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Germany’s Constitutional Court delivered a partial return of law and order to the Eurosystem and dealt a heavy blow for the ECB in its recent ruling. The court stated last week that:
“Following a transitional period of no more than three months allowing for the necessary coordination with the Eurosystem, the Bundesbank may thus no longer participate in the implementation and execution of the ECB decisions at issue, unless the ECB Governing Council adopts a new decision that demonstrates in a comprehensible and substantiated manner that the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the programme. On the same condition, the Bundesbank must ensure that the bonds already purchased and held in its portfolio are sold based on a – possibly long-term – strategy coordinated with the Eurosystem.”
Many have pushed this aside by stating that it requires nothing more than some explanations from the “army of PhDs” in the ECB. While this may be true, we cannot know for sure before a decision is taken by the Governing Council and reviewed by the court. Pertinent questions remain.
Moreover, the hands of the ECB have become effectively tied to what comes to any future “rescue operations”.
What are the implications of the court’s ruling?
First, some of the ECB’s own research shows that the Public Sector Purchase Programme (PSPP) has disproportionately lowered the prices of sovereign bonds in the Eurozone thus making borrowing operations of member states cheaper. “Unfinding” this will require some academic meddling, which is of course completely doable.
Second, it will be difficult to present any plausible plan to sell the bonds, purchased under the PSPP, back to the markets in the future under current conditions without seriously undermining the solvency of weaker member states of the Eurozone. Any hint of this would most likely yield a response in the markets.
Third, the court’s ruling effectively ends any discussion about debt monetisation or the “helicopter drops” of money. This is something the Bundesbank simply cannot take part in anymore.
Fourth, if the court’s decision were to be upheld, the Bundesbank would need to exit from the PSPP and especially the PEPP, or the Pandemic Emergency Purchase Programme. This would mean that the Bundesbank would have a different monetary policy to the rest of the Eurozone, and it would need to exit the ECB.
Effectively, this would mean Germxit, or German exit from the Eurozone. So, in practice, it would be close to impossible for the ECB to continue the PSSP and PEPP, if the constitutional court were to uphold its ruling.
What has been mostly missed in all the debate around the court’s decision is that it has taken a step towards enforcing the “letter” of the TFEU, or Treaty of the Functioning of the European Union. For example, the TFEU Article 123 states that:
“Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.”
It is incomprehensible that PSPP would be ruled not to be a “credit facility” by the European Court of Justice, ECJ, because that is precisely what the programme effectively is. In it, the ECB buys (mostly) sovereign debt from the secondary markets through commercial banks. Thus, the ECB provides a credit line for banks to buy sovereign debt. This turns into “monetary policy” only in some twisted economic models and politically inclined minds of lawyers and judges.
So the German court’s ruling, if enforced, would thus uphold the letter of the TFEU, when the ECJ, in its previous rulings, failed to do that.
Those arguing that the court’s ruling would go against the “independence” of the ECB, fail to understand that that ship has sailed. When PSPP was launched, the ECB became a political actor, as the programme eased the financial burden of member governments.
The final nail on the “independence coffin” came when the ECB discontinued the Emergency Liquidity Assistance program to Greece in Summer 2015, pushing the country into a banking crisis. There could have been no other motivation for a central banking authority to create a banking crisis in a member country than an effort to pressure the Greek government to succumb under the demands of the “Troika”. It was one of the most disgraceful acts in the history of central banking.
Now, joint liabilities are about to come home to roost.
Even if the “masterminds” of the ECB are able to conjure a monetary political explanation of their efforts to support the ailing finances of the member states of the Eurozone through the PSPP, the manoeuvring room of the ECB has been seriously diminished. There will be no debt monetisation or “helicopters” coming to rescue the failing finances of national states in the economic crisis, which has now started.
Moreover, if the PSPP program is discontinued by the court’s ruling, the yields of Italian and Spanish bonds are likely to skyrocket. If countries are not willing to participate on the ESM programs with demands of austerity, the only way for sovereigns to solve their indebtedness issues is through default.
In this case the sovereign debt held by the ECB, or the loans granted by the European Stability Mechanism, ESM, would start to look mighty tempting target for a “foreign default”.
If countries default on their debt held by the ECB, the Bank needs to be recapitalised, which can only happen through national central banks and/or governments. Defaults on the ESM loans would mean that the guarantees issued by the member states would come into play.
In these cases, other member nations would, either through guarantees or through their respective central banks, have been forced to fund other member nations effectively breaching the Article 125 banning all mutual fiscal responsibility.
Then things would get really interesting.
Tuomas Malinen is Chief Economist at GnS Economics.