the Italian election in 2018.

The term of Ignazio Visco, governor or the Bank of Italy, expires in November that year. Mr Grillo would be in a position to appoint his own central banker. Perhaps he would choose someone as resourceful and ruthless as Schacht and able to plot Italy’s way out of the euro, via a parallel currency regime for a transitional period, defaulting on foreign debt in the process. The devaluation and the increase in public sector investment which would be possible under a new regime could bring instant economic growth.

This is interesting, for a couple of reasons. First, the assumption, which Munchau doesn’t feel he needs to defend or even state explicitly, that any elected European government can appoint its own central bank leadership, without the approval of the ECB. (My understanding is that this is indeed the case, though the relevant national laws all include sweeping but presumably unenforceable language that once appointed the central bank leadership is not to take any outside direction.) Also worth noting, the suggestion of a temporary parallel currency, consistent with my idea that exit from the euro would not have to be an all-or-nothing leap, but involves passing through an extended gray area.

The second interesting thing is Munchau’s evident ambivalence. On the one hand, he sees the parallels between today’s the orthodoxy  of the euro today and of the gold standard before World War II. [1] He recognizes the problems with postulating objective constraints on central banks in a depressed economy. He realizes that the current austerity regime shows no signs of delivering material benefits to the great majority of Europeans. And against this … what? “I have no doubt that any populist government in Europe would end in disaster,” he writes, but the basis of this certainty is not explained.

For myself, I have no doubt that the European crisis is not over. At some point, maybe soon, another European government is going to come up hard against the limits of acceptable policy in the Brussels-Frankfurt orthodoxy. I still think the national central banks will be the commanding heights in the ensuing battle.


[1] To be clear: I don’t think there is a close parallel in the way the two systems actually operate, but in their ideology, yes.


9 thoughts on “Reading the FT: The European Central Bank Is Not the Central Bank of Europe”

  1. I can’t remember exactly where Varoufakis commented on this, but the Greek Central Bank was at the center of a political. Syriza vs. the old guard at the central bank.

    The first country to do Corbyn’s “People’s QE” or monetary financing will surge ahead.

    As you said about debt default, I doubt the private sector reaction will be as bad as the ideologues warn.

  2. Related to your first paragraph is the fact that Target2 overdrafts between the Eurosystem NCBs allow for almost automatic accommodation of capital flows in the Eurozone. As long as banks have sufficient collateral, they are able to increase their central bank borrowing and fund capital outflows on a major scale.

    As a result, even the narrative of large capital inflows which ‘financed’ credit growth in the Euro periphery during the 2000-2007 period is not accurate. Banks create purchasing power when extending credit and Target2 accommodates capital flows. Capital inflows merely change the composition of the NIIP from central bank liabilities to government securities and repo loans.

    1. I agree, TARGET2 is the key. Sometimes I even think we should call it the “Target System” rather than the euro system, because what really makes it a single currency is not the fact that the currencies of the different countries happen to have the same name and exchange at par, but that a bank deposit in one country can always be used for payments in another. Your second paragraph is important too. The narrative of offsetting trade imbalances and capital flows ignores bank credit, which — I think — is actually the most important variable both in generating imbalances and in accommodating them.

      The linked post seems exactly right to me. I’m glad to see people are still thinking about this stuff.

      1. Now that the Fed swap lines have been made permanent we have a somewhat similar system between the main central banks only this time it is used to backstop money market rates instead of ‘exchange rates’.

        Regarding Target2, I think Greece was the first time when bank collateral was actually not enough to finance any more outflows (especially given the terrible NPL problem of Greek banks credit claims). In such a context, capital controls can and will be used as a second line of defense in the Euro monetary system.

  3. “any elected European government can appoint its own central bank leadership, without the approval of the ECB.”

    IIRC, when Draghi was appointed as president of the BCE, italian newspapers spun this as a victory for Berlusconi, who pushed for Draghi.
    This was seen as a triangulation and an equilibrium of power issue both between european left and right and between european countries (there were other important appointments at the time that now I don’t remember).

    This is why I have some doubts about the story of the ECB forcing the poor Berlusconi out of power.
    In case anyone doubts that Draghi is close to Berlusconi, here are two articles from Libero, an italian right-wing newspaper, from 2015, where berlusconi says that his own party could candidate Draghi as italian premier (in one of the article B. cites Marchionne, CEO of Fiat group, as another option):–la-pazza-idea.html—Vorrei-Mario.html

  4. So in other words, the ECB is just for show, kind of like Donald Tusk and the European Council. Technically speaking, the ECB is split into three parts, two of which basically includes all the central banks of the 19(I believe?) EU states. Question, who truly runs the EU bloc’s monetary policies? If the Bank of Luxembourg and the disparate central banks are able to print their own euros, then what’s the sense of the ECB?

    PS: I’m in your ECO 310 class for the Spring of 2016.

    1. Thanks for the comment! To the question “who runs the bloc’s monetary policy?”, I think the answer is not obvious. I don’t think we can resolve it just by looking at the formal structure, we have to see how decisions actually get made in conditions of crisis and conflict. So far, we haven’t seen a situation where there was a direct conflict between the ECB and one or more NCBs, so we really don’t know how that would play out.

  5. Schacht’s idea to print money and call it another name in order to spread it arund incospicously is an excellent one. Lincoln did it too with Greenbacks.

    I have also another similar idea that it could pass EU eyes and ban on printing to finance deficits. While Schacht did print new name money that was exchangable for regular money in purposed banks, mine is about diferent nature.

    My idea PILL (Pay In Lieu of Loans) is about using the fact that banks issue new money when giving loans and then have to destroy such money when principal is payed off.

    Instead of banks destroying official money when credit payment is made, let them destroy vauchers with money value.
    A state can raise social spending by giving everyone a portion in vauchers that can be used only with banks in lieu of credit payments.
    Since the biggest problem in todays economy is the debt, private debt and the portion of paycheck that goes to paying monthly payments. Additional vochers that comes from state as social support to low income families can be raised by €100 voucher to pay for credits.

    This way vouchers have a one time use and are destroyed instead of real euros that can stay in private pockets to be spend o other things. This helps banks to decrease loan failures and helps spending in economy. Those that do not have debts can open credit line that can be covered by vauchers and interest part to be covered by income.

    PILL is a way to increase deficits without any trace in national accounting and thus avoid Maastricht constrictions on national spending. I tried to point this idea of mine to Varoufakis when he became Minister, but i got only to intrigue Naked Capitalism contributors. For this to be implemented, it requiers Governors’ agreement and banking cooperation. I doubt that Varoufakis had Greek Governor ear on this prposal. I wrote to Galbreight too about PILL at the time.

    Idea came to me as i was thinking about Steve Keens debt jubilee and Bankruptcy rules for debt forgivness in USA, where only bankruptcy judge can allow banks to erase liabilities from loan defaults without ever paying off loans. How can debt be forgiven without ever costing the state any money and helps banks and debtors at the same time? It is a proverbial free lunch that is so often memerized about in capitlaism.

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