Europe could now break apart very quickly. If Germany does not finally begin to adapt its role within European Monetary Union it’s not fair to blame an ignorant court.

 

Cross-posted from Makroskop and Brave New Europe

Translated and edited by BRAVE NEW EUROPE

 

The ruling of the Federal Constitutional Court (BVerfG) of 5 May 2020 on the European Central Bank (ECB) will go down in history – at least many would agree on that. But what the deeper reasons for such a judgment might be will remain a mystery on all sides for a long time to come. The only thing that seems certain to me is that future historians will find it difficult to understand what happened. It won’t simply be a matter of going to a library to clarify the circumstances and investigate the causes. You have to know and understand the spirit of the times and its media echo in order to answer the question of how it is possible that demonstrably intelligent people can get so totally lost.

The eight judges (one member voted against the verdict without giving his opinion) got lost in an economic jungle whose complexity and impenetrability they were unable to cope with. They could have known that exactly this was going to happen. In a judgment in a similar case in January 2014, Judge Lübbe-Wolff wrote to justify her dissenting opinion, among other things:

“The competences of the judiciary do not depend, at least in normative terms, on the de facto greater or lesser courage of the judges. But where the courage of the judges must dwindle for legal reasons at the latest when the matter is at hand, they should not even get involved in the matter in the first place. The fact that the present decision leaves many possibilities open to the Senate for its later final decision on the proceedings to be taken, to exercise wordy judicial restraint, therefore does not speak in its favour. In constellations in which the role of the judge foreseeably does not permit effective intervention in principle, judicial restraint should be exercised in silence.“

That’s exactly the point. This time the judges really went for it – with disastrous consequences. The matter revolves around several of the most controversial issues in economics, to put it mildly. Actually, one would have to say that the BVerfG has sunk it teeth into exactly those questions on which economists, on which the court mainly relies, have long been chewing.

However, the fact that precisely these questions have never been openly discussed in Germany enabled the highest court to refer to a trend that has never had an effect beyond German borders and has so far only brought a smile to the faces of the majority of the economists who are really internationally active. What is more, German politics and the leading German media have created an intellectual storm in a teacup, persuading all the old German warhorses, including unfortunately those readers of the Frankfurter Allgemeine Zeitung in Karlsruhe (seat of the BverfG) that there could be a return to the quiet village pond of the German Bundesbank: an era when monetary policy had an easy opponent in the form of inflation, and where the other countries of Europe, within the framework of the European Monetary System (EMS), the predecessor of EMU, tacitly followed the guidelines from Germany.

A few months ago, when the former constitutional judge Paul Kirchhoff came out with the claim that German savers were being expropriated by the ECB, I had a bad feeling. The man is cut from the very cloth that is obviously prevalent in the highest German court. There, crude ideas of a market economy merge with absurd ideas about possibilities of controlling the state and its central bank to form a material that is tough, but completely unsuitable for building houses with. Cross-border constructions in particular are impossible.

Debt and saving

I don’t want to say much about saving itself here – we have explained all the important connections in the past. Immediately before the court’s ruling, I held up the mirror of a changed world to German economists. According to Kirchhoff, the “poor saver” is at the centre of the Karlsruhe considerations on proportionality and thus on the “side effects” of monetary policy. But that is exactly where he must stand, albeit in a completely different sense than Kirchhoff thinks. The “poor” saver in a deflationary situation cannot hope for help from monetary policy, because in a deflationary situation it is precisely about discouraging saving and encouraging indebtedness.

The realisation that at a certain point the central bank will not get any further in its efforts to steer the economy and achieve its goal via interest rates is trivial. Even Mario Draghi, former president of the European Central Bank, has said it hundreds of times and called on the states to do more on their part, which of course means getting into debt and ensuring that wages develop sensibly, because otherwise there is logically no way out of weak growth and deflationary tendencies. But economic logic is not the domain of jurisprudence. Which is why the highest German court was foolish enough to give free rein to its prejudices and attack Italy as well:

“The reduction of the general interest rate level supported by the PSPP (public sector purchase programme) thus undisputedly relieves the national budgets of the member states. As a result, there is a risk – despite the “guarantees” accepted by the Court of Justice – that necessary consolidation and reform efforts will not be implemented or continued.”

The “necessary consolidation and reform efforts”! If only one could say clearly what this is? How does a Senate of the Constitutional Court know what is possible and necessary in Italy? It refers here to the Council of Experts (SVR), but obviously cannot judge what position the SVR takes. That this could be extremely one-sided does not occur to the judges. The SVR position lacks any logic in the case of Italian companies being net savers and a high current account surplus of Germany, Italy’s important trading partner. Even a national constitutional court that has been dealing intensively with a European matter for years should at some point understand that no country within a community based on the rule of law and, above all, a monetary union, can be understood without understanding all the countries that belong to it – and the system in which they operate together.

Misunderstood monetary union

The core of the explosive story is still that in Germany the consequences of monetary union are unknown or are being suppressed. In any case, what is being systematically and permanently suppressed is that it was Germany that drove a huge wedge into EMU in the early years of the euro through German deflation. The German government put pressure on German wages through a variety of measures, thereby increasing the competitiveness of German companies vis-à-vis their currency partners. This is exactly what you cannot do in a monetary union.

Since there is a close empirical and theoretically easily explained relationship between national unit labour cost developments and national inflation rates, the undercutting of the common inflation target by a large nation in the Union inevitably results in large and persistent current account imbalances and deflation. Current account imbalances automatically mean higher debt in the deficit countries. However, the central bank cannot do anything about this in a monetary union because, logically, it can only be guided by the average price development of all member states. If the sum of all the states results in an inflation rate that corresponds to the mandate of the central bank, monetary policy cannot and must not react to the misconduct of a single member.

And this is precisely why German wage dumping was the most fundamental and serious violation of the jointly agreed goal of achieving an inflation rate of just under two percent. If Germany had adhered to the two percent target as consistently as France, the ECB could have put the states that deviated beyond the two percent within the limits by raising interest rates. Then the imbalances would only have occurred for a short time and to a much lesser extent.

But Germany’s failure to meet the inflation target tied the ECB’s hands: The ECB can only conduct one and the same monetary policy for all member states at the same time. This came in very handy for Germany in the 2000s, although interest rates were too high in relation to German inflation, which hurt German domestic demand, especially investment demand. But the German saver was happy. And external surpluses in EMU and gains of market shares on international third markets compensated for what was lost internally.

What has happened in EMU since then follows directly from this. The EMU partners are under enormous pressure to reduce wages as well in order to limit their foreign debt. But this in turn results in weak demand in the European single market, which prevents France and Italy in particular from combating their still high unemployment. The only remedy that could be used against this – again for purely logical reasons – namely higher public debt – is prohibited in EMU.

But now the Germans no longer like the common monetary policy, which has to react to the deflationary processes in the EMU partner countries. The German saver, and with him the German savings banks and German insurers, are no longer satisfied because there is no one left who can achieve the interest rates that are so readily collected in Germany without having to go into debt and initiate growth through productive investment at home. Now Germany is paying a heavy price for having always relied solely on foreign countries running up debts. For in the meantime, German production structures have become so skewed in the direction of foreign trade that the whole country is shaken when the willingness of foreigners to take on debt dries up. It was not foreseeable that this would happen so suddenly and comprehensively in the Corona crisis. But it has been obvious for a good 15 years that Germany‘s strategy has been wrong and highly risky.

But it is precisely this story, which is absolutely central to understanding the euro crisis and the ten years thereafter, that has been made a taboo in Germany. Of course, this taboo is also the source of the complete ignorance of the constitutional judges. Can they be blamed for this? I doubt it. The court reflects the reality of German life, from the farmers’ round table in Lower Bavaria to the crab fishermen on the North Sea, who cannot be accused of only being able to absorb and process what politicians, in conjunction with the major media, make the subject of discussion.

The ZDF (second public television channel) has just provided striking proof of the failure of the media. In a 45-minute documentary on the “seven biggest mistakes of the euro”, there was not a word about Germany’s current account surpluses, German wage dumping and its deflationary consequences for the entire euro zone. However, economics professor Hans-Werner Sinn is allowed to explain his abstruse capital flow theory. Such an omission by a significant medium may not fall directly under the term fake news, but it is fake information because it suggests to the viewer that Germany has done everything right.

The ignorance of the Karlsruhe judgment is due to the refusal of politicians and the German public to talk about this German thorn in European flesh. Neither the SPD nor the Greens have clearly turned away from their agenda policy. The Federal President, who plays the big European in every Sunday speech, has never said that he (as the chancellor’s main adviser and minister), together with his then Chancellor Gerhard Schröder, is ultimately responsible for what is happening now. Angela Merkel and her ilk have always been glad that the former Red (Social Democrat)-Green coalition did a “job” that her party would never have dared to do and that it could not have pushed through. The right-of-centre Christian Democrat/Christian Social Union and the Free Democrat (FDP) have also made it their programme to remain silent on the German case.

Monetarism

In view of such mistakes, it is almost superfluous to state that the original mistakes of the Maastricht construction have not yet been rectified, and are not even being discussed. Maastricht was built on monetarism. But monetarism is a fiction – the fiction that there is a money supply that is controlled by an independent and purely technocratically managed central bank in such a way that the desired inflation rate is ultimately achieved. That is the dream of many economists of neutral money.

This dream has nothing, absolutely nothing to do with reality. However, because at the beginning of the 1990s, when the Maastricht Treaty came into being, people firmly believed in this fiction (some, such as Frankfurt Professor Volker Wieland, a member of the Council of Experts, still believe in it today), a separation of monetary and economic policy was written into the Treaty, which is completely alien to life. It was precisely this dream that led Germany to insist that monetary policy could operate completely detached from the real world – and it is precisely for this reason that the central bank should not pursue any objective other than price stability, but that everyone else should adapt to the central bank’s requirements. This was exactly the opposite of the proportionality that the Constitutional Court is now demanding.

Constitutional judges do not need to know all this. But they do need to get themselves properly informed. No one would trust a structural engineer to inspect a bridge unless he was up to date with the latest technology. If new technical know-how has been gained between the construction of the bridge and its inspection, he must take it into account. He cannot defend himself against errors in the inspection by arguing that he has carried out inspections based on the state of knowledge thirty years ago. Monetarism has been put on ice by all the world’s major central banks because money supply management cannot be implemented. Central banks make economic policy via interest rates, what else? Weighing up the effects of this policy on the economy as a whole is therefore a matter of course, and the BVerG’s request to examine the issue of proportionality is therefore completely inappropriate.

Whether central banks that simply make economic policy should be independent is a matter of long debate. In any case, the technocratic arguments for independence put forward by monetarism are completely invalid. However, if, despite overcoming the monetarist fiction, independence is chosen, as Europe has done, it goes without saying that such an institution does not need to take advice on proportionality either from national constitutional courts or from national governments and national parliaments.

Moreover, all central banks are much more closely involved in the practical shaping of economic policy than appears to be the case externally. The ECB is present at meetings of the Eurogroup, including preparatory meetings, at G7, G20 and the other international organisations dealing with financial issues. A central bank that is completely detached from politics and makes lonely decisions in an ivory tower does not exist and never has.

The honest thing to do would be to amend the European Treaties, including the Maastricht Treaty, in order to adapt them to new times and new knowledge. But then Germany would have to bid farewell to the illusions it has cherished for decades. Who would trust this country and its policy to finally be honest with itself?