08 November 2011

Klaus C Engelen: Jean-Claude Trichet - saviour or villain?

Giving an account of how Germans view Trichet's legacy, Engelen says that for some, Trichet is a European hero; for others he is a villain for having turned the ECB into Europe's “bad bank” for toxic assets.

When Draghi takes charge in Frankfurt, the political battle over leveraging EFSF and how its voting mechanism will be structured may have moved to the centre of the euro crisis debate, especially in Germany. Being overruled on the issue of bond purchases in the ECB Governing Council, in spite of the largest general voting share of 18.94 percent and a 28 per cent voting share on ECB balance sheet matters, has given Germany’s monetary conservative establishment a sinking feeling. Fears are growing that the trusted Bundesbank has been taken over—through the ECB Governing Council—by Club Med central bankers.

German Finance Minister, Wolfgang Schäuble, is under considerable political pressure to secure an EFSF voting mechanism that is more reflective of financial and economic realities. The key question is whether Germany, which contributes by far the largest share and the strongest international credit standing to the EFSF, will concede to a voting mechanism of “one country, one vote”, with the added constraint of “unanimity” where most of the eurozone states could be blocked by smaller countries. Berlin should heed the lessons from the ECB under Trichet’s reign, where Germany was overruled on the crucial decision of bond purchases on the basis of “one country, one vote”.

Germany's influence further marginalised

As the eight-year term of ECB President Jean-Claude Trichet ends, German influence on the 23-member ECB Governing Council and the six-member Executive Board will be further minimised. This turn of events cannot be blamed solely on Trichet’s French centrist dictatorial leadership style. Germany has made its share of blunders.

First, the slow and zigzagging way Berlin responded to the Greek financial crisis and its spread to other euro area countries was seen as an invitation to financial market speculators, and shifted ever-larger portions of outstanding value-impaired sovereign debt exposure in the euro area from the private to the public sector. Merkel’s hesitant and indecisive handling of the Greek disaster escalated the crisis and its cost to taxpayers. In order to protect French and German banks with high exposure to euro member countries in difficulty, Berlin and Paris did not push for early market solutions.

Second, after rejecting Deutsche Bank CEO Josef  Ackermann’s early public-private €30 billion bridge loan offer for Greece in April 2010, Merkel and Sarkozy decided at their October 2010 Deauville meeting on private sector involvement—debt rescheduling with “haircuts”— to solve the crisis. But it took until July of this year when, with the cooperation of the Institute of International Finance, the global association of financial institutions, Greek debt reduction amounting to 21 per cent was reached, but on a “voluntary” basis. This allows losses without activating risk premiums and without making the Greek bonds unsuitable as a pledge given by the banks to the ECB to restore liquidity.

Third, unprecedented self-inflicted setbacks by its top representatives are contributing to the loss of influence. Thanks to Germany’s prominent “fugitives from public responsibility”—Axel Weber and Jürgen Stark—the first Italian ECB head can now move the ECB’s policies more to the west, in the direction of the US Federal Reserve or the Bank of England.

Finally, Weber and Stark, but also the new German ECB representatives, Jens Weidmann and Jörg Asmussen, have some explaining to do. Why have they let the horrific misreading of the markets by Berlin’s policymakers happen? Capital market experts agree that Berlin’s ill-timed private-sector involvement proposals caused a massive flight of private pension funds and other big bond investors from the euro area. This was a high-risk policy move, considering that European Member States may need to raise as much as US$2 trillion in debt in 2011. Also, Germany’s former and present representatives at the ECB cannot ignore the fact that without restoring confidence among private investors globally, the European financial systems will be more and more dependent on continuing central bank support or the credit leveraging of the few AAA-rated eurozone countries, with Germany at the top of the list.

What happened with Germany’s ECB relations is adding to the dismal and costly record of German Chancellor Angela Merkel’s response to the euro crisis. High hopes for placing a monetary conservative such as German central banker, Axel Weber, at the helm of the ECB in order to promote a more stability-orientated culture in the tradition of the Bundesbank and regain more control of the country’s monetary destiny have been shattered. The “one country, one vote” rule in the 17 ECB Member States leads to the politically explosive and economically absurd prospect of the eurozone’s highly indebted spenders of yesterday manipulating the European System of Central Banks in order to massively use Germany’s financial resources to soften their adjustment pain.

Berlin's EFSF enhancement battle

EU Commission plans to leverage the 17 eurozone member countries—after its lending capacity was increased from €250 billion to €440 billion, run counter to assurances by the Berlin government. During a two-and-a-half hour parliamentary debate, opposition lawmakers and coalition euro-rebels pressed German Finance Minister Schäuble to confirm speculation that the fund already needed more money than the current legislation provided for, and to say whether it was planned to allow the fund to leverage its assets. But contrary to what has been leaking from the EFSF and the Brussels Commission, Schäuble has been sticking to the line that after the passage of the EFSF enhancement bill, the country’s share, increased from €123 billion to €211 billion plus interest plus costs, would be the end of the rope sustaining a European bailout fund with an effective lending capacity of €440 billion (US$590 billion).

Trichet's questionable legacy

As Jean-Claude Trichet’s turbulent eight-year term at the helm of the European Central Bank winds down at the end of October, he is moving in starkly different worlds. For some he is a European hero, for others he is a villain for having turned the ECB into Europe’s “bad bank” for toxic assets. By buying the outstanding bonds of troubled sovereign debtors, the ECB is in danger of taking high credit risks on its balance sheet, and in consequence needing to be recapitalised by the taxpayers of its financially able Member States—as has already happened.

As witnessed at the annual meeting of the Institute of International Finance in September, the leading movers and shakers in the world of banking and finance hail Trichet for giving leadership to what is considered “the only functioning European institution” in the still escalating debt crisis. But on the other hand, Trichet is under attack and under pressure from many sides as never before. How much he is on the defensive at the close of his term was transmitted around the world’s trading rooms at a press conference on September 8, the day before ECB chief economist Jürgen Stark announced his resignation. Trichet’s emotional, intemperate outburst will go into the history books. Provoked by a question from a German journalist about why his country should not leave the euro, he shot back with a long lecture about the virtues of the European Central Bank. “We have delivered price stability over the first twelve, thirteen years of the euro. Impeccably!” he asserted—better than the Bundesbank’s record. “We do our job. It is not an easy job.” He did not mention though that he alluded to a period of exceptionally low inflation due to the impact of China and other price-depressing factors.

From a German perspective, the ECB Governing Council decision in early May to move into the “fiscal space” of the currency union was—as former Bundesbank President Helmut Schlesinger called it—“crossing the Rubicon”.

“The European Central Bank has gambled away its reputation. ECB President Jean-Claude Trichet is leaving a questionable legacy. He put without real need the central bank in the service of fiscal policy. The ECB Governing Council acted as willing helpers.” So reads the headline of a recent not-so-friendly two-page report in Germany’s economic and financial daily Handelsblatt on Trichet’s eight-year reign. It was written by Marietta Kurm-Engels, who for decades has worked as a Bundesbank and ECB watcher for Handelsblatt’s Frankfurt office. Her piece began with this sentence: “Talking these days to former German central bankers, one meets sheer horror mainly due to the ECB decision of August 7 to start a purchasing programme for Italian and Spanish government bonds”. Kurm-Engels quoted a former German central banker: “There are a few things I could think of but not this. That last spring they started to buy sovereign bonds (of eurozone countries) was bad enough. That they now resume this in this way is incredible.”

See below for full article, published in The International Economy

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