Ultra Vires ECB

Ultra vires is a latin phrase meaning literally “beyond powers”. If an act requires legal authority and it is done with such authority, it is characterised in law as intra vires. If it is done without such authority, it is ultra vires. Acts that are intra vires may equivalently be termed “valid” and those that are ultra vires “invalid”.

The verdict of the German Constitutional Court (GCC) last friday february 7 to declare the European Central Bank’s (ECB) Outright Monetary Transactions (OMT) program Ultra Vires, that is, not compatible with the EU Lisbon Treaty and with the German Constitution, but at the same time avoiding taking any binding resolutions and sending the case to the European Court of Justice (ECJ) has confused everybody.

We already discussed the issue of the GCC’s stance in relation to the ECBs programs and policies here and here and here and here. Now we update and continue this analysis.

In his editorial “The Euro after the Karlsruhe ruling” FT supports the GCC in its letting the ECJ decide on the process while at the same time criticizing that the argumentation by which the GCC considers the OMT Ultra Vires: “The judges in Karlsruhe argue that OMT goes against the ECB’s mandate since it amounts de facto to monetary financing of government debt – which is prohibited under article 123 of the European Treaty. This is also the position of the Bundesbank, Germany’s central bank, which has consistently opposed OMT. But this interpretation is highly questionable, since the ECB would only buy bonds on the secondary market. The court also claims that the bond-buying scheme goes beyond the ECB’s remit, which is limited to monetary policy. But OMT was necessary to overcome the fragmentation of the Eurozone credit market, which made it impossible for the ECB’s monetary policy to work.”

What the FT editorial forgets to mention though, is that in reference to purchases in the secondary market not being explicitly forbidden by article 123 of the European Treaty, the GCC declared that “es liegt auf der Hand, dass dieses Verbot nicht durch funktional äquivalente Massnahmen umgangen werden darf”, that is, purchasing bonds in huge quantities on the secondary market would conceptually be equivalent to acquiring them in the primary market, which is illegal, as is commented in the FAZ article “Die Angst der Verfassungsrichter”.

According to FT’s Alphaville “the decision to refer the OMT to the ECJ shouldn’t cause a political storm in Germany: the political institutions that matter long ago made their peace with the OMT. But the confusion about what the OMT does — Gerhardt alone nails it there — hardly helps.”. They argue that the german parliament, the Bundestag, has already had opportunity to boycott the OMT, and that the fact that it has chosen not to, would give democratic legitimacy to the ECB’s plan.

Also in the FT’s piece “Germany’s Constitutional court and the bond-buying plan” argues for a partial victory for the ECB, since they expect “the ECJ to sing from the ECB’s hymn sheet”, but they also have caveats: “The ECB is not completely off the hook, however. Until the ECJ makes its decision, uncertainty about the legality of OMT will persist. Some of the leading plaintiffs who brought the case in Germany argued on Friday that the ECB would not dare to activate its bond-buying scheme so long as the ECJ was considering the case – an exercise that could take at least a year.”

Gunnar Beck a law professor at London University, is cited in the same article  and blasted the GCC’s decision as “legally indefensible”, emphasizing that the constitutional court’s decision marks the first time it has handed a case to the European court:  “Up to now the [constitutional] court had consistently maintained that it alone – and not the EU courts – had the final say on whether the EU institutions exceeded their competence. Because if this matter were left to the court of justice of the EU, Germany would lose any control over the transfer of sovereign rights to the EU under the EU Treaties.” and “Today’s decision therefore amounts to nothing less than a surrender of sovereignty by Germany’s highest court.”

We can find a good summary of the GCC’s resolution in “Ein Richterspruch mit Risiko” @ Zeit Online where the main points are clearly synthesized: 1) The OMT program would have “Verteilungseffekte” (distribution effects), in that it would favor bonds of some countries (supposedly the ones from the most indebted countries, Greece, Portugal, Italy, Spain, Ireland) over those of other members of the Eurozone, which would amount to state financing, something that the ECB is not allowed to do. 2) The OMT program should not have as objective the artificial modification of government bond rates of the different countries of the Eurozone, bond prices should not be manipulated (“Eingriffe in die Preisbildung am Markt”), but that is precisely what the OMT is supposed to do. 3) Finally, the GCC leaves an open door for a “decaf” OMT that would comply with conditions 1 and 2 already mentioned and, also, the size of the program would not be unlimited (“whatever it takes”) but with a definite and finite size beforehand.

So what can we conclude of it all?

  1. Although the GCC’s remit of the OMT case to the ECJ appears to be a victory for Draghi’s co-opted ECB, the fact stands that it will be more difficult for the ECB to implement its OMT program while its legality has already been declared null by a 6 to 2 vote at the GCC and there is a pending case relating to the same issue before the ECJ. Although everybody assumes that the ECJ will give a favorable ruling as to the legality of the OMT program, what if it did not? Does the ECB want to run the risk of having started a program whose legality has been denied by the GCC and on which the ECJ has yet to issue its ruling?
  2. At the very least the GCC has argued and conveyed the idea that the OMT is illegal, and that if the ECB finally decides to use it, it will be with “dirty hands”. Also, and it is not a negligible victory, the pressure on the ECB to avoid using the OMT before the ECJ has issued its verdict will be enormous.
  3. Opposition by german citizens to the OMT, and to the ECB policies in general will not disappear with this resolution. The idea that Mario Draghi’s ECB has been co-opted, will, if anything, increase, creating a moral hazard issue that the ECB  will find increasingly difficult to ignore.
  4. The importance of the final outcome of this case goes well beyond the economic and financial consequences of the possible implementation of a “money printing” program by the ECB. Its main significance lies in the question of whether legality in Europe has any meaning anymore, whether to fulfill globalist (?) dreams international treaties and national constitutions can be superseded.
  5. Perhaps this resolution should be analyzed and judged in the context of what governments and parliaments have done since the global economic and financial crisis exploded in 2008. If something characterizes the economic and monetary policies in the West in the last 5 years, is, on one side, almost unlimited money creation by central banks, labeled differently depending on the country (QE, LTRO, pegging of the Swiss Franc to the Euro, the japanese “three arrows program” etc. etc.), and an almost biblical reluctance on the part of governments to rein in the financial sector that has had to be rescued, at tax payers’ cost, everywhere. Like Simon Johnson argued a few years ago in “The Quiet Coup”, the financial sector has co-opted the state. He was talking about the USA, but the same argumentation could be applied to most western countries. What some people call New World Order (NWO) or Neofeudalism, has advanced, not gone backwards, in this crisis. That being so, was it perhaps not too much to expect the GCC to swim alone against this NWO tide? By voting against the OMT 6-2, naming it illegal, and referring the case to the ECJ, they have perhaps shown as much courage as they’ve been able to summon and, in any case, much more than governments and parliaments.

The GCC could have done better, it could and it should have declared the OMT illegal without remitting the case to the ECJ, but in a world in which the NWO finds almost no opposition, it could also have done worse. In the end, we doubt Mario Draghi is happy with the GCC’s resolution and, inasmuch as he is unhappy with it, the GCC snatched a small victory from the jaws of defeat.

Make nominal spending the new target? We hope not.

In the January 2 2013 edition of the Financial Times Mr. Scott Summer, economics professor at Bentley University, publishes an article titled Make nominal spending the new target, where he argues for the revolutionary, and increasingly MSM-pushed idea of making Nominal GDP Targeting (NGDPT) the official policy of central banks in most western countries. This policy was already hinted last December at a conference in Toronto by the present governor of the Bank of Canada (BoC), and future governor of the Bank of England (BoE), Mark Carney.

This in an article fraught with ideas that, if implemented, will permanently transform the nature of western economies and pave the way for structurally high inflation, potential hyperinflation, economic misallocation of resources, moral hazard (savers, wage earners and pensioners being punished), and general impoverishment of the population except for the few taking advantage of it thru their access to cheap financing: financial institutions and überwealthy individuals.

Mr. Scott Summer states: “Once a central bank sets an inflation target, they have essentially set a path for aggregate demand. In that case, what possible role can there be for fiscal stimulus? But as the past few years have shown, stimulus advocates and opponents are as vociferous as ever. And despite a widespread perception that most developed economies would benefit from more demand, central bankers seem unwilling or unable to deliver that growth.”

TYR states: This paragraph foreshadows the huge amounts of half-truths and outright lies that conform the article. It sets the stage for the assertion that a central bank’s main role is to foster “demand”, foster growth. This has never been the role assigned to monetary policy, whose main aim is, and should be, to preserve the purchasing value of the currency, that is , to keep inflation low. By positing that central banks should aim at fostering demand, the author conveniently ignores the fact that nominal GDP growth comes at the expense of inflation, that by debasing the currency in order to reach a theoretical NGDP target, no real growth is achieved, only the appearance of it, since that growth is basically inflation. This has been well-known since roman emperors clipped their silver coins. A not so obvious harm that such a policy would cause is a further misallocation of resources in the economy. By artificially fostering some sectors of the economy that depend on cheap financing (finance, housing) thru monetary policy, the same misallocation that was an important cause of the 2008 crisis is being perpetuated.

Mr. Scott Summer states: “Inflation targeting failed in two ways. First, it was a poor indicator of the adequacy of aggregate demand. Second, it is susceptible to “liquidity traps”, a period of near zero interest rates where central banks’ favourite tool – interest rate targeting – is rendered ineffective”.

TYR states: Inflation targeting was never intended to be an indicator of aggregate demand, but a (bad) tool to control inflation, the main aim of the guardians of the currency, central banks. Liquidity traps, a Keynesian and non-scientific term, is not caused by inflation targeting, but by debt overhangs, resulting in crisis, like the one in 2008, originated in  previous monetary laxity, precisely what the author recommends as future policy.

Mr. Scott Summer states: “This problem occurs because when the economy is very weak, even a 2 per cent inflation target might not be high enough to generate the sort of bullish expectations needed to stimulate demand. There’s already plenty of money in the system – we need higher spending growth expectations to push that money into circulation.”

TYR states: The author ignores the reasons behind the weakness in the economy, too much debt and misallocation of resources in the economy with some sectors overrepresented, housing and finance.

Mr. Scott Summer states: “Mark Carney’s speech on December 11 in Toronto demonstrated the growing interest in replacing inflation targeting with nominal gross domestic product level targeting, even among central bankers. The central bank would set a growth path for nominal GDP of perhaps 4 per cent or 5 per cent per year, and commit to return to that trend line when spending falls short or overshoots. Nominal GDP targeting would moderate the business cycle by being more contractionary than inflation targeting during a boom and more expansionary during a recession. And NGDP could do this while still delivering roughly the same long-run rate of inflation.”

TYR states: It is a huge mistake to assume that there is a “natural” nominal GDP growth rate, where is the scientific proof for this assumption? For centuries, GDP growth was very low, until the First Industrial Revolution speeded it up. What does that have to do with monetary policy? GDP growth depends basically on population growth and productivity, and productivity depends on availability of resources, capital and technological innovation, none of which are by any means affected by monetary policy.

Mr. Scott Summer states: “And there are many other advantages. If investors had known in 2008 that any declines in NGDP would be quickly made up, then asset prices would have fallen much less sharply, and demand would also have been more stable. The current prices of stocks, commodities and property are strongly influenced by their expected prices several years out. The severe asset price decline of late 2008 reflected the belief that central banks would fail to take decisive action to restore NGDP to the trend line.”

TYR states: Do we have to conclude that the inflated asset prices of 2008 should have been allowed to remain inflated for the sake of mantaining an arbitrarily determined nominal GDP level? In what way is this different from a centrally planned, fascist-soviet economy? What role does the cleansing mechanishm of failure have under such an economic system? This is certainly not capitalism.

Mr. Scott Summer states: “Some fear that inflation will become unanchored if we move to NGDP targeting. In fact, most of the problems that people associate with inflation are more closely linked to high and unstable NGDP growth. Wages tend to follow growth in national income. As long as NGDP growth is low and stable, wages and core inflation will remain well anchored.”

TYR states: Wages do not necessarily follow growth in national income. This has not been the fact in the last 40 years where wages have reduced their share as a percentage of GDP from 53% to 44%. It is corporate profits that have benefited the most from the covert inflation we’ve had since the USA dollar was unlinked from gold in 1971. But even if the author was right in this assumption, assume for example that we have a NGDP growth rate of 5%, an inflation rate of 5% and a wage growth of 5%…do we have any real GDP or income growth at all? No.

Mr. Scott Summer states: “A stable path for NGDP growth will also produce better policy decisions in other areas. Fiscal spending will have to be justified on a cost-benefit basis, once it is no longer expected to boost nominal demand. The cost of bailing out failed companies will be more transparent, as it will be obvious that more jobs in the rescued company are offset by fewer jobs elsewhere. Those claiming that Chinese exports cost jobs will have to provide a mechanism other than “less demand”, and won’t be able to do so. And, most importantly, countries will be able to address the public debt problem, as they should, without fear that austerity will cost jobs.”

TYR states: Here the author assumes that failed companies will be bailed out (moral hazard and misallocation of resources again) and that there will be fiscal prudence just because some mumbo-jumbo cost benefit analysis will conclude that any further spending does not contribute to nominal GDP growth. Central planning, covert economic fascism again. Finally, the author seems to assume that by central banks financing government deficits “countries will be able to address the public debt problem, as they should, without fear that austerity will cost jobs.”. Does anybody believe that by making deficits immune to their collateral negative effects, increase in interest rates and the associated recession, government deficits will be tackled?

Make nominal spending the new target? We hope not.