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Some central banks are more equal than others

Some central banks are more equal than others

Bundesbank come to terms with isolation
ESM boost plans could raise confidence - or vulnerability

by David Marsh

Mon 24 Sep 2012

Judging by Bundesbank president Jens Weidmann's pronouncements, the German central bank is making the best of its position of isolation on the European Central Bank’s governing council over the controversial issue of ECB purchases of weaker countries’ bonds.

But how likely is it that the Bundesbank really will find itself with its back to the ECB wall?

One piece of good news over the weekend for the German central bank is that the Berlin finance ministry is considering ways of quadrupling the size of the ESM rescue fund to €2tn. This is something for which the Bundesbank has been discreetly campaigning in recent months. However, if the move is accomplished through obscure credit mechanisms rather than parliamentary votes of state money, then the move will not raise confidence but will heighten concern over the vulnerability of economic and monetary union (EMU).

For EMU monetary policy, the Bundesbank has just one vote on the 22-member council, under the ‘one-man-one-vote’ system brought in when the ECB was set up in 1998. An intriguing question is whether the Bundesbank will seek to gain extra leverage over ECB decisions by making use of provisions in the ECB’s statutes granting it much greater voting rights for decisions affecting the ECB’s capital.

Weidmann has used recent council meetings to emphasise opposition to the ECB’s new policy of so-called Outright Monetary Transactions (OMT). The description is skilfully designed to sidestep the ambiguity over whether bond purchases are actually fiscal rather than monetary measures.

No transactions have been carried out since ECB president Mario Draghi hinted at the new strategy on 26 July and then presided over the council’s agreement (opposed solely by Weidmann) to bring in OMT on 6 September.

We are still in a 'phoney war'. Spain, the country most likely to profit from OMT purchases, is still hesitating, perhaps for a dangerous length of time, over whether it wishes to submit to the European (and IMF) conditionality of a formal rescue programme that would trigger ECB purchases of Madrid government bonds.

The Spanish government has asked the ECB to provide details of how many bonds the central bank might buy, and at what interest rates, if Madrid applied for funding under the rescue packages. Revealing Weidmann-like steeliness, the ECB has declined to provide any pre-emptive details, on the ground that it never 'pre-commits'.

Is Weidmann’s position on the council really as isolated as everyone thinks? Article 10 of the ECB’s statutes says that the one-man-one-vote method should not apply to decisions affecting the ECB's capital, transfer of national central banks’ foreign assets, allocations of monetary income and net profits and losses. In these circumstances, decisions are made on a capital-weighted basis by EMU's 17 national central bank governors alone, depending on these national central banks’ stake in the ECB’s capital. This would give the Bundesbank a 27% share of the votes – very different from the position in which Weidmann currently finds himself.

It is moot whether decisions to implement the OMT, which could open the ECB (and the Bundesbank as its main shareholder) to large risks, should be carried out according to the capital-weighted method. Legal experts and practitioners say this is a grey area.

However, the Bundesbank has already publicised the fact that any decisions to allocate potential losses on the Eurosystem’s Target-2 internal payments system (where Bundesbank claims on the ECB are currently €750bn) would be carried out on a capital majority. If the OMT does indeed get going, the Bundesbank may have some legal tricks up its sleeve to limit its implementation. It’s worth looking at the small print in the ECB’s constitution. Maybe the Bundesbank has more power than everyone thinks. All central banks are equal. But some are more equal than others.

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