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Simon Johnson

Simon Johnson

Posted: February 19, 2010 09:48 AM

The Struggle for Power at the Heart of Europe

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Cross-posted from The Baseline Scenario

Given recent maneuverings around European Central Bank (ECB) appointments and the obvious discomfort of Mario Draghi -- he carries the Goldman Sachs connection now like other people carry albatrosses -- the German financial-industrial complex seems to regard Axel Weber as a "done deal" to become the new ECB president.

Such an assumption is premature. Mr. Weber, as long standing head of the Bundesbank and general German economic maestro (including, quietly, on fiscal issues), is due to face his own round of questioning -- if you listen carefully, you can hear southern Europeans sharpening their arguments, and with good reason.

There are six important and difficult subject areas for Mr. Weber.

  1. Who was asleep at which wheel when Deutsche Bank was allowed to become one of the most leveraged banks in the world, betting and losing heavily on subprime mortgages -- among other things?
  2. What exactly was Mr. Weber's involvement in the Hypo Bank debacle? Germany likes to claim that it can regulate large banks effectively -- and there is no reason to limit their size. To the rest of us, it seems like Germany can't even regulate and control relatively small banks.
  3. Why does Germany continue to resist sensible proposals to increase capital requirements on banks (both at the deputy minister level and through the relentless lobbying of Josef Ackermann)? The presumption among their closest allies is that this is to hide losses - and general government culpability -- in the mismanagement of German public banks (Landesbanken). Why is it reasonable to hold up the entire G20 process (and the BIS, etc), at a technical level, for what is essentially a broad form of political cover-up?
  4. Why have the full results of European bank stress tests never been published? Is this because of large current and likely future losses on the balance sheets of financial institutions that fall within Mr. Weber's remit?
  5. German officials are keen to criticize the southern periphery of the eurozone, but let's face it - eurozone monetary policy was highly procyclical (exaggerating the boom and the bust, e.g., in Spain), and regulators looked the other way as northern/core banks extended credit to the Mediterranean and East European neighbors. The upside benefited German exporters; the downside is now being laid entirely at the door of "profligate" nations. Is this entirely fair and reasonable?
  6. As Mr. Weber aspires to European-level leadership, here is the big issue. Is it his intention to manage the currency zone to suit the preferences of the core nations (i.e., Germany), while letting those on the periphery be whipped around by policies that are not suited for them? Is there anything at all that he and others take as lessons from recent experience?

More broadly, Germany and Mr. Weber have been central in building a version of the Bretton Woods fixed exchange rate system within Europe. The entire burden of adjustment is placed on deficit countries (talk to Greece); it is considered beyond the pale to even suggest that German fiscal policy may be too tight, that Germany needs to expand domestic demand, or -- heaven forbid -- that Germany's intention to export its way back to growth (with a current account surplus, in their view) is not exactly a model of enlightened economic leadership.

On top of this, and unlike Bretton Woods, there is no mechanism for adjusting exchange rates within the currency union. Given what we have learned in the past two years, is this still such a bright idea?

With Draghi damaged and the Weberian model so open to question, look (or hope) for dark horses to emerge in the race for the ECB.

And don't make the mistake of thinking that you don't care. The broader European economy accounts for around 1/3 of world GDP, depending on how you count it. The President of the European Central Bank is the preeminent policy maker in this space.

If the growth prospects for this area remain dismal while European banks stay loosely supervised (our Axel Weber baseline), expect even more destabilizing capital flows into emerging markets - and into the United States.