The real side of the crisis and the safety net of the ECB

27 February 2014

The crisis is not over and the ways that lead out of it are all miserable. This was the message that Hans-Werner Sinn, President of the ifo Institute in Munich, conveyed to a large audience at Goethe University Frankfurt on Wednesday afternoon. CFS President Otmar Issing had invited Sinn to give his  talk “The real side of the crisis and the safety net of the ECB” as part of the CFS Presidential Lecture series.

Based on many numbers and comparative statistics, Sinn, at the outset, demonstrated that the current situation, which may seem to have calmed down, continues to be serious: shrinking current account balances are a result of decreasing imports, industrial production continues to be depressed, and unemployment is still high. Competitiveness is nowhere improving, with the exception of Ireland. The crisis countries in Southern Europe are still too expensive. This problem, which is not new, has grown from the time of the EU’s eastern enlargement: salaries in Spain or Italy were double or threefold those in Poland or the Czech Republic. This difference is not justified by higher productivity, Sinn said.

Four miserable options

According to Sinn, there are only four options – all of them miserable – to make crisis countries competitive again: 1. A transfer union. 2. A real depreciation: crisis countries would need to implement even more drastic austerity programs; these would lead to insolvencies and mass unemployment which would induce salaries to sink and, in turn, improve competitiveness. No country would be able to undertake such a scenario, Sinn judged. 3. Inflation in the core countries, especially Germany: in Sinn’s view, this option is not possible either. According to some calculations, Germany would need to appreciate by 70 percent. On the one hand, nobody knows how to achieve such a goal, on the other hand, the ECB would need to accept inflation rates higher than two percent for a longer period, which would be against its mandate. 4. Some member states exit the EU.

At the moment, the EU has embarked upon a path directed towards a transfer union seeking its “rescue in the printing press”, Sinn said. This has been made possible by the system of Emergency Liquidity Assistance (ELA) as part of the European System of Central Banks (ESCB). Every central bank in the ESCB has been allowed to provide liquidity to national financial institutions at its own risk. Through this back door, Sinn said, central banks in the crisis countries have created huge amounts of money during the last years that have helped their economies to repay loans and maintain their standard of living. The money has been transferred to the core countries by consumption or the repayment of credits which has led to a significant rise in the so called “target” balances in the ESCB. “All money circulating in Germany at the moment was created in the crisis countries”, Sinn explained.

According to his calculations, these indirect transfers add up to EUR 589 billion. Altogether, EUR 1,029 billion have flown from north to south since the beginning of the crisis – more than 30 “Marshall Plans”. Only 38 percent of this was legitimated by parliamentary decisions, whereas the ECB alone is responsible for the remaining 62 percent, by granting ELA and (previously) by buying government bonds. This is a huge problem for democracy, Sinn argued.

An imminent constitutional crisis

It is only because of the ECB’s OMT Program (Outright Monetary Transactions) and the promise to buy government bonds of crisis countries without limit, in case of emergency, that the current situation has calmed down, Sinn said. He reviewed, in detail, the decision of the German Constitutional Court (GCC) in early February. The Court has not, as many have written, delegated the decision to the European Court of Justice (ECJ). In contrast, it has stated very clearly that the OMT Program is against the law, Sinn said. In his view, the ECJ will not be able to decide against the GCC without provoking a constitutional crisis in Germany. The German Parliament would not be allowed to accept that the ECB – as a foreign power – would take control over the German budget. Therefore, Sinn assumes that both Courts will try to find a solution that, in the end, will set limits to the OMT. In his view, this is urgently necessary. The ECB should not reduce the steering potential of financial markets by buying government bonds. The spread of interest rates is a fundamental element of a monetary union. The Euro will never flourish without, he predicted.

As a way out of the crisis, Sinn demanded relief for government debt, bank debt and target debt at the expense of creditors. Nevertheless, it may not be avoidable, he argued, that some countries – he mentioned Greece – will need to temporarily leave the EU. Not least, national central banks should give up some of their rights, in order to stop the increase in emergency credits. According to Sinn, the current path towards a transfer union will come to a dead end: “We are turning the countries of Europe into creditors and lenders. This is no policy of peace.”