The euro crisis led to long-term lending by the ECB and a massive purchase of government bonds.
(Photo: Reuters)
Every year there is a fuss in the US Congress about raising the national debt limit without this slowing down the rise in US national debt. Couldn’t the government simply do one to avoid the drama? Coin with a face value of one trillion dollars coin and then sell them to the central bank?
Legal speaks after opinion of leading lawyers don’t mind, because the government has the right to circulate coins. For Nobel laureate Paul Krugman, this allows the Treasury Department to bypass the debt ceiling, “without causing any economic damage“.
The thought is not far from that Demand from European economists as Thomas Piketty removes, the European Central Bank (ECB) should wipe government debt off its books: “We practically owe this debt to ourselves,” write Piketty and his comrades-in-arms.
This step would only affect the ECB on paper, but what no real economic importance have. Since central banks create the money they issue themselves, the logic goes, they cannot become illiquid, and therefore it does not matter how valuable the assets on the balance sheet are.
A fatal mistake. When a central bank has too many risky and worthless assets on its balance sheet, it loses the ability to recover from the market the money it issues. If the financial markets doubt the value of the assets, speculation against the currency ensues.
Assets back the money supply of central banks
Domestic currency is sold, currencies perceived as solid are bought. The beginning of inflation.
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The economist Ingo Sauer, who teaches at the Goethe University in Frankfurt am Main, shows how important the quality of the assets in the central bank balance sheet is for the value of money in an econometric and historical study of periods of high inflation entitled: “The Lessons from 1923 for the Euro Area “. After that, it was the insufficient assets of the Reichsbank compared to the circulating money supply that made the Reichsbank vulnerable on the currency markets, led to the permanent devaluation of the mark and ultimately to hyperinflation.
If Sauer is right, central bank assets are just as important to a currency’s stability and value as the money supply, since assets back that money supply. He also shows that it is extremely difficult to get out of inflation, which is ultimately based on the central bank’s balance sheet problems, due to various self-reinforcing processes and political dynamics, and to push through the costly recapitalization of the central bank politically.
It is difficult to determine in advance how far assets can depreciate in value before spiraling into inflation. Sauer is increasingly concerned about the quality of its assets given the ECB’s inflated balance sheet total. In the course of the euro crisis, second-rate collateral from commercial banks was initially accepted. Then there was long-term lending by the ECB and the massive purchase of government bonds. Most recently, debtors with poorer credit ratings such as Greece, Spain and Italy were openly preferred.
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If central bank solvency is critical to currency and price stability, then not only are trillion dollar coins and sovereign debt cancellations dangerous, but so is continued ECB balance sheet deterioration. If the euro collapsed or even if Italy left the common currency, the Bundesbank would lose hundreds of billions in claims overnight and would have to be recapitalized by the state.
Eurozone governments must stop delegating the problems of monetary union to the ECB and tackle fundamental reform. The ECB’s balance sheet is too important to continue to be the repository for bad assets.
Daniel Stelter is the founder of the discussion forum beyond the obvious, which specializes in strategy and macroeconomics, as well as a management consultant and author. Every Sunday his podcast goes online at www.think-bto.com.
(Photo: Robert Recker/ Berlin)
Daniel Stelter is the founder of the discussion forum beyond the obvious, which specializes in strategy and macroeconomics, as well as a management consultant and author. Every Sunday his podcast goes online at www.think-bto.com.
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