Thursday, 26 April 2012

The ECB and the Forthcoming Referendum

Jim Stewart: A recent speech delivered by Mr Asmussen (Executive Director of the ECB) at a seminar organised by the IIEA in Dublin (The Irish Case From An ECB Perspective), gives powerful (though unintended) grounds for a no vote in the forthcoming referendum.

Mr Asmussen emphasised that from an ECB perspective it was of the “utmost importance” that all euro area countries adopt the fiscal compact to regain the confidence of markets. The overall policy can be summarised as austerity (raising taxes cutting expenditure) releases, what Paul Krugman has called the ‘confidence fairy’ and recapitalising banks and repaying senior bond holders, releases the ‘banking fairy’ – banks will once again start lending. Both policies in the absence of policies to encourage growth and investment will simply result in further stagnation. The Fiscal Treaty will make the adoption of policies supporting growth more difficult if not impossible.

Specifically in relation to Ireland, Mr Asmussen clearly outlined ECB thinking on the origins of the crisis and subsequent developments. In summary the view of the ECB is that while the crisis largely originated in Ireland, the solutions devised in conjunction with the Commission and the IMF and set out in the EU/IMF Programme for Ireland are working . The ECB has been particularly generous in its support to Ireland (“working as a true partner”), and because the programme is working there must not be any deviation from it for example in relation to the payment in full of the promissory notes, issued to finance the Irish Bank Resolution Corporation.

The following examines three claims made by Mr. Asmussen:-
1 “The Programme is on track. So far Ireland has delivered” (p.1);
2 The ECB is “a true partner” to Ireland (p.3);
3 “No other institution has provided more help to Ireland than the ECB” (p.7).

“The Programme is on track. So far Ireland has delivered”
Many might query that the EU/IMF Programme is working. Mr Asmussen states Ireland “is the only programme country that has managed to close its deficit and to return to growth last year” and cites growth last year of 0.7% and projected growth of 0.5% in 2012. But we should note projected growth (Table 1) at the time the Memorandum of Understanding was signed (16 December 2010), and on which the programme was predicated, was considerably larger than actual and projected GDP.

Table 1:

'10 '11 '12; '14 '15
Department of Finance forecast of GOP growth, December 20101
0.3 1.7 3.2 3.0 2.8
Actual 2010-2011 IMF forecast,
-.04 0.7 0.5 2.0 2.5
Department of Finance forecast of unemployment rate, December 2010
13.4 13.2 12.0 10.9 9.8
Actual Unemployment rate for 2010-11 and IMF forecast April 2012 13.6 14.4 14.5 13.8 13.0
Department of Finance forecast of
change in total numbers at work 10th,
December 2010
-4.0 -0.2 1.3 1.6 1.8
IMF forecasts for change in numbers
at work April 2012
-4.2 -2.0 -1.0 0.07

The ECB does recognise unemployment as an issue. Mr. Asmussen states, (p. 6) “worst of all, perhaps, is the fact that a large portion of the population is currently out of work”. What is not stated is that unemployment in Ireland is the second highest in what the IMF classifies as advanced Europe (IMF World Economic Outlook April 2012, Table 2.1 p. 53) at 14.4% in 2011 and is forecast at 10.5% in 2017. Examples cited by Mr Asmussen such as deregulating the market for legal and medical services (p. 5) are most unlikely (even if implemented), to “expand activity and increase employment” in any meaningful way.

The ECB is “a true partner” to Ireland;
Mr Asmussen describes the ECB “as a true partner”. In fact many of the policies implemented and required by the ECB have magnified the crisis in Ireland. In his address Mr Asmussen clarified that the ECB regarded repayment of Anglo bondholders as a key consideration to prevent negative effects to “banks in other European countries”. This clarification is strangely absent from the written statement (available here). These ‘negative effects’ are uncertain. Bondholders may have held insurance in the form of credit default swaps. Default on senior bank debt by banks in Denmark had no or very little (reported consequences) for banks in other countries (see Denmark Takes Over Second Bank to Trigger Bail-in Resolution, Bloomberg 27 June 2011) and yields on Danish Government debt are close to or below those for Germany. But the main implication of Mr Assussens comments are that the ECB sought to give preferential treatment to banks in other countries at the expense of the Irish State and Irish society. This transfer in wealth (it was a transfer as Anglo-Irish and other banks senior debt was trading far below the value at which it was redeemed before the new government took office) has helped increase the cost to the State of the bank recapitalisation to €62.8 billion by March 2012 approximately 38% of General Government gross debt. Without any bank recapitalisation Irelands Debt/GDP ratio would be approx 65% of GDP (ignoring interest savings)- amongst the lowest in the eurozone.

In February 2011 the five institutions recapitalised, held €35 billion in senior unguaranteed secured and unsecured bank debt (see Senior Debt and Subordinated Debt Issuance by Irish Credit Institutions, Central bank March 2, 2011 available here). If this were written down by 50%, the Debt/GDP ratio (as measured by the IMF), would fall from 105% for 2011 to 94%. (Note this excludes the approximately €71 billion in bonds redeemed at face value prior to February 2011). Any policies that reduce government borrowing and the Debt/GDP ratio, without advesely affecting economic growth will enhance Irelands ability to access market based funding. The ECB belief that negotiating a reduction in the cost of the promissory notes would adversely affect Ireland’s credit rating is delusional. The IMF has recently urged the need to reduce the links between sovereign debt and bank debt. In Ireland the policies of the ECB have the effect of increasing these links.

“No other institution has provided more help to Ireland than the ECB”.
The one area where ECB policy is beneficial to Ireland has been through Eurosytem liquidity provision. Mr Asmussen implies that this liquidity provision was in some sense preferential aid to Ireland. He states “Relative to the size of the economy, no other euro area country has received so much support from the Eurosytem. And no other institution has provided more help to Ireland than the ECB”. However the provision of unlimited liquidity is one of the main functions of a Central Bank and liquidity was provided to banks in Ireland fully in accordance with ECB rules (a point acknowledged by M. Asmussen) and cannot in this sense be preferential. Furthermore the benefit of this liquidity provision accrues not just to Ireland but in a monetary union given large scale interbank borrowing and the presence of a large EU owned bank sector in Ireland, throughout the monetary union. A collapse in Ireland’s banking sector would have been a calamitous event not just for Ireland but for the Eurosystem.

Mr. Asmussen states that the level of this “support” contradicts claims that the ECB “bounced” Ireland into the EU/IMF programme in late 2010. Rather the level of liquidity provision which the ECB erroneously believed was in some sense a gift or aid, exclusively to the benefit of Ireland, and the desire of the ECB to reduce this as quickly as possible were likely to be prime factors in the initiation of the EU/IMF programme. Reducing ECB liquidity provision to Irish banks remains a key policy objective of the ECB. Mr Asmussen states “There can be no doubt that the current amount of liquidity support by the ECB and the Central Bank of Ireland needs to be substantially reduced over time”.

The expressed wish to reduce the amount of eurosystem liquidity provision is not in Ireland’s current interest. A policy objective should be to maximise the amount of liquidity provision from the Eurosystem, given the risks of bank deleveraging as a response to the economic crisis. This risk has been exacerbated in Ireland by the imposition of a higher core Tier 1 capital ratio (equity/risk weighted assets) than that required by the European Banking Authority (10.5% compared with 9%) and at the same time reducing the loan to deposit ratio from 180 to 122.5% (See Central Bank, Financial Measures Support programme, p. 7 and 12).

The crisis in Ireland is largely of our own making involving multiple failures at many institutions (public and private) and at many levels, but ECB policies have magnified the crisis. Policy at the ECB and other EU institutions can and must change to support a pro-growth strategy for Europe as a whole. This is in the interest of all countries in the EU, and in the vital long run interest of Germany. Irish Government policy should be to support the likely new Hollande administration in amending the fiscal treaty and in reforming the ECB (See “Hollande seeks wider EU fiscal pact”, Financial Times April 24, 2012).


paul sweeney said...

“The Programme is on track. So far Ireland has delivered”
Many might query that the EU/IMF Programme is working.
For sure.
I think the Troika is finally admitting that it has not got it right in today’s epistle, where it actually talks of the need for jobs and growth!
When they say “Ireland is on track”, they largely mean in meeting the targets on heading to the 3% deficit. They also are pushing for the closing of the stable doors after the six banks have escaped and making solid new “regulatory” doors around our subsidised banks.
The ECB is “a true partner” to Ireland;
Mr Asmussen describes the ECB “as a true partner”.
In relationships, it is recognised that there are abused partners. Is that what he means about Ireland? Sure they give us money (so we can pay off the banks they were supposed to regulate), but what else?

Anonymous said...

Stewart has expertly demonstrated the extent to which the ECB’s enforcement of a destructive Neanderthal orthodoxy has contributed to the worsening of the crisis for Ireland.

Whereas one can debate ad nauseam the causes of the crisis, there can be no debate as Stewart has so comprehensively demonstrated that the ECB is the major cause of the unnecessary exacerbation of the crisis for Ireland.

Stewart also demonstrates the complete absence of integrity on the part of the ECB – its attempt to deny its role in precipitously forcing the then Irish government to take on additional debt to pay off international banksters in what has come to be referred to as a bail-out.

In reality what the ECB has been responsible for since 2008 is the subjecting of entire generations of Irish taxpayers to an act of looting on a scale unparalleled since the days of the great famine. As Stewart has highlighted, the motivation for this manacling of entire generations of Irish taxpayers was unintentionally acknowledged by Asmussen to be the prevention of negative effects to “banks in other European countries.”

Stewart has directly exposed as a complete distortion the hitherto unchallenged assertions from the ECB that it is some way doing Ireland a special favour with its liquidity provision. This repeated assertion by the ECB indicates a complete absence of honesty and integrity on the part of the ECB and/or a complete ignorance on its part of one of the basic functions of a central bank. It is hard to know which explanation is the more damming as far the ECB is concerned.

Ireland and Europe desperately need a European Central Bank that is composed of individuals that have an appreciation of the functions of a Central bank and whose integrity and competence are not compromised by their indoctrination with an obsolete orthodoxy.

We have to go back to the Europe of the Middle Ages to find an equivalent period of insanity as exists today with the ECB when right and reason were suppressed in favour of obsolete dogma.

It is time for democracy to assert itself in Europe and for control of Europe’s destiny to be vested in democratic institutions whose hallmarks are accountability, competence and reason.


Paul Hunt said...

"Sure they give us money (so we can pay off the banks they were supposed to regulate).."

The problems have arisen precisely because 'they' were not empowered to supervise the banks or to regulate the financial sector in the EZ member-states; or to ensure that increases in the cost bases of individual economies were not kept in line with the overall EZ target of 2% a year; or (in combination with the Commission) to ensure that commitments to public expenditure increases were not funded by ephemeral tax revenues.

On all three counts successive Irish governments (and those they appointed to formulate and implement policy) failed to discharge their duties to the Irish people and to Ireland's EU partners.

It is truly unfortunate that the ECB had to sanction bumping investors in bank bonds ahead of investors in sovereign bonds to prevent a meltdown, but they had little choice - given the extent to which all EZ member-states had refused to give them the powers to act as a proper central bank. But what is done is done, and the focus now must be on recovery.

The upshot is a requirement to minimise the risk of sovereign bonds so that they can, once again, move ahead of bank bonds in the queue and attract 'rate' investors. This is best achieved by reducing the amount of sovereign bonds in circulation. And this is what the Fiscal Compact is about.

The Troika Programme had three legs. Colm McCarthy summed them up: "fix the fiscal deficit, fix the banks and reduce the cost base of the economy". The last was intended to counteract the deflationary impact of fiscal adjustment. But the Government - under pressure from the various vested interests - has succeeded in whittling this down to almost nothingness.

That is where the problem is.