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Why is Germany constantly clashing with the ECB?

The European Central Bank in Frankfurt, Germany
Getty Images
The European Central Bank in Frankfurt, Germany

The answer is simple: These two never seem to agree about the euro area monetary policy.

Please note that the emphasis in the above sentence is on the word "simple." That assertion of simplicity has to be tested, because in feuding Europe, nothing is simple. But let's start with the simple before largely unsuspected political designs show that the French poet and philosopher Paul Valéry was on to something when he said "What is simple is always false."

So, here is the question: How is it possible to have disagreements about the ECB's monetary policy when the mandate, written in a treaty authored by Germany, says that the bank is solely responsible for price stability within the European monetary union?

Indeed, how is it possible to have constant and publicly aired bitter disputes between German members of the ECB's Council (the bank's main decision-making body) and the rest, when the average inflation rate within the euro area, since its inception, has been 1.8 percent? That should make Germans happy, because the ECB beats the average German inflation of 2.23 percent during the twenty years preceding the introduction of euro coins and notes on January 1, 2002.


The ECB's recent inflation record is even better. During the year to February, the euro area inflation has been in and out of negative territory. Last month, for example, it was -0.2 percent, almost identical to the deflation rate of -0.3 percent in February 2015. The ECB is now forecasting an inflation rate of 0.1 percent this year, and it expects that the upper range of its 0-2 percent policy target won't be hit until 2018.

The not-so-hidden agenda

One may now ask, in the New York vernacular, "What is there not to like?"

Well, that's where things get complicated in a way postulated by the French philosopher.

The German government appointee to the ECB's Council is now saying "yes, but …" The "yes" is an apparently grudging admission that the ECB has "to do something" to get inflation back up in the target range, but Germany considers that interest rate cuts, asset purchases and other extraordinary monetary policy instruments are going "too far."

At a closer look, it turns out that asset purchases are for Germans the main part of that alleged policy overkill. And that is nothing new. A German national, who was ECB's chief economist, stormed out in September 2011 protesting the purchases of Italian and Spanish bonds. That was the second high-profile German resignation from the ECB Council in 2011.

But Germany did not leave it at that. To get back at the ECB, Berlin sued to the German Constitutional Court and the European Court of Justice, accusing the bank of violating its mandate because it was "financing governments by printing banknotes."

Germany lost both cases.

And that's as it should be. Asset buying or selling programs are the key instrument of monetary policy. By buying (selling) government bonds, the central bank is creating (destroying) money measured by an aggregate called the monetary base (the right-hand side of the central bank's balance sheet), or M0. Higher-order monetary aggregates (M1, M2, M3 … M15) are then created through the operation of the monetary multiplier.

This elementary piece of monetary theory tells you how far the Germans are prepared to go to block and control the ordinary conduct of ECB's duties.

Using euro to create German Europe won't work

Aha! Some people reading these lines will scream that this is not true. They will argue that Germans merely want the ECB to stop buying "bad assets" (sic) because they fear that this will create contingent liabilities for German taxpayers.

What are these people really saying? If they care to be "politically correct," they won't name names; they will just say that the ECB should stay away from debt instruments of heavily indebted euro area countries.

And here is who these countries are: France, Italy, Spain, Portugal and Greece, where gross public debt/GDP ratios last year fell in the range of 119 percent (Spain) and 190 percent (Greece).

Germans would, therefore, prevent the ECB from buying government bonds of countries representing 63 percent of the euro area economy.

And this is where we are coming to the moment of truth: Germans are dead set against ECB's direct or indirect purchases of these countries' debt (indirect purchases being those made by banks using large amounts of cheap liquidity) because that is defeating harsh fiscal austerity policies they imposed on their so-called euro area partners.

There is also more to it. Germans, in fact, want to dismantle the ECB's strategy to manage the euro area economic recovery.

Asset buying programs are at the heart of all that. The ECB says that cheap and abundant liquidity offered to banks is intended to help them rebuild their balance sheets with default-free assets. Once that process is well under way, the ECB expects that banks will be in a better position to fund household spending and business investments. And to make sure that banks don't drag their feet in going back to their core business, the ECB has also introduced negative interest rates to discourage banks' accumulation of loanable funds in idle excess reserves.

But then things are getting ugly in vicious ad hominem attacks.

Realizing that they lost this mutual policy demolition contest, Germans are now lashing out at the ECB's President Mario Draghi. The country's main center-right daily ran an editorial last Wednesday (March 23) calling the 13 billion euro budget surplus, generated by stronger economy and falling interest charges on Germany's public debt, "rotten fruits from Mario Draghi's garden."

Incredible, isn't it? And Draghi continues to tease them. He unleashed a storm when – most probably tongue-in-cheek -- he said earlier this month (March 10) that Milton Friedman's idea of "helicopter money was a very interesting concept." In response to that, a widely read pro-government daily quoted a German analyst's opinion that Draghi, a highly trained economist with a doctorate from M.I.T., suffered from a "total mental confusion."

Investment thoughts

It has been obvious from the outset that austerity policies imposed by Germany in the midst of the euro area's deepening recession were just a cruel punishment for "fiscal miscreants and those failing to properly supervise their banks."

Predictably, these policies were abandoned after they left a legacy of soaring unemployment, poverty, falling governments, seriously unbalanced economic systems and the advent of increasingly radical political fringes – including in Germany, where the extreme-right AfD, founded in February 2013, quickly became the third-largest political party polling at about 15 percent, and counting.

The fact that the growth of the euro area economy accelerated to 1.5 percent last year from 0.9 percent in 2014 shows that the ECB policies are working. It is likely that growth will continue to strengthen as large and cheap liquidity latches on to more relaxed fiscal policies in Germany, France, Italy and Spain, which represent more than three-quarters of the euro area economy.

The ECB is on the right track, and its policies are fully supported by an overwhelming majority of member countries.

That is the most important thing to keep in mind at a time when German economic and immigration policies have set in train political and social changes that are tearing Europe apart.

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