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Richard Werner on the Ideal ‘European’ Central Bank

As I stated yesterday we will publish some ideas about the future of the ECB. Yesterday some ideas of Willem Buiter were published. He wanted to abolish national central banks, to change the mandate, more transparency and an end to the prohibition of monetary financing. Today: Richard Werner. He warns us that it’s not just about the central bank but also about the ‘normal’ banks. More localism is needed. And the ‘tool’ credit guidance plus more localized banking may be more important than a mandate: let decentralized decisions rule money creation (as long as it is not for purchasing existing assets)!

The ideal central bank does not have the legal status of ECB or Reichsbank [the pre-1946 central bank of Germany, M.K.], but that of the Bundesbank

In my analysis of the ECB, published first in 2003 in my bestseller ‘Princes of the Yen: Japan’s Central Bankers and the Transformation of the Economy’ as chapter 19, and published in 2006 here, I pointed out that the ECB had not, in fact, been modelled on the Bundesbank, as had been variously claimed.

No doubt, the strong track record of the Bundesbank was the main reason why the ECB’s promoters felt it was beneficial for them to make such a claim. And since the ECB was located in Frankfurt, the psychological connection was suggestive. But as I show in my work, the truth could not have been further from it. To see this, to understand just what made the Bundesbank different and successful, and to understand just which central bank the ECB was in fact modelled on, one has to go back further into history.

The party line pushed by the talking heads and corporate media at the time was that the Bundesbank was so successful, because of its great independence. Hence making the ECB independent meant that the ECB was modelled on the Bundesbank, it was said, and thus would be equally successful in its endeavours. I had warned that this was not the case and that, sadly, under the ECB the euro zone was likely to experience massive bank credit-driven asset bubbles, banking crises and large-scale recessions with vast unemployment. As readers know, this warning of mine from 2003 came to pass almost ten years ago, initially in Ireland, Portugal, Spain and Greece. Today Germany is next in line to receive the ECB’s bubble/bust treatment.

But back to the argument. The official party line that the ECB was modelled on the Bundesbank, was equally independent, and hence was going to be as successful, was based on the simplistic and, in fact, fraudulent, analysis peddled by the European Commission since 1990 (see the commissioned Emerson study ‘One Market, One Money’, here, which claimed that greater central bank independence meant lower inflation. James Forder, Deputy Warden of Balliol College, University of Oxford, debunked these claims, proving that data points were ‘mysteriously’ ‘moved’ and wrong in crucial and much-cited studies. A careful reworking of the actual data – even within the restricted Emerson framework – showed no such link between central bank independence and low inflation. To repeat, there was in fact no evidence that more independent central banks delivered less inflation.

But an even more fundamental problem of the European Commission’s approach was its narrow and unjustified focus on inflation as the sole measure of the success of the policies of the central bank. During the 20th century the biggest problem of misguided central bank policy had not been inflation, but the central bank-instigated creation and propagation of large business cycles, asset boom/bust cycles and large-scale banking crises followed by major economic slumps with vast unemployment. The central bank that had excelled in such activity had been the German central bank, first creating an asset bubble in the 1870s, then large-scale deflation in the 1880s, then hyperinflation from 1923 and in the later 1920s and early 1930s the policies that demonstrably brought Adolf Hitler to power.

When the post-war experts in Germany analysed this surely most disastrous central bank of a major economy in history, they concluded, in my view entirely correctly, that the main problem was the excessive independence of the central bank and its total lack of meaningful accountability to democratically elected assemblies or parliament. For the Reichsbank had been the most autonomous, independent and unaccountable central bank in history. They concluded that the main task in shaping the post-war German central bank, which was to become the Bundesbank, was to REDUCE its independence and make it meaningfully accountable and subject to instruction and supervision from parliament. The formula was a great success and the Bundesbank made history as, in my view, indeed the best central bank in history.

The reader may now understand my concern when I found out that the ECB was, according to the Maastricht Treaty signed in 1993 and its subsequent reflections in European treaties threw overboard this surely most important lesson of German, indeed European monetary history, and abolished the oversight and meaningful accountability that the Bundesbank had to parliament, and adopted point after point of the Reichsbank statutes, which had rendered the Reichsbank since 1923 the most unaccountable central bank in history. The ECB, like the Reichsbank, is not only independent from governments, but independent from any democratically elected assembly or parliament, and according to the ludicrous Article 107 of the original Maastricht Treaty it could even be argued that any criticism or normal democratic debate and attempts by democratic representatives to persuade the leadership of the ECB to adopt sensible policies are ILLEGAL.

This explains why I have argued since 2003 (Princes of the Yen) that the ECB is the REVIVED Reichsbank. The ECB is the most unaccountable and independent central bank in history, whose senior staff are international diplomats that cannot be arrested and whose documents cannot be accessed and audited by any court of audit or public prosecutor in the world – it is above the law, just like the Reichsbank and its sister organisation, the Bank for International Settlements. When the Frankfurt fire brigade thought there was a fire in the former ECB Headquarters, they found out that they would not be let into the building, since it is extraterritorial.

As a result I also predicted that, just like the Reichsbank, the ECB’s decision-makers were likely to abuse such unlimited power, just as Lord Acton, British member of parliament and son of a Bavarian princess, had warned: “Power corrupts. Absolute power corrupts absolutely”. This is why I predicted that the ECB was going to oversee the creation of the vast bank credit-driven asset bubbles (with bank credit visibly ballooning by between 20% and 40% for years in the mid-2000s), which were going to be followed by banking crises and again policy-induced long and deep recessions with vast unemployment. Just why the ECB adopted such policies can be learned by reading my book Princes of Yen.

It is also important to note that the ECB has consciously shrouded its entire operations and presentation to the public in misinformation. For instance, the ECB has repeatedly claimed – often against fierce opposition of its own staff that had hailed from the Bundesbank – that its monetary policy is made mainly by moving interest rates – hence the move towards negative rates in recent years, on both ends of the yield curve, which has been the result of ECB policies.

This is premised on the idea that lower rates will stimulate the economy and is supposed to create the illusion that the ECB has been working hard to stimulate the European economies since the 2008 crisis. But in fact the ECB has worked hard to exacerbate the crises and recessions, notably in Greece and Spain.

The latest careful empirical research has shown that the claim that lower interest rates result in higher economic growth (and higher rates slow growth) is not based on any empirical evidence. In fact, the empirical evidence shows the reverse: see the recent study ‘Reconsidering Monetary Policy’ by Lee and Werner (2018) in the journal of Ecological Economics. Concluding, it is clear that the Bundesbank WAS the ideal central bank. It has the best track record of major central banks and under its watch no asset bubble and major banking crisis was allowed in Germany, which was a major achievement – and one that likely made it unpopular among other central banks: The Bundesbank refused to play the boom/bust cycle game. Is it surprising that major political and financial forces developed that colluded to end up stripping the Bundesbank of almost all its powers? And that revived the Reichsbank, which had served its 100% private shareholders apparently so well – alas, in contrast to the general public. (On the Reichsbank, please see the entry ‘Reichsbank’ in Louis-Philippe Rochon and Sergio Rossi (eds.), The Encyclopedia of Central Banking, Cheltenham: Edward Elgar Publishing, 2015.

I, for one, recommend abolishing the ECB and restoring the old status and function of the Bundesbank. Through its multi-faceted monetary policy that made active use of bill re-discounting the Bundesbank ensured that the German banking system would stay decentralised and consist of many thousands of healthy small, local community banks that would deliver funds effectively to productive small and medium-sized enterprises, rendering economic decision-making decentralised, effective and sustainable and delivering high and stable equitable economic growth without crises and without inflation. Why anyone wanted to scrap this marvelous success story is hard to understand. Sadly, the ECB is currently moving to rid the eurozone of its many good community banks, whether in the Netherlands or in Germany, and its interest and regulatory policies are designed to implement Mr Draghi’s declared plan to reduce the number of banks in the eurozone. Needless to mention, it is the small banks that the ECB wants to get rid of, not the Goldman Sachses of this world. This policy is mistaken, and in the process the ECB is currently creating a significant property bubble in Germany. What follows, is not difficult to predict – it is possible that forces inside the ECB are looking forward to the day when they can use their ever increasing powers (now also in the form of the ‘banking union’ and SSM) to force all 1,500 German community banks into two or three large banks.

Zugehörige Website: http://www.sciencedirect.com/science/article/pii/S0921800916307510

Mit freundlichen Grüßen


Prof. Richard Werner

University of Southhampton, Southampton

  1. December 8, 2017 at 4:43 pm

    One of the delights of NWER is snippets of sanity like this that arrive in my email, pouring clarity out of a well-researched banking brain. Thank you, Richard Werner!

    Does your book ‘Princes of the Yen’ give a good account of the old Bundesbank, and its credit guidance tools?

  2. Blissex
    December 10, 2017 at 1:33 am

    There is a little known point about Glass-Steagall and related “New Deal” legislation that is very relevant here, one that I read somewhere but I can’t give proper credit for:

    * Glass-Steagall not only forbade the mix if investment and retail banking, but also effectively prevented banks chartered in one state or nationally to buy banks in other states, or to open branches in other states, because that depended on licensing by the legislature of the other state, that would protect their own state chartered banks.

    * This meant that as long as Glass-Steagall was enforced there were very many small but profitable state chartered banks across the USA, and that they were a powerful lobby that fought hard against the nationally chartered and “money center” banks of New York, California, Chicago, and for sounder economic policies, as the health and profitability of the smaller state chartered banks was tied strongly to that of the local businesses they lent to.

    * The most important but unappreciated consequences of the end of enforcement of Glass-Steagall was that “money centre” banks swamped the markets or simply bought all most of the smaller starte-chartered banks, leading to massive consolidation of banking, and the effective evaporation of the small-bank lobby that had effectively countered the lobbying power of the “money center” banks. So the most important consequence was political and regulatory, not economic.

  3. Blissex
    December 10, 2017 at 12:40 pm

    What Prof. Werner is really saying is that “independent” central banks become completely captured by the banking industry, as indeed has happened in the USA and the UK and other places, and the banking industry has a big interest in asset price inflation and high volatility, because traders and executives have compensation proportional to short-term beta, not long-term alpha… As to this:

    «no such link between central bank independence and low inflation»

    As to this there is a subtle, that is, not really subtle detail: independence as such is really irrelevant. What really matters is that a (wage) inflation target be announced publicly and be hit reliably. that is the thing that really matters because:

    * It guarantees to bond buyers (and not just of government bonds) that there is no risk of their investment being devalued by a sudden rise in (wage) inflation, something that has been used by many governments to shrink the real value of their debt. This means that real interest rates will be lower, and that therefore asset prices will be bigger.

    * It allows governments to play a “fiscal dominance” game: given that the *central bank* (not the government) has a publicly announced target of 2% (wage) inflation, a fiscal squeeze will run the risk to undershoot the target, “forcing” the central bank to loosen credit to create a giant asset bubble hoping that this results in a “wealth effect” that “trickles down” into higher (wage) inflation. This game is possible because asset price increases don’t count as (wage) inflation.

    Both ways the overall purpose of a publicly announced (wage) inflation target is to drive down interest rates to make asset prices zoom up.

  4. December 13, 2017 at 2:39 pm

    I support the notion that decentralization is the key to fighting and combating the financial menace of inflation. Having several local community banks would significantly aid small and medium enterprises. A decentralized economy would ensure that decision making does not fully rest in the hands of a few rendered as powerful. This would help in establishing a sustainable and equitable working environment.

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