QE Deemed Illegal
In the midst of a pandemic and an important presidential election, it is very easy to miss globally significant events.
Here is one that is way under the radar: The German Constitutional Court ruled the ECB’s QE Program Could be Illegal.
That is a landmark ruling that challenges the independence of the ECB and the authority of the Court of Justice of the European Union (CJEU).
In announcing the ruling, German Chief Justice Andreas Voßkuhle said the CJEU had approved a practice that “was obviously not covered” by the ECB’s mandate. Voßkuhle spent months crafting the 77-page decision, announcing the ruling just a day before his official retirement on Wednesday.
“Dismissing a 2018 CJEU decision to allow the bond purchases, the German court ordered the ECB to provide Germany with adequate justification for the program within the next three months. Should it fail to do so, the Bundesbank, Germany’s central bank, would no longer be permitted to participate in the program.
What it Means for the Future of the EU
Eurointelligence explains What it Means for the Future of the EU.
The ruling raises complex and potentially troubling issues for the EU as a whole. The German constitutional court has accused the ECB and the CJEU, the court of Justice of the European Union, of abusing their power, and of acting beyond their assigned competences. That concept is known in German constitutional law as acting ultra vires. In the German legal interpretation of European integration, all sovereignty still rests with the member states. The EU is clearly not a federal state, but a deferred power. Member states have transferred certain rights to the EU. The German court said it accepts that it is bound by CJEU rulings, but only those that occur within the EU’s agreed competences. All bets are off it the CJEU goes ultra vires. And, crucially, the German court decides if and when that happens.
This is the most serious challenge to the EU’s legal framework we have yet come across. In the UK, the courts operated under the assumption that conflicts between EU and UK law would always be settled on the basis that EU law is supreme.
The ruling is unusually explicit about the breach of competences on the part of the CJEU. It criticised the CJEU’s positive ruling on the asset purchases as implausible, and objectively arbitrary. It accused the EU court of an evident neglect to investigate the wider consequences of the ECB’s programme. The word evident crops up many times in the ruling. It is a legally more loaded word than it appears at first sight. Moreover, the ruling accuses the CJEU of a breach of EU treaty law.
The German court’s interpretation will have important consequences if other national courts follow suit, which we think is very likely. Poland’s deputy justice minister already declared that member states have regained their position as the masters of the EU treaties. We expect the ruling to strengthen the determination by the Polish government to press ahead with judicial reform, and to resist interference by the EU into what they consider domestic legal affairs.
Surprise 7-1 Ruling
Perhaps the biggest surprise was the 7-1 ruling.
Price to Pay
In the ECB’s view, the negative effect of lower interest rates was the price to pay for keeping the euro intact.
That price to pay keeps rising and rising.
This Eurozone Crisis Will Be Even Worse Than Last Time
Please consider The shock of coronavirus could split Europe
The economic fallout of Covid-19 hits all members of the currency bloc. But no mechanism exists that allows the governments of the eurozone to respond jointly to such a shock. The result is that the policy reactions to the pandemic are so far overwhelmingly national – accentuating differences rather than bringing Europe together in a time of crisis. Even in the face of a symmetric shock, the eurozone responds asymmetrically.
Germany reacted forcefully to Covid-19. Berlin abandoned its cherished debt-brake – which sharply constrains its government borrowing – and legislated a €750bn rescue package for the German economy. Italy, the country with the highest number of infections and deaths from the virus, does not have the same fiscal leeway. Its response to Covid-19 amounts to a mere €28bn – about 4% of the size of the German package.
This substantial disparity in the policy response is exacerbated by differences in initial conditions. In 2019, Italian output was still 4% lower than in 2007 while German GDP was 16% higher. Owing to the ongoing GDP collapse, the Italian public debt ratio will soon approach 150% of GDP – even without a new support package. Yet despite their comparatively tepid response, Italian policymakers already have to nervously watch the interest rate differential between Italian and German government bonds. The spread widened substantially in recent weeks.
The writing is on the wall: without solidarity from its fellow eurozone members, Italy will not be able to respond to the crisis in the same way that other countries can. It is at risk of an economic depression on top of a humanitarian catastrophe.
Negative Interest Rates
In March of 2015, ECB president Mario Draghi forced more reserves into the system, via a Quantitative Easing QE program.
The ECB also forced interest rates negative then required the banks to pay the ECB interest on those reserves.
In contrast, the Fed paid interest on excess reserves. In the process, the Fed slowly recapitalized US banks over time.
The ECB’s negative interest rate policy further damaged European banks that were in terrible shape to begin with.
Why?
Before he served as ECB president, Draghi was president of the Italian central bank from 2005 through 2011.
What better way to get Eurobonds and debt commingling than cripple the entire European banking system with negative rates and massive QE programs?
If the European banking system went down, including Deutsche Bank, wouldn’t Germany be forced to go along with banking changes?
My counter-argument is on grounds of Occam’s Razor which suggests when stupidity is one of the possible answers it is highly likely to to be the correct one.
Actually, Occam’s Razor says simpler explanations are more likely to be correct, but what is simpler than stupidity?
Surprise, Surprise
The EU is not used to surprises. But the German court ruling makes three in a row.
- Brexit Vote
- Brexit Vote Success
- German Court Ruling
I am surprised too.
Why?
Because in every case to date, the German Constitutional Court looked the other way, There have been numerous ECB-related challenges which the German court threw to the CJEU with obvious consequences.
And there was no indication that the German court would suddenly reverse course.
So I am not only surprised by the ruling, I am shocked that it was 7-1.
Even Those Who Filed the Suit Were Surprised
“I was surprised by how clear the ruling was,” said Peter Gauweiler, a 70-year-old Eurosceptic lawyer who has been waging a legal war against the EU and ECB for almost three decades.
Debt Mutualization
What Germany fears now and has from the outset is “debt mutualization” in which Germany would bailout Greece, Spain, Portugal, and Italy.
That is why Germany insisted the Maastricht Treaty, which founded the Eurozone, prohibit debt mutualization.
But time and time again, politicians and the ECB found ways to chip away at the treaty.
And they still do even in the wake of the German court ruling.
New Battle Cry – Step Up or Risk Extinction
Today, Spain’s Deputy PM Calls for EU to Step Up or Risk Extinction
Pablo Iglesias, Spain’s Deputy PM. says a “certain [level of] debt mutualisation is a [necessary] condition of the [continued] existence of the EU”.
He also wants Portugal and Italy to join the a pan-EU minimum income guarantee cause to “establish European standards of dignity and to protect consumption”.
“Everyone now understands you need an activist state,” says Iglesias.
What “Everyone” Understands
Given the 7-1 ruling might I suggest there is a major flaw in the Iglesias’ understanding of the word “everyone”.
Germany Pays One Way or Another
I understand where Germany is coming from. And I expected this outcome all along.
But one way or another, creditor states pay through the nose. Either Germany agrees to debt mutualization or Target-2 liabilities go up in smoke.
Target-2 Imbalances
Chart from the ECB Data Warehouse Target Balances.
Target is a measure of capital flight and purchases of goods by debtor nations that cannot possibly be paid for.
Italy and Spain owe nearly a trillion euros to Germany. That’s an amount that can never be paid back.
But everyone pretends the debt is good because the ECB guarantees the debt. And those guarantees represent a fundamental flaw in the Eurozone that allowed this debt to pile up in the first place.
If Italy were to withdraw from the eurozone, its banks’ assets and liabilities would be redenominated in its new currency. Germany would not get paid back in in euros, but rather Lira or some new currency, assuming Germany got paid back at all.
For further discussion, please see my August 2018 article, Debate Over Target2 Continues: Twilight of the Euro
The question is not whether Italy should pay its Target2 deficit, but how it possibly could. The Bank of Italy would almost certainly default on a bill for half a trillion euros.
As long as everyone can pretend these claims are good and no one will leave the Eurozone, then everything is fine.
But what if Italy or Spain jumps ship? And what are the other options?
Three Alternative Paths
- Germany and the creditor nations forgive enough debt for Europe to grow
- Permanently high unemployment and slow growth in Spain, Greece, Italy, with stagnation elsewhere in Europe
- Breakup of the eurozone
Pick Your Poison
- The German court signaled it has had enough of the current path towards more mutualization.
- It is unreasonable to expect #2 to last forever.
- The only door remaining is door #3.
Option 3 can be planned or chaos. Germany is arguably in the best shape to suffer the consequences so it would be wise for it to leave the Eurozone rather than have Spain or Italy default, setting off a cascade of defaults.
I outlined those three alternate paths in my 2016 post Michael Pettis Calls Surplus Trade Statements by German Finance Minister “Utter Lunacy”
Kick the Can – How Long Can It Last?
The court ruling comes in the midst of a pandemic, Brexit, the rise of the German Greens, a eurosceptic Italian government, and an EU judicial clash with Poland.
Yet, these can kicking episodes last far longer than anyone expects. The difference this time is the unexpected ruling by the German constitutional court.
The ECB cannot do more, nor can the CJEU, nor will there be coronabonds or eurobonds unless Germany agrees.
Undoubtedly, the path of least resistance is still door number 2: Germany will talk solidarity but act against it.
The result will be a continuation of high unemployment and slow growth in Spain, Greece, Italy, with stagnation elsewhere in Europe …. until the major unexpected happens, Italy or some other country decides it has finally had enough.
Mish
I agree whole-heartedly with Caradoc…and Mish, although they would seem to be contradictory. My German relations would sooner break up the currency union (which they all equate with the end of the European Union), than sell their grandmothers into slavery…and yet it is difficult to see how this overall currency union situation can continue. My hunch, for what it’s worth, is that the Germans will be pushed into ever closer union and debt mutualisation in some sort of way – although the country seems increasingly polarised between Greens and APD, my money is for the moment on the former since the political consensus is not to break with the post-war…consenus!
This is a huge story that I would have missed. Thanks for sharing. I wonder how long the Germans will go on financing countries who can’t pay them back? Capital markets exacerbated this problem by valuing Southern European debt as if it could be paid back. That huge miscalculation plus German complacency continues to allow these bankrupt countries to borrow with abandon. The music will stop – probably soon as you say. This is the next global financial crisis. Germany either takes back control of its own future or they bleed to death by 1000 cuts. They will probably kick that can and bleed a lot more before doing anything.
The people in northern Europe have a very different culture than southern Europe.
Why anyone ever thought they could merge and be successful is a mystery.
The globalists are trying to change human nature, and they are failing badly…..
Maybe Europe is 20 years ahead of the US… imagine if red states had to pay their own way, or go into debt to the blue states that fund them! We in the blue states historically have been willing to sacrifice for the good of the nation, but it’s getting harder and harder to feed the hand that bites it, with red states laughing about Covid19 deaths in NYC, and Republicans from red states nixing federal funds to help blue state budgets dealing with disasters like Covid19, or hurricane relief for Puerto Rico. If blue states decide to cut the red states loose, red states need to understand the poverty and hardship that awaits them. https://wallethub.com/edu/states-most-least-dependent-on-the-federal-government/2700/
Great insight Mish.
I do think, however, that legal problems have little chance by themselves of bringing down the EU. Judges and politicians everywhere have been amazingly creative in twisting their interpretation of the law to suit their desired result. Legal problems have more often been used simply to justify one’s proposed course of action. There seem to be few in Europe who still truly believe in the Rule of Law.
At some point, though, Germans will have had enough. Since their hyperinflation a century ago, Germans have been thrifty savers. Most people in other countries in Europe are not that way, and when bad times come (i.e., now) it will be the story of the ant and the grasshopper all over again.
There is major lasting economic pain coming for the world; keep up the great analysis on what is coming!
….and to think that the PIGS were more prosperous and with happier people in general BEFORE the Maastricht treaty and the megalomaniac, insane common currency ! DOWN with the EU MONSTER !
People are mentioning EU and national borders, but what is occuring now is unusual. Travel between and within most EU countries is restricted for most of them, whether it is permissions, flat border closures, prohibition to move large distances within a country, etc. etc. etc.
However this new reality is obviously not based on migrants or nationalism, and it is coordinated to an extent between countries. So you have what is a return to national control of territory, one that even when understood is basically welcomed by few because it is restricting their freedom. It’s funny, because I think that re-opening from these restrictions will be understood as courtesy of an international management, which will then be regarded as representative of people’s new freedom of movement, of re-enabling it, of safeguarding it, whereas previously open borders within EU were often seen as a national concession whether worthwhile or not.
Well that is how it looks to me sometimes – people are now more interested in travel themselves even if local, than to want to restrict that of others.
Here is Spain’s approach courtesy Matthew Bennett :
“Requests to move to the next level in the national non-race to full freedom can be processed every Monday, Illa says, and once a province moves to the next phase, it must stay there for 14 days in order to assess the situation.”
Where there are phases 0 to 3 all with complex rules, 0 being the strictest. This is the current map of what phase any region is at
So much for the law. Schengen guaranteed free flow withing EU member nations. So muchfor law right?
It just vanished, absconded to “it’s so obvious it doesn’t need saying or explaining” land.
I am a US citizen and Irish citizen so I carry both passports. If the EU were to collapse it would be because of nations like Germany and France which have the largest central banks quit floating debt in the nane of every European. And there is about as much chance of that as the Fed sobering up.
I think it is likelier that the ECB will greatly outdo the BOJ and Fed combined. And any German court rulings will be void. We may hear in ten years that ruling is overruled, and it never went into effect pending appeals.
So this is a zero news story.
Lets hope the EU breaks up and starts enforcing its boarders. Before long,the nightmare of globalization will be in the rearview mirror.
Door number 3 please. The euro has overstayed its welcome at least 10 years.
A curious fact of note: the average private Italian is wealthier than the average private German. The average Italian does not trust his government and neither do we Northern Europeans trust it.
“the average private Italian is wealthier than the average private German”
Which tell you more about the arbitrariness of empirical “economics” and accounting in the financialized fiat era, than about anything fundamental and real.
Looks like China has already colonized Italy.
You may actually be onto something, wrt why Germany is suddenly starting to get cold feet about sinking capital into propping up Italy……
With Southern European finances increasingly African in solidity, those countries may find themselves just as tempted by the new Megalodon on the block, as their neighbors across the Med is.
China’s the hero?
If you’re Chinese.
I am wondering why no one has posed a legal challenge to the fed’s Enron style financial gimmicery.
Who is being harmed by the Fed’s actions that also has standing to sue?
Those savers, retirees in the Main street, pension funds and Insurance companies who rely on fixed income who cannot afford to plan, for future distributions and liabilities in a volatile CREDIT mkt!
May be the banks join them when it goes NIRP!
How about those who want to buy assets at fair market value not bubble valuations courtesy of the politburo on Eccles street.
“Who is being harmed by the Fed’s actions that also has standing to sue?”
The second half of that sentence illustrates the fundamental economic illiteracy of current “Law.”
We’re essentially legally enforcing the seen vs unseen fallacy.
Rule of law left the building when trumpty was sworn in. It has been fraying for a couple of decades, but the rope snapped in 2016.
There hasn’t been even a trace of “rule of law”, or at least not “rule of any meaningful, non-arbitrary hence valid law” since at least Nixon.
And that matters. Because it demonstrates the state, or “system” itself is failed. It’s not a functioning state who just happened to find itself with some random “bad guy” in charge. Instead, Trump is just another President. Presiding over a failed terror state way beyond redemption.
I know he even caused the virus itself and he held Powell at gunpoint. Don’t tell anybody.
“Rule of law left the building when trumpty was sworn in.”
Rule of law was gone before Trump was sworn in. No banker was prosecuted for their crimes during the housing bubble. The FBI also broke protocol in the Hillary server case, well before they broke protocol in the Flynn case.
Maybe because the prosecution and the defendant would be the same entity, a classic conflict of interest. Only the people could break this logjam, but the people are high on drugs, and games.
“… in every case to date, the German Constitutional Court looked the other way…”
Not much of a Constitutional Court, if they are not going to uphold the constitution.
Just put the word kangaroo in front of Constitutional Court.
It looks like sovereignty and territory do matter after all. I think the court probably had enough of migrants from Africa, Syria and elsewhere in Europe. These people who want one government for the region or world are whackos forgot about NIMBY and the effects of open borders.
The chance of a break-up is close to zero. Germans are being softened up right across the political spectrum to show solidarity and gratitude to Europe post WW2. Today is VE day and Germans thankful to Europe – read EU.,
No way will break-up happen of EU or Eurozone until blood begins to be split in my humble opinion. It will have to go that far.
The whole edifice is now a religion. Until you have encountered the zealots involved you will never understand. No price is too high to pay for them and they hold the power behind the scenes.
German productivity and competitiveness will go down the drain, if its industry has to bear the cost of crazy Spanish Kenynesians, and their hangers on, hell bent on protecting “consumption” out of all things. Germany is already struggling as a result of ECB dislocations. As evidenced by rising German housing prices, rents, the increasing size of FIRE vs industry, increasingly politically driven “investments”, whether in “green” utopias or other weirdness which wouldn’t see the light of day without political pressure.
German industry may be world leading in may areas. But they aren’t far enough ahead to keep everyone else living in splendor without doing anything except consume. And even if they were, the sheer cost of having to shoulder such costs, would starve them of the capital required to remain so going forward.
That’s how the Anglo countries collapsed and became de industrialized wastelands, ran solely by and for negative value add Fed and Government enabled racketeers. If Germany goes down that same road, no matter how strong their current position, it won’t take to long before Mercedes Benz is the new Cadillac. And the ambulance chasers, banksters and politicians picking over the remaining carcass, are all choosing to show off by driving Chinese Branded cars instead.
I wouldn’t guess at possibilities of break-up, but you are right that the management is extreme. I don’t know about the PSPP aspect, but am wondering either if this move is to float German yields again and have the rest follow via ECB pinning them to German and not the almost inevitable zero bound that compresses them all together. Alternatively the ECB and EU are being prompted to arrange fiscal oversight of nations. The Troika is out of fashion, and so budgetary control and fiscal oversight at EU level might be the “means of justification” sought. The bond buying was reaction to gfc and to allow counter-cyclical public spending, but apart from the binned debt to gdp restraints there is no oversight or control to “national excesses”. The ECB could justify its program very simply – there would be default or financial/economic/political breakdown across EU otherwise. That is not ECB mandate though, at which point the fiscal management would be understood to need to be placed under the combined political management of EU to shape the economic outcome within fiscal rules.
I’m guessing though, could be a long way out on what the intent is – and there is surely an intent because to force a blunt dissolution of Euro would not be permitted of the constitutional court , no matter how important their position.
This perpetual remembrance of this or that event from 75 years ago has totally lost it’s meaning. Europe is invaded and replaced by populations who had no part, and no relation to those events. Yet, here we go again. I guess, when the replacement is complete, it will stop.
You may very well be correct about the zealots. But when the consequences on the others becomes even more extreme, it may very well be that its time for the blood of the same zealots to be spilt.
At which point, the zealots will think better the split rather than the spilt! 🙂
I agree with this C-O, Ireland at first resisted joining the EU, it voted down the treaty in a plebiscite originally till it was made clear that they would be required to vote again and keep re voting till they “got it right.” So in the second round they approved it by a threadbare majority, and yet in national polls undertaken recently the highest approval rating for the EU was with the Irish. Once they adopted what they had resisted and found out what it was like to get to feed at the ECB trough they were ecstatic. Of course they were also among the hardest hit economies in the GFC going from the Celtic Tiger and Chinese like levels of growth (based upon debt I might add) to one of the worst basket cases almost overnight. And nowhere is the EU as a religion more profound than in Ireland now. It is as if they transferred their Catholicism directly to the EU/ECB. And it is revolting to me as an Irish citizen to see this total abandonment of sovereignty so long and hard fought for after more than 800 years of foreign occupation to be so rudely dumped on the trash heap of history.
I would say the EU member states that are part of the Eurozone having given up their national powers to not even Brussels but Frankfurt would think again if the transfer were military rather than economic.
What if the EU set up something like a Department of Defense that granted itself the right to conscript from each nation soldiers to serve in that military which was headed by appointed rather than elected officials, who basically acted as independent of member state laws, not bound to national budgets or treaties, routinely ignored court rulings, and spent without any input from members as to both blood and money? And then that defense department started making not only treaties and foreign policy but started wars and occupied certain recalcitrant member states viewed as at risk of trying to leave the EU?
The entire EU would be in an uproar, probably targeted by the only national power in the region capable of confronting them, Russia. Yet, in an economic sense rather than military this is pretty much what the ECB does every day.
That member countries would not only allow usurpation of sovereignty but enthusiastically invite it is just sickening. And that they do it not for valid moral reasons but for the welfare goodies they derive from their surrender just makes that doubly so. And I have lived there, it is almost comical to see otherwise rational people stretch for justifications for it. I ask people I met what they thought about the loss of their neutrality which had been so prized after the republic gained independence. Had it not been so sad to see them flounder for an answer it would have been a scream.
“I understand where Germany is coming from. And I expected this outcome all along.”
…
Yes. And not just you. German 10yr, 20yr, 30yr bonds ALL sporting negative yields.
I guessed years ago (when yields solidly positive) premium paid for them in anticipation when breakup occurred German debt would be repriced in marks … and soar relative to euro. Still kicking myself for not buying when had chance.
“Breakup of the eurozone”
…
EU is China’s largest export market. If breakup, Black Swan takes flight (massive yuan devaluation). With, uhh, slight repercussion for US.
The med countries should have never been allowed to joined the Euro zone.
Northern Europeans are generaly frugal and the med countries love to live beyond their means and have done so historicaly.
Thanks for a well-reasoned essay, Mish. I could see the EU breaking up, but in its place two blocs: the fiscally responsible vs the fiscally irresponsible.