The eurozone is about to go bust
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It is a rock of stability. It is the soundest financial institution in the world. And it played a crucial role in rebuilding the country after WWII. If there is one thing we don’t expect it is for Germany’s once-mighty Bundesbank to be losing money.
That is why it came as a shock when the central bank last week announced an annual distributable profit of zero, after burning through the entire €19 billion of provisions it built up to cover financial risks. Sure, it can draw on reserves, and if it has to it can draw on the government as well. Yet central banks right across the eurozone are losing money and at an accelerating rate.
Over the seven decades since it was founded amid the ruins of post-War Germany, the country’s central bank acquired a hard-won reputation as the most conservative, responsible, and best run financial institution in the world. “Not all Germans believe in God but they all believe in the Bundesbank”, Jacques Delors, former president of the European Commission, once quipped. For historians its ability to banish the inflationary chaos of the pre-War years has often, quite rightly, been seen as playing a crucial role in the success and stability of modern Germany.
The trouble is, it is not looking quite as solid as it once did. Last week, the Bank revealed that it would have made a loss of €21.6 billion last year if it had not burned through the reserves it built up to pay for a financial crisis. The reserves are now down to just €700 million, and yet it expects another significant loss this year, and perhaps the year after. The explanation? The divergence between the higher interest rates that it now has to pay on the money banks deposit with it and the far smaller amount it earns on the vast quantities of bonds it has been forced to buy under the ECB’s bond buying programmes over the last decade. Last June, Germany’s federal audit office, the Bundesrechnungshof, warned that the central bank might have to be recapitalised by the government.
It is not as if it is alone. Last week, the Dutch central bank, another financial institution with a long and proud history of stability, said it had lost €3.5 billion last year. Likewise, the ECB itself said last week it had lost €1.3 billion last year. One after another, the central banks that between them make up Europe’s single currency are racking up losses, and it ought to be causing greater alarm.
It is not hard to work out what is happening. Over the last decade, the ECB has embarked on a vast programme of quantitative easing both to deal with deflation, and more importantly to stop countries such as Italy going bust. If no one wants bonds from a member state, the central bank will always step in to buy them (known as doing “whatever it takes” to preserve the euro, as former ECB president Mario Draghi famously put it). Amounting to the equivalent of 82pc of its GDP, the ECB has printed far more money than the Federal Reserve, on 36pc of GDP, or indeed the Bank of England, on 39pc of GDP. The member central banks were forced into buying bonds at near zero interest rates, and now have to pay far higher rates on the cash deposited with them. At the same time, the financial imbalances inside the zone, with huge trade surpluses in Germany matched by deficits elsewhere, have to be recycled through the banking system, creating yet more liabilities. And right now, there is no end in sight to the red ink.
True, the Bundesbank is not bust yet. “The Bundesbank’s balance sheet is solid” declared its president Dr Joachim Nagel. Meanwhile the governor of the Banque de France François Villeroy de Galhau argued in a speech last month that it had sufficient reserves to cover any losses.
And yet, it is rarely an encouraging sign when central bankers have to start regularly reassuring everyone that they are not about to go bankrupt. In a working paper last year, the IMF complacently assured everyone “that losses, while large, will be temporary and recoupable”. Governments won’t get any of the profits that their central banks used to make, which unfortunately means that taxes will have to rise elsewhere, it admitted. But they won’t need a bailout.
We will see. In reality, there are three big issues. First, if inflation does not come under control this year, and interest rates stay high or even go higher, the losses will rise and rise to eye-watering levels. Next, with no end to Italian deficits, and no sign of a return to sustained growth, the ECB may well have to keep buying those bonds to prevent a run on the country.
And finally, and most importantly, if the Bundesbank does have to be recapitalised by the government in Berlin, it will surely break the patience of the German voting public with the central currency. They were told again and again that the euro wouldn’t mean they would be forced to pay for a bailout of other countries, and that promise will have clearly been broken. The trust will have been shattered forever, with unpredictable results. One point is certain. If the Bundesbank is bust, then so is the eurozone – even if it takes a few years for that to become clear.
