As I’ve noted in previous articles, there is a growing tension between the ECB, the central bank backstop for Europe, and Germany, the de facto sovereign EU backstop.
In brief, the ECB has wanted to monetize and bailout needy EU members aggressively while the inflation-phobic Germany has wanted to impose fiscal constraints as well as austerity measures (essentially fiscal sovereignty) on needy EU members in exchange for bailout funds.
The reason for this difference in attitudes is political in nature: Germany has already experienced the consequence of rampant monetization (Weimar). Moreover, Germany, sees this as an opportunity to further extend its reach and political clout in Europe. So it’s used every chance it can to advance a German-lead “political union” (German Finance Minister Wolfgang Schauble’s own choice of words).
In light of this, Germany has been willing to stomach the ECB’s moves because it does not want:
- To be seen as the cause of a Euro breakup
- To kick off a banking collapse via #1
However, things have recently taken a sharp turn for the worse in ECB/ German relations. The reason? The ECB first swapped out its Greek debt exposure for bonds that would not take a haircut on the second Greek bailout… then announced that any of the losses on its PIIGS portfolio (over a quarter of its $3.8 billion balance sheet) would be rolled back onto national Central Bank shoulders (aka Germany’s Bundesbank).
Germany was none too pleased about this, and has taken steps to rein in the ECB’s policies:
Germany launches strategy to counter ECB largesse
The plans have major implications for monetary union, dashing hopes in Southern Europe that Germany might accept a few years of mini-boom at home to help lift the whole system off the reefs.
Andreas Dombret, a key board member of the Bundesbank, said the body would be given powers to check “excessive credit growth” and impose “maximum leverage ratios” to nip economic overheating in the bud.
The Bundesbank will be able to impose “counter-cyclical capital buffers” on lenders, and use “macro-prudential haircuts” in the securities markets. It is understood that the menu of new tools will include limits on the loan-to-value on mortgages along the lines of those used in Hong Kong and other Asian states.
The new framework - introduced by German government in a draft law this week - is partly inspired by the Bank of England’s new system but it also has a German twist…
German house prices rose 5.6pc last year after a decade of stagnation. Officials in Frankfurt are watching the property data closely, fearing that Germany may succumb to the sort of housing bubble that engulfed the Club Med bloc in the early years of EMU.
“The Bundesbank does not want to be blamed for making the same mistakes as central banks in Ireland and Spain where they did not address asset bubbles early enough,” said Bernhard Speyer from Deutsche Bank.
The German authorities are in effect preparing a form of quasi-monetary tightening to offset ECB largesse…
“If the eurozone is to adjust, southern countries must be able to run trade surpluses, and that means somebody else must run deficits,” said Dr Speyer.
“One way to do that is to allow higher inflation in Germany but I don’t see any willingness in the German government to tolerate that, or to accept a current account deficit.
The ECB recognizes a warning shot when it sees one. Indeed, ECB President Mario Draghi knows that if inflation rises in Germany, the latter will take very serious actions, including potentially threatening to walk out of the Euro:
Draghi Says Inflation Risks Prevail as Economy Stabilizes
European Central Bank President Mario Draghi said policy makers are prepared to act against inflation threats if needed, while assuring investors that the ECB doesn't plan to withdraw emergency stimulus any time soon.
"All the necessary tools are available to address upside risks to price stability in a firm and timely manner," Draghi told reporters in Frankfurt after the ECB held its benchmark rate at a record low of 1 percent today. At the same time, it's premature to talk about the ECB's exit strategy, Draghi said, adding that the economic outlook is subject to downside risks and inflation will remain contained in the medium term.
The ECB is balancing the threat of inflation in Germany, Europe's largest economy, against the need to fight the sovereign debt crisis. While nations from Greece to Spain are battling recessions and record unemployment, workers in Germany are winning some of the biggest pay increases in 20 years.
[ECB President Mario Draghi] declined to comment on recent wage settlements in Germany, where 2 million public service workers are set for a 6.3 percent raise over two years, according to the Ver.di union. It would be the biggest increase negotiated by the union since 1992. IG Metall, Europe's biggest labor union with about 3.6 million workers, is demanding 6.5 percent more pay.
And so the ECB, like the Fed, has found its hands tied: if it continues to monetize aggressively, inflation will surge and Germany will either leave the Euro or at the very least make life very, very difficult for the ECB and those EU members asking for bailouts.
Which means the bailout gravy train is slowing and possibly even stopping right at the time when Spain (a REAL problem) is going to start looking for a bailout. So what do you think happens when the ECB chooses to print more and Germany threatens to pull out the Euro… OR the ECB tells Spain it can’t provide any additional funds?
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