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Eurozone Breakup Risk at New High


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sancho panza

Hardly a revelation on a site like Dosbods but the EU looks like it's in deep trouble.

https://www.thestreet.com/mishtalk/economics/eurozone-breakup-risk-at-new-high

The German Constitutional Court made an unexpected and significant ruling last week against the ECB and Quantitative Easing.

QE Deemed Illegal

In the midst of a pandemic and an important presidential election, it is very easy  to miss globally significant events. 

Here is one that is way under the radar: The German Constitutional Court ruled the ECB's QE Program Could be Illegal.

That is a landmark ruling that challenges the independence of the ECB and the authority of the Court of Justice of the European Union (CJEU).

In announcing the ruling, German Chief Justice Andreas Voßkuhle said the CJEU had approved a practice that “was obviously not covered” by the ECB’s mandate. Voßkuhle spent months crafting the 77-page decision, announcing the ruling just a day before his official retirement on Wednesday. "

Dismissing a 2018 CJEU decision to allow the bond purchases, the German court ordered the ECB to provide Germany with adequate justification for the program within the next three months. Should it fail to do so, the Bundesbank, Germany’s central bank, would no longer be permitted to participate in the program.

What it Means for the Future of the EU

Eurointelligence explains What it Means for the Future of the EU.

The ruling raises complex and potentially troubling issues for the EU as a whole. The German constitutional court has accused the ECB and the CJEU, the court of Justice of the European Union, of abusing their power, and of acting beyond their assigned competences. That concept is known in German constitutional law as acting ultra vires. In the German legal interpretation of European integration, all sovereignty still rests with the member states. The EU is clearly not a federal state, but a deferred power. Member states have transferred certain rights to the EU. The German court said it accepts that it is bound by CJEU rulings, but only those that occur within the EU's agreed competences. All bets are off it the CJEU goes ultra vires. And, crucially, the German court decides if and when that happens.

This is the most serious challenge to the EU's legal framework we have yet come across. In the UK, the courts operated under the assumption that conflicts between EU and UK law would always be settled on the basis that EU law is supreme.

The ruling is unusually explicit about the breach of competences on the part of the CJEU. It criticised the CJEU's positive ruling on the asset purchases as implausible, and objectively arbitrary. It accused the EU court of an evident neglect to investigate the wider consequences of the ECB's programme. The word evident crops up many times in the ruling. It is a legally more loaded word than it appears at first sight. Moreover, the ruling accuses the CJEU of a breach of EU treaty law.

The German court's interpretation will have important consequences if other national courts follow suit, which we think is very likely. Poland's deputy justice minister already declared that member states have regained their position as the masters of the EU treaties. We expect the ruling to strengthen the determination by the Polish government to press ahead with judicial reform, and to resist interference by the EU into what they consider domestic legal affairs.

 

Price to Pay

In the ECB’s view, the negative effect of lower interest rates was the price to pay for keeping the euro intact. 

That price to pay keeps rising and rising. 

This Eurozone Crisis Will Be Even Worse Than Last Time

Please consider The shock of coronavirus could split Europe

The economic fallout of Covid-19 hits all members of the currency bloc. But no mechanism exists that allows the governments of the eurozone to respond jointly to such a shock. The result is that the policy reactions to the pandemic are so far overwhelmingly national – accentuating differences rather than bringing Europe together in a time of crisis. Even in the face of a symmetric shock, the eurozone responds asymmetrically.

Germany reacted forcefully to Covid-19. Berlin abandoned its cherished debt-brake – which sharply constrains its government borrowing – and legislated a €750bn rescue package for the German economy. Italy, the country with the highest number of infections and deaths from the virus, does not have the same fiscal leeway. Its response to Covid-19 amounts to a mere €28bn – about 4% of the size of the German package.

This substantial disparity in the policy response is exacerbated by differences in initial conditions. In 2019, Italian output was still 4% lower than in 2007 while German GDP was 16% higher. Owing to the ongoing GDP collapse, the Italian public debt ratio will soon approach 150% of GDP – even without a new support package. Yet despite their comparatively tepid response, Italian policymakers already have to nervously watch the interest rate differential between Italian and German government bonds. The spread widened substantially in recent weeks. 

The writing is on the wall: without solidarity from its fellow eurozone members, Italy will not be able to respond to the crisis in the same way that other countries can. It is at risk of an economic depression on top of a humanitarian catastrophe.

Negative Interest Rate

In March of 2015, ECB president Mario Draghi forced more reserves into the system, via a Quantitative Easing QE program. The ECB also forced interest rates negative then required the banks to pay the ECB interest on those reserves.

In contrast, the Fed paid interest on excess reserves. In the process, the Fed slowly recapitalized US banks over time.

The ECB's negative interest rate policy further damaged European banks that were in terrible shape to begin with. 

Why?

Before he served as ECB president, Draghi was president of the Italian central bank from 2005 through 2011. 

What better way to get Eurobonds and debt commingling than cripple the entire European banking system with negative rates and massive QE programs?

If the European banking system went down, including Deutsche Bank, wouldn't Germany be forced to go along with banking changes?

My counter-argument is on grounds of Occam's Razor which suggests when stupidity is one of the possible answers it is highly likely to to be the correct one.

Actually, Occam's Razor says simpler explanations are more likely to be correct, but what is simpler than stupidity?

Surprise, Surprise

The EU is not used to surprises. But the German court ruling makes three in a row.

  1. Brexit Vote
  2. Brexit Vote Success
  3. German Court Ruling

I am surprised too. 

Why?

Because in every case to date, the German Constitutional Court looked the other way, There have been numerous ECB-related challenges which the German court threw to the CJEU with obvious consequences. 

And there was no indication that the German court would suddenly reverse course. 

So I am not only surprised by the ruling, I am shocked that it was 7-1.

Even Those Who Filed the Suit Were Surprise

I was surprised by how clear the ruling was," said Peter Gauweiler, a 70-year-old Eurosceptic lawyer who has been waging a legal war against the EU and ECB for almost three decades.

Debt Mutualization

What Germany fears now and has from the outset is "debt mutualization" in which Germany would bailout Greece, Spain, Portugal, and Italy. 

That is why Germany insisted the Maastricht Treaty, which founded the Eurozone, prohibit debt mutualization.

But time and time again, politicians and the ECB found ways to chip away at the treaty.

And they still do even in the wake of the German court ruling.

New Battle Cry - Step Up or Risk Extinction

Today, Spain’s Deputy PM Calls for EU to Step Up or Risk Extinction

Pablo Iglesias, Spain's Deputy PM. says a “certain [level of] debt mutualisation is a [necessary] condition of the [continued] existence of the EU”.

He also wants Portugal and Italy to join the a pan-EU minimum income guarantee cause to “establish European standards of dignity and to protect consumption”. 

"Everyone now understands you need an activist state," says Iglesias.

What "Everyone" Understands

Given the 7-1 ruling might I suggest there is a major flaw in the Iglesias' understanding of the word "everyone". 

Germany Pays One Way or Another

I understand where Germany is coming from. And I expected this outcome all along. 

But one way or another, creditor states pay through the nose. Either Germany agrees to debt mutualization or Target-2 liabilities go up in smoke. 

Target-2 Imbalances 

Target 2 ImBalances 2020-05-08
 

Chart from the ECB Data Warehouse Target Balances.

 

Target is a measure of capital flight and purchases of goods by debtor nations that cannot possibly be paid for.

Italy and Spain owe nearly a trillion euros to Germany. That's an amount that can never be paid back. 

But everyone pretends the debt is good because the ECB guarantees the debt. And those guarantees represent a fundamental flaw in the Eurozone that allowed this debt to pile up in the first place.

If Italy were to withdraw from the eurozone, its banks’ assets and liabilities would be redenominated in its new currency. Germany would not get paid back in in euros, but rather Lira or some new currency, assuming Germany got paid back at all.

For further discussion, please see my August 2018 article, Debate Over Target2 Continues: Twilight of the Euro 

The question is not whether Italy should pay its Target2 deficit, but how it possibly could. The Bank of Italy would almost certainly default on a bill for half a trillion euros.

As long as everyone can pretend these claims are good and no one will leave the Eurozone, then everything is fine. 

But what if Italy or Spain jumps ship? And what are the other options?

Three Alternative Paths 

  1. Germany and the creditor nations forgive enough debt for Europe to grow 
  2. Permanently high unemployment and slow growth in Spain, Greece, Italy, with stagnation elsewhere in Europe
  3. Breakup of the eurozone 

Pick Your Poison

  • The German court signaled it has had enough of the current path towards more mutualization.
  • It is unreasonable to expect #2 to last forever.
  • The only door remaining is door #3. 
 

Option 3 can be planned or chaos. Germany is arguably in the best shape to suffer the consequences so it would be wise for it to leave the Eurozone rather than have Spain or Italy default, setting off a cascade of defaults. 

I outlined those three alternate paths in my 2016 post Michael Pettis Calls Surplus Trade Statements by German Finance Minister “Utter Lunacy”

Kick the Can - How Long Can It Last?

The court ruling comes in the midst of a pandemic, Brexit, the rise of the German Greens, a eurosceptic Italian government, and an EU judicial clash with Poland. 

Yet, these can kicking episodes last far longer than anyone expects. The difference this time is the unexpected ruling by the German constitutional court. 

The ECB cannot do more, nor can the CJEU, nor will there be coronabonds or eurobonds unless Germany agrees.

Undoubtedly, the path of least resistance is still door number 2: Germany will talk solidarity but act against it.  

The result will be a continuation of high unemployment and slow growth in Spain, Greece, Italy, with stagnation elsewhere in Europe .... until the major unexpected happens, Italy or some other country decides it has finally had enough.

Mish

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spygirl

I came to post this to.

Massive. Huge fucking thing.

Typical BBC

German court criticises European Central Bank crisis bond-buying

https://www.bbc.co.uk/news/world-europe-52542993

 

More accurate

https://www.bloomberg.com/news/articles/2020-05-05/eu-court-faces-declaration-of-war-from-germany-s-top-judges

EU’s top court reasserts primacy after German challenge

ECJ issues rare warning over EU legal order after German judges question its superiority

https://www.ft.com/content/894369cd-9631-43cc-8844-d6cd515e874b

 

So, will the Germans meekly accept the judgement and be happy being ruled over by a bunch of bent, loose moneyed non Germans.

Or 'invade Poland' - other acts of German aggression are possible.

GEREXIT?

 

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spygirl

Best comment

Yes the German court has challenged the supremacy of the ECJ and for good measure instructed the German Central Bank not to comply with the ECB if the ECB fails to provide the proofs required by the German court. 

Such challenges are inevitable so long as the EU is based on a series of fudges, and no one honestly denies the decades of fudges. 

The EU requires a new treaty clearly setting out the powers it currently assumes, however the EU will never seek such a treaty as it rightly thinks many countries will not be willing to agree such a document.  And there it is in a nub, the EU wishes to exercise powers its people will not grant it by circumnavigating the people.  An unsound democratic foundation for town let alone a continent.

The ECB is basically making it up as it goes along, with no legal or economic justification, just Well, this ought to work....

Then theres Poland n Hungary genuinely breaking hard EU laws. Fuck all bar grumbling.

The EU is rapidly becoming a huge farce.

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DurhamBorn
1 hour ago, spygirl said:

Best comment

Yes the German court has challenged the supremacy of the ECJ and for good measure instructed the German Central Bank not to comply with the ECB if the ECB fails to provide the proofs required by the German court. 

Such challenges are inevitable so long as the EU is based on a series of fudges, and no one honestly denies the decades of fudges. 

The EU requires a new treaty clearly setting out the powers it currently assumes, however the EU will never seek such a treaty as it rightly thinks many countries will not be willing to agree such a document.  And there it is in a nub, the EU wishes to exercise powers its people will not grant it by circumnavigating the people.  An unsound democratic foundation for town let alone a continent.

The ECB is basically making it up as it goes along, with no legal or economic justification, just Well, this ought to work....

Then theres Poland n Hungary genuinely breaking hard EU laws. Fuck all bar grumbling.

The EU is rapidly becoming a huge farce.

Germans know the thing they fear most is coming.Inflation.Its too late though.If they dont print the US will have far more capacity to enjoy the cycle than they will.

Europe has a choice.Our own inflation,or import it.The choice of low inflation is so last cycle.Its just going past the drivers door for one last big wave,then into the rear view mirror.

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reformed nice guy
3 hours ago, spygirl said:

 

The ECB is basically making it up as it goes along, with no legal or economic justification, just Well, this ought to work....

 

EU law can be made on the hoof and often is. Any decision made by the ECJ is just as binding as any law cooked up by the commission. 

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spygirl

The dreadful science meets dreadful Gallic political fuckheads.

ECB rebuffs bank complaints on negative interest rates

Radical policy ‘broadly neutral’ for profitability at eurozone lenders, central bank paper maintains

https://www.ft.com/content/52de6e70-56bc-4da9-adf7-b228c8da79a0


Six years of negative interest rates have done as much to boost profitability at eurozone banks as they have to weigh it down, the European Central Bank said in a research paper that is likely to raise eyebrows among financiers.

Rebuffing the claims often made by lenders that the central bank’s sub-zero deposit rate is a big reason for their weak returns, ECB economists calculated that the controversial policy was a “broadly neutral” factor for bank profitability.

The findings may be contested by some bank executives, who complain that their sector has paid €25bn in negative rates to the central bank since its deposit rate went below zero in June 2014, eating into their already weak profits. 

There you go. ECB has saved the world Again.

At worse, ZIRP has been neutral for the banking sector ....

Among the benefits they said banks had received from sub-zero rates, they listed a lower level of provisions for bad loans because of cheaper financing costs and higher economic growth, as well as increased demand for loans and a rise in the value of debt securities they owned.

Books stuffed full of zombie, debt junkie companies FFS.

Top rated comment nails it

This report is just another confirmation of fears held by many that the ECB simply doesn't really know what it's doing. The latest change, the appointment of a French politician with no track record in this field (or any other for that matter) and an obvious lack of grasp of fundamental economic concepts contributes to that confirmation.

Many people refer to negative interest rates and an "experiment". But an experiment is started for a reason, conducted, then finished with a result. The result of this experiment is that negative rates are not curing the endemic problems of the EU and Eurozone. But the mad scientists (if only they were are as bright as scientists) are simply addicted to and enjoying the experiment too much to stop.

The ECB has no prospect whatsoever of returning to a positive interest rate environment in the next 10 years or longer. Just none. Fundamentally that is because the debt pile they have generated to fund their great experiment is now just unserviceable.

They are like the proverbial household rolling credit card debts from one card to another just to take advantage of the 12-month interest holiday. Keep up the monthly payments, nothing more, and have zero financial resources for anything else.

As for this report saying that interest rates have no real impact on bank earnings... again, truly, truly alarming. They have no clue how commercial and investment banks operate and earn revenue. Combined with the fact that this low-rate environment will drive banks back toward riskier products, and seek to earn revenue in less traditional ways, it's also morally hazardous.

How I long for the days of the European Community when it was a functioning economic trading block that somehow accommodated the great economic and cultural contours of the continent, without the huge fiscal claims, imbalances and political tension that the Euro has created. Maybe it was too successful, and the cake became just too big for the fat bellies of Brussels to stay away from. But this sad experiment to compete with the US and China - on their terms not ours - has left a generation with little hope.

It's a real shame to see the EU experiment ending in such a horribly drawn-out and painful way, thanks largely to a new plutocratic and aristocratic political class, but unfortunately that pain is now only just beginning.

 

 

 

 

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VeryMeanReversion
On 13/05/2020 at 12:54, spygirl said:


The ECB has no prospect whatsoever of returning to a positive interest rate environment in the next 10 years or longer. Just none. Fundamentally that is because the debt pile they have generated to fund their great experiment is now just unserviceable.
 

 

My personal strategy is based on the expectation of increasingly negative real interest rates i.e. Inflation goes up, interest rates down.

Since interest rates are so low, there is no point saving more than emergency funds in cash accounts. Since economic risks are so high, there is no point borrowing  There's too much money being printed, too much debt to service.

I save as much as I can but not in cash.  Divi-stocks for income and PM's for protection in my SIPP.

Anything else goes into home improvements and building projects. I've got a good sized plot that could support 5500 sqft of buildings for family use or rental income (1500sqft -> 2500sqft so far.)  At least its mine, debt-free and enjoyable to live-in every day.

 

 

 

 

 

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  • 2 weeks later...
spygirl

Theyv rolled out the new German member f ECB

https://www.ft.com/content/a48b8982-3e75-4a35-8fb5-a66f4fb0fedc

293c7b78-371d-47aa-80bb-1373435dac45.jpg

Another economist .....

Comments:

It’s a strange feeling seeing German EU officials brushing aside German constitutional court rulings. It’s fully expected of other nationals, why should a Spaniard care about a German court? But for a German ... that court has a special meaning, it’s not just like any other court. It has the highest trust of all state institutions in Germany among the population and standing against it means loss of public support.

I understand that technically the EU institutions shouldn’t care what one nations court or even people think, I hope they are aware though that this might cause a real shift in Germany and will play into the hands of eurosceptic politicians. It gives them validation, turns them from extreme positions to guardians of the constitutional order.

It doesn’t help that the German people never had a vote about joining the EU or the euro. How can something that wasn’t mandated by the people stand above our constitution? The current pandemic all but mutes politicians on the sidelines, but this will come back to haunt us all. The people in bruessels I see yapping on this ... they are not even elected. The only EU institution I can take serious is the EU parliament, those at least represent actual people albeit imperfectly.

 

Response pulls the youdont undertand demotratve democracy bullshit. which ignore the deocracy works by being able to reverse and get rid of people you voted for.

Sorry, but you need to learn to understand indirect democratic legitimisation. You never directly voted for most state power in Germany: you never voted for the Chancellor. You never voted for the President. You never voted for the Cabinet. You never voted for the members of the Bundesrat. You never voted for all the civil servants. You never voted for the judges at the BVerfG (or indeed any other court). 

They all derive their democratic legitimacy indirectly — eg, by elected MPs voting for the Chancellor; the Chancellor appointing the members of the Cabinet; they in turn appoint civil servants who are chosen according to law for their knowledge and competence etc. 

And so it is in the EU; indeed the Council has exactly the same indirect democratic legitimacy as the Bundesrat: they both consist of representatives of the governments of states (Länder and EU MS, respectively). The Parliament has direct legitimacy (which you concede). The EU Commission has one of the most rigorous selection concours I know of.

And while the EU has nearly the same democratic legitimacy as a state, it is not a state. The reason, for example, why the Council (only indirectly democratically legitimised) has so much power is that the EU is for the constitutional parts an intergovernmental organisation. No other intergovernmental organisation has similar mechanisms for democratic legitimisation; of course, this is justified and necesary because the EU as a supranational entity sui generis also has more power than “normal” intergovernmental organisations. But compare this to, eg, the democratic legitimacy of the WTO.

So, please stop this “the EU has no democratic legitimacy” nonsense. One can talk about improving things, but most improvements would shift the EU closer to statehood. 

Best response

Full speed ahead and damn the torpedoes!

Having allowed Germans to believe that she was a bit hawkish around the time she was appointed, this lady went native in the first half of February, with a speech that presented the central bank community's politically convenient party line: (1) "natural rates" are low and exogenous to monetary policy, (2) savers may lose but borrowers gain - a statement of the obvious which ignores a key point of debt, which is to provide, short of default, an income / cost that is maintained in bad times and good, (3) monetary policy is not sustaining zombie businesses, because there are few non-performing loans - which might be expected when the demands made by tiny interest rates on "performance" is low, and (4) there has been a surge in asset prices, but it has been moderate compared with the past, and is to be expected given low interest rates - which one might think are supposed to be a response to the kind of economic downturn that should depress asset prices.

Let's be honest about the euro here, instead of ideological.  The brutal truth is that the euro was foisted on Germany as a quid pro quo for a united Germany, and northern Europe's wealth is what stands behind the Eurosystem.  The finding by the BVerfG, a measured degree more assertive and clearer than the last, is a warning that the paymasters' patience is beginning to run out.  This I see, ironically, is the most realistic danger to the Eurozone, not withdrawal by the indebted countries.

As I keep pointing out in FT comments, by my reckoning, the interest rate risk that the ECB have taken on in their Asset Purchase Programme is such that a 1% increase in euro interest rates across the yield curve would result in a loss of about the size of the entire annual EU budget, making it increasingly troublesome to withdraw the present measure of monetary easing.  Central banks in charge of other developed country currencies are exposed to similar losses in the event that monetary policy tightening is required.

It is time for central bankers to get a bit more humble, and appreciate that their independence is predicated on them having price stability as their priority principle, which, regardless of the present rates of inflation in the main currency areas (which I would argue are not incompatible with the intentions of inflation targets around 2% when originally set anyway), or even medium term forecasts of inflation, must be endangered where central bankers put themselves in a position where tightening monetary policy becomes financially ruinous.

 

The ECB has took a postion with its bond buying that is so big that it cannot get out of it or changecourse.

 

 

 

 

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