Schauble-Draghi clash more about politics than monetary policy

by Enrico Colombatto

In April, German Finance Minister Wolfgang Schauble was particularly vocal in his criticism of European Central Bank President Mario Draghi’s performance, going as far as to blame his policies for the rise of the German far-right party Alternative for Germany (AfD). The confrontation between these two European financial heavyweights is significant, both because it is unusual (such showdowns generally take place behind closed doors) and because it can shed light on what the future holds for the European Union and the euro.

There are two ways of interpreting this episode. First, since Mr. Draghi’s term expires in 2019, it is possible that at least some European leaders want to start identifying his successor. Second, German leaders may be trying to take advantage of Mr. Draghi’s weaknesses in order to strengthen their own political position. This report focuses on the latter possibility.

Pluses and minuses

Mr. Draghi’s record as president of the ECB is mixed. Since being appointed in November 2011, he can claim credit for having saved some European governments from defaulting on their public debts. The financial community also likes that he boosted the balance sheets of several banks that would have suffered badly had he not injected large amounts of liquidity to restore the public’s confidence in the banking system.

However, his ongoing quantitative easing (QE) program of buying up government bonds has failed to ignite growth and has given policymakers an excuse to delay unpopular but badly needed reforms. Most people would argue that under Mr. Draghi the ECB saved the European Union and the euro currency from collapse, but at the cost of growth and credibility.

However, Mr. Draghi’s approach has shored up a vision of the EU project which consists in centralized policymaking and sees local problems as requiring shared responses that are designed and implemented by unaccountable technocrats. This vision is not disputed – not even by Mr. Schauble.

All for show

The public tends to associate Mr. Schauble with German fiscal rigor, a kind of EU bad cop. But he is probably less hostile to Mr. Draghi than meets the eye.

The German government, headed by Chancellor Angel Merkel, has recently advocated fiscal discipline and opposed unconditional bailouts, such as the one some want for Greece. However, considering Germany has frequently given the green light to blatant violations of EU agreements, the clamoring seems to be more of an attempt to save face with the German electorate than a matter of substance, let alone principle. Mr. Schauble’s opprobrium could be part of this effort.

Dissatisfaction with Ms. Merkel’s migration policy has added to the German public’s discontent with the European Union, its monetary policy and the role that German politicians have been playing therein. Although a potential Brexit fails to stir emotions (many on the continent consider it a British problem), Greece will soon make headlines again, and it is easy to predict that a new wave of tension will materialize.

Ms. Merkel’s government was surprised by the AfD’s ability to win so much of the protest vote, and knows that further challenges lie ahead. It might have decided to improve its image with the German public. Distancing itself from Mr. Draghi and the ECB is part of this strategy. Mr. Schauble’s criticisms might therefore be less dramatic than they seem – an exercise in window dressing rather than an effort to change direction.

Interest rates stuck

Mr. Schauble’s attack on Mr. Draghi’s QE program partially misses the point, and the alternative is not necessarily satisfactory for Europe or Germany.

It is true that quantitative easing has failed to generate significant growth. By making large quantities of funds available to the banking industry, it has kept interest rates low. Debtors win, savers suffer.

The savers include German households, many of which counted on the interest paid on the bonds in their portfolios as a source of income. That source of income has now dried up and the prospects for the future are dim. It is unsurprising that German politicians set out to blame Mr. Draghi before the German electorate holds them responsible for the flop.

However, Mr. Schauble is barking up the wrong tree: interest rates will not move significantly once QE comes to an end. Savings are on the rise, since Europeans are fretting over their future and putting off consumption in order to enhance their purchasing power later. Firms are holding back on investment because they don’t know what will happen next. The widespread uncertainty ensures that even without QE, interest rates would only be significantly higher for risky assets. It is doubtful that Mr. Schauble really wants to turn Germans into gamblers.

Transfer of power

The alternative to Mr. Draghi’s bond buying is Europe’s “ever-closer union,” which means political integration, a synonym for further centralization. If Mr. Schauble’s vision prevails, monetary intervention might become less frequent, but fiscal sovereignty (including public debts) would be transferred from the member countries to Brussels.

This does not necessarily mean that fiscal policy in the EU would be run by the Germans; nor does it mean that the German public would be happy with that outcome. But it does mean that the power of German policymakers in Brussels would increase substantially, especially while drafting a new set of treaties for the bloc.

What about those who consider the EU an insurance company and a round table where treaties can be interpreted and manipulated according to the circumstances? Though it was welcomed by many, Mr. Draghi’s QE was not ideal for the political elites in troubled countries. Politicians prefer to deal with other politicians who are equally accountable to voters, rather than with bureaucrats or technocrats. Moreover, bailouts are always discretionary and need to be negotiated each time. Automatic mechanisms are preferable.

Technocracy vs. centralization

Finally, centralization does not rule out abuse, but allows the central tax authorities to increase tax pressure (and expenditure), while keeping local politicians’ hands clean. From the viewpoint of most European politicians, therefore, if Mr. Schauble’s attack aims to replace discretionary, technocratic policymaking with centralization, then the German finance minister’s criticism is timely and welcome.

In contrast to first impressions, the recent clash between Mr. Schauble and Mr. Draghi is not just about economic technicalities. Mr. Draghi clearly resents the tone of Mr. Schauble’s remarks, but the entire EU establishment might be pleased to see that Germany’s political leadership objects to technocratic power and is leaving the door open to proposals for political union and fiscal centralization.

The failure of monetary management will probably offer new ammunition to the advocates of harmonization and bring together political elites, regardless of their ideological bent and nationality. European workers and taxpayers will pay for the consequences. However, if this is the German manifesto for the future of the EU, it will meet with plenty of interest, and Germany’s ambition to obtain the top job at the ECB might gain currency.

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Source: Geopolitical Intelligence Services