When I first began writing The Daily Reckoning Australia Weekend Edition in 2010, my job title was a running joke. I had several roles in the company which were completely unrelated, leading to a lot of confusion.
One of my roles was to follow the European sovereign debt crisis closely and report back to readers. Which led to my sarcastic but semi-official job title of ‘Resident German Expert’.
My colleagues here in London recently described me as ‘a reclusive German anarchist’ in one of our reports, so things haven’t really changed all that much in 10 years…
Anyway, today I return to my old role. Because we’re heading back into another European sovereign debt crisis. One that I believe will trigger a global financial crisis unlike anything we’ve ever seen before. Including the largest default in history.
It’s time to pay attention again, even if these events are unfolding on the other side of the world. But why now?
No, not because of COVID-19. That’s not even the spark. Although it is adding a lot of fuel to the fire.
The story is all about a ruling from the German constitutional court. It hit the press on Tuesday.
Before you switch off — something I had to battle with for Aussie readers back in 2010 too — check out these headlines in the media:
Bloomberg:
‘EU Court Faces “Declaration of War” From German Top Judges’
The Financial Times:
‘German court has set a bomb under the EU legal order’
The Guardian:
‘Jolt to eurozone as German court warns against central bank stimulus
‘Fears ruling could undermine ECB’s authority to ward off the financial crisis and spell end of quantitative easing’
The Express:
‘Germany issues “declaration of war” against European Central Bank’s £1.9trillion bailout’
And The Telegraph:
‘The German court decision threatens to undermine confidence in the euro’
And you thought I was exaggerating!
We’re talking about the survival of the euro itself here. And, if it doesn’t survive, we’re likely talking about sovereign defaults that would break records by a large order of magnitude.
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But what did the German court do?
Well, the fact that they did anything at all is shocking enough. This is the first time that a national court has overruled the European court in Luxembourg. And the Germans explained why too.
As the German court sees things, the eurozone and EU are still only existent based on the national authority and acceptance of nation states and their laws, via treaties between governments.
The eurozone and EU are not yet empowered like nation states themselves are. They can’t make their own changes to their own policies without having to worry about the national level politics and laws getting in the way. The EU exists by assent from national governments only.
This is vaguely similar to the issue which sparked the US civil war — the rights of states versus the federal government. Who has supreme power? Over what? Who must comply with the other’s legal constraints?
Usually it’s the federal government that rules states, with a constitution defining what is within its remit. That’s the Aussie system too. Federal law trumps state law.
But the EU is not federal, yet. It is a series of treaties between national governments. And that makes national governments supreme still. The EU can only do what the nation states agree to and they can only agree to what is legal in those nation states’ constitutions. That’s why and how the EU was rejected by many of its members’ voters — in votes to change national constitutions to make them EU-friendly.
So, the EU cannot make laws or conduct policies that contravene national law in its nation states. Especially constitutional law, because the national government can’t just change that without the people agreeing in a referendum (usually).
This raises some problems. As Professor of Political Economy Henrik Enderlein pointed out on Twitter:
‘How would Germany react if Hungarian or Polish Courts issued such statements?’
If each country can object to the EU, the EU isn’t really viable as a government. It isn’t one.
What we’re talking about here is a battle over who controls the eurozone and EU. Nation states, or the EU institutions?
The Germans have made a power grab which forces the issue to be decided.
As for the actual court ruling, that’s even more messy.
The constitutional court handed down its judgement on one of the ECB’s money printing programs, known as PSPP. They ruled the ECB violated its competencies — ‘kompetenzwidrig’ — which means it acted outside its legal mandate. The actions were described as ‘ultra vires’ by the court, meaning ‘acting beyond one’s legal capacity or authority’.
And the German government and parliament’s own failures to be aware of this were ‘partially in breach of the German constitution’ — ‘teilweise verfassungswidrig’.
You see, the ECB is only allowed to do certain things. But those things are partially defined by the intention with which they’re done, not necessarily the act itself. The same act — QE in this case — can be legal or illegal depending on whether it’s done to control inflation or bail out Italy. Which sounds like a stupid way to set up the rules, and it is.
The way that you distinguish whether the central bank is acting with the right legal intention or not is to measure whether the action was ‘proportionate’ to the legal purpose, or whether the ECB is acting so far out of proportion to that legal goal that something else must be going on.
The German court gave the ECB three months to explain how their actions are proportionate, or else.
Or else what?
A few people have a few different takes on that. The point is that nobody knows. But let’s look at what’s at stake.
Because the ECB must conduct monetary policy for all of the eurozone at the same time, it cannot favour individual countries by buying more of their bonds than others. If the Germans ban QE in Germany in three months by forcing the ECB’s German subsidiary to stop buying, the ECB might not be able to conduct QE anywhere else either. Which would leave Italy to the mercy of financial markets for funding. We’re talking a rerun of Greece in 2010, but far larger.
What do stock markets think about all this? Well, European markets appeared to take a hit when the German court announcement was made. The spread between German and Italian bonds surged…a little.
But three months is a long time these days. And PSPP is only one of the tools in the ECB’s toolbox.
The biggest tool of all is Christine Lagarde, the new president of the ECB. The lawyer and politician has a grand total of zero years of experience in central banking. She is however the undisputed world leader in ignoring laws and providing bailouts.
Let’s start with her criminal conviction for failing to challenge a state payout during her time as French finance minister…
But it’s this quote from her time as head of the IMF that’s most relevant: ‘We violated all the rules because we wanted to close ranks and really rescue the euro zone,’ Lagarde said the last time the euro was threatened. ‘The Treaty of Lisbon was very straight-forward. No bailout.’ But bailout there was for Greece.
But this time, it’s within Germany and German law that there’s a problem with ECB policy. It’s the German constitution that’s being ignored by the ECB via the German central bank — the Bundesbank.
My point here is that Europe’s usual methods of weaselling their way out of a wrangle may not work because it’s a national issue this time. Political fudges may not work on the German constitution. The EU can’t change that constitution, nor pressure the European courts to allow contravention of it.
The Germans are going to force another European sovereign debt crisis to get the likes of Italy and Spain to implement austerity, as the Greeks had to. After several of them self-immolated in the process.
Get your portfolio ready for another round of chaos in the eurozone.
| Until next time, |
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| Nick Hubble, |
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