Like setting off a nuclear bomb
by Martin Hellwig
The ECB denying Greece emergency loans would be blackmail, writes economist Martin Hellwig. A crisis like 1931 could be created.
After the „no” vote in the Greek referendum, everyone is waiting to see what happens next. Perhaps not much will happen at all. The Greek government won’t receive new funding — but then it won’t need much because the lion’s share of any new „aid” would serve to pay back old „aid”. And if it’s not paid, then what should be common knowledge since the Latin American debt crisis in the 1980s will become clear — that without a bailiff, debt collection is difficult.
The crucial question is how the European Central Bank (ECB) will react. The president of the German central bank, Jens Weidmann, and the head of Ifo, Hans-Werner Sinn, have long demanded an outright halt to emergency loans to Greece. But in fact, even freezing these loans is questionable. According to the Treaty on European Union, the ECB’s task is „to promote the smooth operation of payment systems,” and to do this for all member states including Greece.
Freezing emergency loans to Greece would cause its banks to close and lead to massive restrictions on payment transactions. This is not in accordance with the ECB’s contractual duties.
„But the Greeks aren’t sticking to the treaty either!” This is an inadmissible collective accusation. Instead of talking about „the Greeks,” we have to make a distinction between the Greek government, Greek commercial banks and the Greek central bank. It’s true that the Greek government is not willing to stick to the agreements it has drawn up — credit agreements. But is this sufficient reason to hold all Greek banks to ransom? The European Banking Union has been in place since 2014 whereby banks are no longer subject to national supervision, but to the supervision of the ECB.
„But the ECB’s money is being passed from the banks to the government, and is supporting this breach of contract!” This statement is untrue. The money does not come from the ECB, but from the Greek central bank, which is liable for any losses. And the money is not used to finance the Greek state, but to compensate the huge drops in customer deposits. Apart from this, as a supervisory committee, the ECB has prohibited Greek banks from increasing its public sector loans — as just one example of how the Banking Union breaks the ties between states and banks.
Images that bring to mind the 1931 crisis
Issuing emergency loans in the event of a run on the banks belongs to the core duties of a central bank. Banks finance themselves in the short term through customer deposits and by granting mid- to long-term loans. If depositors panic and withdraw their money, banks are defenceless. Then either the central banks steps in, or a crisis occurs that causes repercussions for the economy as a whole.
The photos emerging from Greece bring to mind images of Germany in 1931. On 9 July 1931, the Reichsbank stopped any further aid to German banks. Following this was a run on the banks by customers. On 13 July, the Danatbank was forced to close. On 14 and 15 July, there was a state-imposed „Bank Holiday” for all banks, followed by a three-week restriction on payment transactions. As a consequence, economic activity plummeted by another 20 per cent to 60 per cent of its pre-1929 level, while employment fell by a further two million.
These experiences in the 1930s were one reason for the massive state aid in 2008. And it makes the ECB’s failure to support the Greek banks any further all the more disconcerting. The effect this has on a country’s economy is akin to setting off a nuclear bomb. The damage is incalculable. Its threat alone has huge blackmail potential. This could possibly be aimed at Germany too. For our country and our democracy, it would be much more dangerous than the potential losses that the ECB’s critics are getting worked up over now.
„But the Greek banks are insolvent!” When Sinn raised this objection in February for the first time, his facts were not correct. The Greek banks had acquired a large amount of own capital in 2013 and performed well in the ECB audit. But soon Sinn’s statement is likely to come true. If the payment system collapses, companies whose customers are broke will not be able to service their debts, which in turn will make the banks go bust.
The costs of the crisis
According to ECB regulations, only solvent banks are allowed to receive loans from the central bank. This protects it from losses. But in 1931, would it not have been better to continue giving loans to commercial banks, even the clearly insolvent Danatbank? The costs of the crisis for Germany were so high that the answer to this question should be simple. But back then, the Reichsbank had to cut off its support because it ran out of the gold exchange and foreign currency holdings necessary to cover currency.
The rule only to lend money to solvent banks dates back to a time when central banks had to be ready to convert their banknotes into gold or foreign currency at any given moment. Concern about their gold and foreign currency holdings, and the fear of a run on the banks, caused them to be especially careful. This caution prevented a suitable monetary policy being devised during the global economic crisis.
In the meantime, a pure banknote currency now exists with no conversion obligation whatsoever. Central banks can support the monetary and banking system without concern for their own ability to act. Shouldn’t the responsibility for the operability of payment systems set out in the European Treaty take priority over an internal ECB rule that dates back to the era of the gold standard, and which the treaty doesn’t cover?
Martin Hellwig, 66, is the director of the Max Planck Institute for Research on Collective Goods. He has taught at Harvard, Stanford and Princeton and in in Bonn, Basel and Mannheim.