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Analysis
The Emminger letter reappears

The Emminger letter reappears

by David Marsh

Tue 2 Apr 2013

The ‘Emminger letter’ forms one of the more obscure parts of the history of the German Bundesbank. It is also one of the most chilling. And, in the hard-line negotiations over the latest Cyprus bail-out package, 35 years after it was written, it has just made a singular re-entry.

The document, drawn up in secret in 1978, gave the German central bank the power to side-step formal obligations to support weaker countries via foreign exchange intervention during European currency turmoil. Emminger was one of the most influential figures rebuilding German post-war central banking from the 1950s.

He was a member of the board of the Bundesbank and its forerunner, Bank deutscher Länder, for 26 years, finishing as Bundesbank president from 1977 to 1979. Emminger died in 1986. But his spirit lingers on.

The European Central Bank (ECB) ultimatum delivered to Cyprus on 21 March, giving the country until the following Monday to agree a lending deal with the International Monetary Fund and the European Union or risk bankruptcy, bore the Emminger hallmarks. The ECB governing council said its Emergency Liquidity Assistance (ELA) to Cyprus would not be renewed unless an official programme was in place – sparking frantic diplomatic action that led finally to a deal closing down the island’s second biggest bank and imposing swingeing write-offs on large depositors.

The ultimatum marked a dramatic change of ECB tactics. In previous action, the ECB had maintained generous ELA assistance for Ireland and Greece, under lending that is deemed semi-automatic unless the governing council (currently 23 people, all men) decides with a two-thirds majority to close it down. The lending has attracted great displeasure in Germany and other current account surplus countries.

With Cyprus, the hard currency central banks behind the ECB, led by the Bundesbank, decided they had had enough. By ensuring its habitually tough line unreservedly became ECB policy, the Bundesbank – without needing to act in public – strode to the front line of the debate over the future of economic and monetary union (EMU).

The Emminger episode bears resemblance to this because, in the 1960s and 1970s, the Bundesbank was perennially haunted by the fear that its efforts to control the German monetary base and hence German inflation would be compromised by commitments to buy large volumes of foreign currencies to maintain exchange rate stability. These obligations were imposed first by the Bretton Woods fixed exchange rate agreements and then by various European currency arrangements.

In EMU, the Bundesbank is highly wary of the risks caused by the build-up of its assets with the ECB reflecting the ECB’s lending to hard-hit peripheral countries, which includes borrowings under the ELA. The Bundesbank’s assets under the so-called Target-2 system for short term liquidity transfers were €613bn as of end-February, up from €547bn in February last year, making up roughly two-thirds of the Bundesbank’s balance sheet. The Target-2 total has declined by around €140bn since the peak in August last year, but greatly exceeds the Bundesbank’s gold stocks worth €132bn as of end-February as well as its €29bn of foreign exchange reserves.

The significance of the Emminger letter is that he wrote it at a similarly fraught time of skirmishing over Europe’s monetary framework. Emminger sent the missive to Helmut Schmidt, then West German chancellor, on 16 November 1978 to register the Bundesbank council’s approval of most of the elements of the prospective agreement setting up the European Monetary System (EMS), which developed later into EMU.

However, Emminger and his council colleagues disagreed with the feature of the EMS agreement that the Bundesbank would be forced to intervene with unlimited amounts of D-Mark sales and foreign currency purchases whenever European partners’ currencies reached their floor in the EMS’s exchange rate mechanism (ERM).

The letter made clear the Bundesbank’s desire to be freed from this obligation to intervene during monetary crises. Schmidt sent Emminger a telex message signalling agreement on all the outstanding issues apart from the intervention exemption.

On 30 November Schmidt attended a lengthy Bundesbank council meeting in Frankfurt to clinch agreement on the EMS details. Schmidt pointed out, to Emminger’s evident satisfaction, that – in relation to the intervention exemption – he had annotated the Bundesbank president’s letter of 16 November with an ‘r’ to indicate ‘richtig’ (‘right’ in German) or, as he said, ‘factual agreement’.

This deviation, Schmidt told the council, was allowable under the classical legal exemption clause ‘clausula rebus sic stantibus’ (‘Treaties may become inapplicable because of changes in circumstances’). However, he affirmed that the modification should remain secret and could not be part of a formal agreement. ‘Let us imagine that this appeared in a French or Italian newspaper tomorrow,’ Schmidt told the council, according to official documents that were published only 30 years later. ‘The editorials would criticise their own governments for believing such a shallow promise from the Germans. A [German] government promises to intervene to uphold certain rules of the game, but then writes in an internal paper that it intends to act differently at times of emergency.’

The Emminger letter was brought into play, with great effect, 24 years later on Friday 11 September 1992, a day after the Banca d’Italia, the Italian central bank, publicly complained about ‘excessively high’ Bundesbank interest rates, when the lira fell to its lowest permitted point in the exchange rate mechanism, triggering enormous obligatory intervention from the Bundesbank and Banca d’Italia. In the light of massive inflows of liquidity threatening to disrupt German monetary policy, the Bundesbank invoked the Emminger let-out clause to free it from the constraint of making unlimited lira support purchases.

The news shocked the Italians. Carlo Azeglio Ciampi, governor of the Banca d’Italia, was conferring with prime minister Giuliano Amato and finance minister Piero Barucci at the prime minister’s office in Rome when Ciampi was called to the telephone to be told that the Bundesbank would stop intervening on Monday. ‘When he came back, he was pale, almost white,’ Amato recalled later. The episode forced a lira devaluation over the weekend and helped sparked a run on the British pound on Wednesday 16 September (known later as ‘Black Wednesday’) when both the UK and Italy had to leave the ERM.

The Bundesbank carefully avoided having to resort to the Emminger letter that day because it intervened to buy Dutch guilders, forcing the guilder rather than the D-Mark to the top of the ERM intervention framework against sterling and therefore avoiding any Bundesbank obligation to undertake unlimited purchases of sterling.

The Emminger letter was also invoked later that month in a furious battle with the French government and the Banque de France to prevent the French franc from devaluing within the ERM. A top French official Guillaume Hannezo reiterated Paris’s surprise over the discovery of the Emminger letter limiting the Bundesbank’s intervention obligations. ‘This is singular: a treaty from state to state can be repudiated by an independent public organ.’

The various intrigues surrounding the Emminger letter are shadowy and somewhat convoluted. Jens Weidmann, the current Bundesbank president, who has been known to cite Emminger approvingly in his speeches, was 10 years old when the document was written.

However, there is one man to whom it is not a mystery. Mario Draghi, the ECB president, and the man who authorised the 21 March Cypriot ultimatum, was head of the Italian Treasury during the September 1992 encounters with the Bundesbank.

Draghi has been on the receiving end of the Bundesbank’s power. And he could be excused for now thinking he can unleash some of it in the service of the ECB.

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