Ronald Janssen
The ‘non-paper’ which Wolfgang Schäuble presented to his fellow finance ministers at a recent ECOFIN council in Luxemburg (leaked by the Handelsblatt newspaper) represents something of a paradox.
One of its main ideas is that the euro area lacks a procedure that could declare member states bankrupt when having lost access to financial markets. This makes the restructuring of unsustainably high debt burdens even more complicated than it is. Schäuble’s non-paper even uses the Greek crisis to argue that this situation produces ‘unnecessary social hardship’ and deepens the crisis.
Is it necessary to recall that this is the same finance minister who, only a couple of months ago, stubbornly refused to discuss any measure of debt relief for Greece and this despite the fact that Greece is burdened by an enormous debt load and suffering from a recession that is already worse than the Great Depression? Does anybody need reminding that it is Wolfgang Schäuble who openly threatened to kick Greece out of the single currency on the argument that any default on debt is ‘illegal’ in the euro area because of the European Treaty’s ‘no-bail out’ clause? Of course, politicians are not really renowned for their consistency (to put it politely…).
Moreover, and as French finance minister Michel Sapin argued in an interview over the summer and as was confirmed by the ECB’s vice president Vitor Constâncio last week, there is the possibility that Schäuble and others were simply putting on a show and the threat of kicking Greece out of the euro was never meant to be taken seriously. However, things start to make a certain sense when looked upon from a financial perspective.
Here I refer to a Halle Institute paper pointing out that financial markets look for safety by shifting capital into German bonds every time there is bad news for Greece. The interest rate savings that result from this are estimated to be huge, at around €100bn over the period covering 2010 – 2015. Moreover, these benefits add up year after year as sizeable amounts of bonds issued at very low interest rates over recent years are still far from reaching maturity. This lower interest rate bill outweighs the total amount of debt that is owed by Greece to Germany. In other words, even if Greece defaulted on all its debt (which seems rather unlikely given the fact that policy in Europe is ruled by the principle of the ‘sanctity of debt’), Germany would still draw a net profit from all of this.
This enables one to explain Schäuble’s remarkable U-turn of turning from acting as a ‘harsh creditor’ only two months previously into a ‘compassionate’ one. Indeed, in both cases, the effect of Schäuble’s proposals is to make markets more insecure and more risk-averse so that more financial capital shifts from peripheral countries, thereby pushing interest rates on non-German bonds up but down on German bonds. In the earlier #Grexit scenario, this effect comes about by downgrading the euro from a common currency into a system of fixed exchange rates where members can be kicked out.
In the latest proposal, markets would be destabilised by imposing a rule that all new debt issuance in the euro area should include a clause specifying that the maturity of outstanding debt will be prolonged automatically from the moment a member state receives financial aid from the European Stability Mechanism. To compensate for this risk, markets will demand an increased premium on southern European sovereign debt but not on debt originating from member states such as Germany.
Programming even more market turmoil for the debtors
Unfortunately, the bad news for the euro area debtor countries does not stop here. Wolfgang Schäuble’s non-paper contains two additional ideas with a similar effect on financial markets.
The first of these is to impose capital requirements on banks that buy sovereign debt paper. At the moment, banks do not have to set aside any capital reserve when investing in sovereign debt titles. If this changes, and if this capital requirement depends on the rating of sovereign debt, then non-AAA debt would be less attractive for the banks to invest in and demand for it would go down.
His second proposal has to do with the potential conflict of interest for the ECB. The bank steers monetary policy so as to guarantee price stability but is at the same time responsible for the oversight of major European banks. This may lead to a situation where the ECB hesitates to increase interest rates if such an increase gets some of the banks that are under its aegis into trouble. While this conflict of interest may be theoretically valid (recall, however, how the ECB did not hesitate to cooperate with the euro group in disciplining Greece, even if the consequence was to close down the entire banking sector of Greece…), the practical consequence Schäuble draws from this is to openly declare that there can be no further euro area-wide sharing of banking sector risk. In particular Schäuble rejects any progress on a common deposit insurance, as long as this conflict of interest within the ECB is not settled.
The latter implies that the clock is turned back on the small steps forward that were delivered by the project of a Banking Union for the euro area, steps that are highly desirable to break the so-called doom loop between distressed sovereigns and their banks. This then is again an attempt to establish a negative bias in the markets against weaker member states. The fact that member states are basically on their own and cannot expect much European help in handling troubled banks is being rubbed in.
Reflections on European Monetary Union: Back to the origins….
When discussing the construction of a European single currency, Germany’s concern was always that it would lose the competitive advantage of relatively low interest rates for its capital-intensive industry. On the other hand, German policy makers also realised that the single currency would allow it to fully unleash the already successful German exports machine without having to fear any backlash as the Deutschmark appreciates vis-à-vis other European currencies, thereby hiking up the price of German exports.
Twenty years later, one can only observe that the tables have again been turned and that Germany has been able to regain the competitive advantage it gave up when entering monetary union. German business can now finance itself at very low interest rates, rates that are lower than those Spanish or Italian companies have to pay. At the same time, and this is thanks to the existence of a single currency, German industry is protected from any substantial currency appreciation and this despite recording a giant and growing current account surplus of close to 10% of GDP.
Germany, in other words, is living in the best of two worlds. Not so, however, are other euro area countries. These are having to deal with relatively higher financing conditions than Germany while remaining unable to resort to currency depreciation.
It needs to be realised, however, that a monetary union in which one part is drawing all the benefits while others are experiencing all the costs is clearly unsustainable in the longer run. Wolfgang Schäuble’s paradoxical approach of systematically introducing a financial market bias against higher indebted countries while at the same time paying lip service to their difficult social and economic situation are far from helpful in this respect. Instead they boil down to nothing more than throwing more oil on the fire.
Ronald Janssen is senior economic adviser to the Trade Union Advisory Committee of the Organisation for Economic Co-operation and Development. He was formerly chief economist at the European Trade Union Confederation.