ECB independence, succession in question

The front-runner to succeed Jean-Claude Trichet as ECB president, Axel Weber of Germany, openly dissented from the crucial decision to purchase eurozone government bonds to steady markets, warning that it could raise inflation risks.

Less than 24 hours after he was apparently outvoted, the standard-bearer of Bundesbank monetary orthodoxy told Boersen- Zeitung: “Buying government bonds entails considerable stability policy risks, and thus I regard this part of the ECB council’s decision critically even in this exceptional situation.”

Weber’s unprecedented public criticism of what may have been the most sensitive decision in the bank’s 11-year history seems bound to affect his chances of winning the top job when Trichet’s term expires in 2012 – an appointment due next year.

It also shows how Europe’s north-south split in economic culture, highlighted by divergent reactions to the debt crisis, is now also tearing at the unity of the central bank.

Trichet won global plaudits for his assured handling of the global credit crisis. He was the first central banker to inject massive liquidity in August 2007 when the US subprime mortgage crisis froze inter-bank lending, and his role in the response to the collapse of Lehman Brothers was widely admired.

But the “steady hand” on which he has prided himself – refusing to be stampeded into policy changes – seems to have given way to a shaky hand, or even a forced hand, in the latest throes of the eurozone debt crisis.

U-turns
The ECB’s visible U-turns on loosening collateral policy for Greece and on government bond purchases “make it look as if the central bank has had to be reluctantly co-opted into a political consensus”, the Eurointelligence economic website said.

Trichet vehemently denied having yielded to pressure from EU leaders or speculators, saying the decision had been taken because of the commitment of eurozone governments to make bigger efforts to cut their deficits.

“We are fiercely and totally independent. This decision is the decision of the governing council and not the result of any kind of pressure of any sort,” he told journalists.

But the chronology of recent events suggests that EU leaders and perhaps expressions of concern from US monetary authorities played a significant role in changing his mind.

As recently as May 6, the ECB chief said the governing council did not discuss the option of buying bonds.

A global market sell-off accelerated after that comment, which was widely read as meaning the ECB had decided to do nothing, and turned into a rout afterward. That prompted President Obama to telephone German Chancellor Angela Merkel and urge Europe to take decisive action.

Trichet acknowledged that the ECB decision was not unanimous, but said an overwhelming majority had supported it. However an overwhelming majority without Germany, the eurozone’s biggest economy and erstwhile home of the iconically hard deutschmark, is a bit like Hamlet without the prince.

A senior European monetary source told reporters the biggest difficulty in deciding whether to buy government debt on the open market had been the risk of losing German support.

No easy choices
Neither of the recent ECB choices was easy, and it’s not surprising that central bankers differed on them.

Maintaining rigid collateral rules would have imperiled the solvency of Greek banks and other holders of Greek government bonds, leaving them at the mercy of a single ratings agency downgrade and potentially triggering a chain of defaults.

But purists argue that easing the rules introduces moral hazard, since if the central bank lends tens of billions of euros against bonds classed as “junk”, it rewards institutions that go on buying dodgy sovereign debt and states that issue it.

Buying the bonds of states with high debts and deficits such as Greece, Portugal, Italy, Ireland and Spain carries the risk of easing market pressure on them to make painful reforms. But leaving them at the mercy of speculative runs was starting to cause a seizure of global credit markets.

Unlike the US Fed and the Bank of England, the ECB does not publish minutes or voting records of its policy-setting meetings, so internal debates become public mainly through nuances of difference in speeches and public remarks.

Some rifts have surfaced in the past, notably early in 2009 when some governing council members wanted to cut interest rates below one percent while Weber argued that one percent should be the floor, for fear of losing control of monetary policy.

Weber prevailed. Instead, the ECB pumped unlimited liquidity into the banking system with 12-month repos at its base rate but it didn’t go below the one percent limbo bar.

The other undeclared contender in the ECB race is Bank of Italy governor Mario Draghi, who also chairs the international Financial Stability Board.

Weber is an academic monetary economist in the tradition of German monetary orthodoxy. Draghi has had wider international and private sector experience, but may be compromised by having worked for Goldman Sachs in the boom years of the early 2000s.

Weber’s dissent plus some of the media reaction to the emergency package have raised the impression that the ECB has lost its political virginity.

The left-wing French daily Liberation said approvingly: “For the first time Europe has rejected its monetary straitjacket and called into question the sacrosanct independence of the ECB.”

On the other side, Germany’s conservative Die Welt published a death notice for ECB independence.

“The eurozone is dominated by countries for whom currency stability is not so important… What seemed yesterday set in stone is today no longer valid. Nothing symbolises that more strongly than the loss of the central bank’s independence,” it said.