Sunday, July 7, 2013

Inside The Mind Of Jens Weidmann

Jens Weidmann is the president of the Bundesbank and a member of the ECB Governing Council. He is seen as the leader of the Hawkish Group  at the ECB. He holds views that are diametrically different from mine (not that he knows or cares). But it is crucial to understand how he thinks, because he holds an effective veto over ECB policy. That makes him one of the most important central bankers in the world. His views cannot be ignored.

Weidmann has provided us with two recent insights into his thinking: a speech today (7/7) in France, and a recent interview (6/24) with Suddeutsche Zeitung.  Helpfully,  both documents are available in English on the Bundesbank website.
Weidmann speaks in plain language and doesn’t mince words, or at least no more than he must. It appears that he regrets EMU, although he denies that (as he must as a board member of the ECB). His official posture is: effective monetary union will require greater fiscal discipline and structural reform; easy money is not the answer. His views about EMU can be summed up as: In the absence of fiscal union, EMU remains a looser grouping of countries that will face the discipline of the financial markets if they fail to produce economic convergence.
With respect to monetary policy, Weidmann adheres to a  strict interpretation of the ECB Treaty which provides for a single mandate, price stability, and which excludes “monetary financing” or deficit monetization.
Weidmann’s attitude is: EMU was founded on the explicit understanding that the ECB would be as single-minded as the Bundesbank in its focus on the single mandate. His view is that not only does the ECB lack a growth mandate, it should not have one (and nor should any central bank). He is a supply-sider: growth results from sound fiscal, structural and monetary policies, not from “artificial stimulus”.
There is nothing radical or heterodox about Weidmann’s views. They are shared by a number of members of the FOMC. Indeed, his views are orthodox. I think that his true desire is a federal eurozone, modeled on the dollar zone. This would be a eurozone without national central banks and without national banking systems. South Dakota does not have a central bank, nor does it have a financial system. The Fed and the FDIC could not care less if South Dakota defaulted on its muni bonds.
Here are his words:
“We need to make sure that in a system of national control and national responsibility [federalism] , sovereign default is possible without bringing down the financial system. Only then will we really do away with the implicit guarantee for sovereigns. To achieve this, we have to sever the excessively close links between banks and sovereigns. Currently, European banks hold too many of their own governments’ bonds.”

Weidmann desires a eurozone where governments can default without collapsing their financial systems. He also desires a eurozone where banks can fail without becoming contingent liabilities of their governments:
“Getting to grips with the implicit guarantee for sovereigns would be a big step towards eliminating the inherent tensions in the monetary union’s structure. Removing the implicit guarantee for banks would be another one. To make that happen, we have to ensure the resolvability of banks. Defining a clear hierarchy of creditors is crucial. Shareholders and creditors will have to be first in line when it comes to bearing banks’ losses – instead of taxpayers.”
This is American federalism: states can go bankrupt without destroying their financial systems, and banks can fail without having any claim on their state. (Washington State did not shudder when WaMu failed.) We know that such a system could work because the dollar zone has worked for a couple of centuries.

But next we come to the crux: eurozone monetary policy. As a monetarist, I adhere to the view that the quantity theory operates, and that real growth is a derivative of money growth. In a nutshell: you can’t have 4% real growth with 1% nominal growth, and you can’t have 6% nominal growth without some inflation. That’s Market Monetarism, although it is really both Fisherian and Keynesian.
Here is Weidmann’s view: “The best contribution a central bank can make to a lasting resolution of the crisis is to fulfil its mandate: that of maintaining price stability.” In other words, there is no reason why the eurozone periphery cannot resume strong growth with 0% inflation and 0% nominal growth. I don’t mean to caricature his view, but it comes pretty close to that.
Has Weidmann read Fisher lately (or Bernanke, or Sumner)? To my knowledge he has not refuted the necessity of reflation in ending a depression. Indeed, I think that he is a sincere liquidationist, who views depressions and defaults as prophylactic. He wants to remake Southern Europe in the image of Northern Europe. He believes that, in the long run, it is in their own interest. He should read a financial history of the last three years of the Weimar Republic.

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