The International Economy, Spring 2012, pp. 20-21.
The ECB’s actions will not have a good ending.
During the financial crisis, the European Central Bank has progressively reduced its rating requirements for the collateral that banks have to provide for refinancing credit, from A- to BBB-. It accepted Greek, Portuguese, and Irish government bonds regardless of their ratings. It allowed the national central banks to provide emergency liquidity assistance credit, guaranteed only by the national central banks themselves. It allowed commercial banks to construct asset-backed securities composed from dubious ingredients. It prolonged the maturity of its refinancing operations from a maximum of three months to first one year and, recently, even three years. And it now plans to accept even company credit titles as collateral.
With this policy, it has helped the troubled countries of the eurozone to (electronically) print about €800 billion worth of central bank money beyond what they needed for their internal circulation, allowing them to redeem their foreign debt and to buy foreign assets or goods, in net terms, using the printing press. This is measured by the so-called TARGET credits. In a letter to ECB President Mario Draghi, Bundesbank President Jens Weidmann recently complained about the risk that the TARGET balances imposed on the Bundesbank, asking for guarantees. The ECB argues that its policy was first aid, merely stepping in for the seized-up interbank market that was not providing enough credit to the periphery countries. However, this is only one interpretation. Another one is that the ECB itself helped to destroy the interbank market by establishing the money-printing press as a competitor to commercial banks. While commercial banks from the capital-exporting countries demand a substantial risk premium in the form of interest rates, the ECB has been offering its credit at a rate of only 1 percent, far undercutting the credit market. Small wonder that the periphery banks have preferred to borrow the printing press, taking the opportunity to relieve themselves of their foreign debt burden.
The policy has reduced the periphery countries’ pressure to restructure and lessened the pain that the austerity measures necessary to regain international competitiveness would have inflicted on the population. But for this very reason it also has undermined the allocative function of the capital markets. After years of excessive capital flows to the periphery, the savers of Europe’s core countries and their financial institutions ultimately realized their mistake and preferred to stay in their home harbor, redirecting the scarce investment capital to safer and ultimately more profitable uses, which would also result in more growth and prosperity for Europe as a whole. Even though the redirection may have been too hasty, it was a necessary and useful correction of previous mistakes, potentially ending a period of excessive capital flows and current account deficits. However, the Club Med’s 70 percent majority in the ECB Council did not like this correction and has therefore made sure that the savings capital of the core countries continued to flow to the periphery despite its new-found aversion to doing so. This is an allocative distortion, since the investment risks are now being socialized via the ECB system and are, in fact, now largely borne by those same savers who no longer dare send their money abroad. After all, losses in the ECB system are socialized among the participating member central banks, and their losses are borne by the national taxpayers, which are largely identical with national savers. These policies mean that Europe is moving away from the rules of a market economy towards a system with centrally planned capital flows. This will not have a good ending.