This is Why the German Court Ruling Regarding ECB’s QE Program is Serious

Posted on 05/08/2020


The European Union just dealt with Brexit for quite some time, while trying to reel from the Eurozone sovereign debt crisis. Populism, an aging demographic, national pride, local government rights, low economic growth, and the refugee migrant crisis are all factors weighing in on viability of a unified European currency and financial system. The ascension of U.S. President Donald Trump and his administration’s trade policies have accelerated the timetable of remnant Cold War policy and structures.

The European Central Bank (ECB), which is based in Frankfurt, formed its controversial Public Sector Purchase Programme (PSPP) in 2015. After years of quantitative easing, segments of the German government grew impatient with such policies. The Karlsruhe-based German constitutional court (Bundesverfassungsgericht) ruled the ECB’s bond-buying efforts to stabilize the Eurozone was legal; however, voiced concerns that the QE plans partially violate the German constitution. The German constitutional court is challenging the ECB to prove its mega buying of government debt is proportionate, or face the possibility of the Bundesbank, Germany’s central bank, being blocked from participating in the PSPP. The German court believes there is not enough political oversight in the bond buying. The German court gave the ECB a path out and wants the supranational central bank to justify the QE program within three months. The ECB has purchased more than €2.2 trillion of public sector debt since the launch of PSPP. With the coronavirus pandemic, the ECB is not done and is on track to purchase around €1.1 trillion worth of bonds this year.

There is pressure from the ECB to not respond to the German court, which could possibly expose the ECB to potential legal pressure from member national courts.

This could be the first time a national EU member court had declared a European Court of Justice judgment (a 2018 ruling) to be invalid, thus opening up the possibility of undermining the uniform application of European Union law. The struggling EU members in Europe’s south are in dire need of the PSPP continuing. Spain, Greece, and Portugal continue to need liquidity to shore up their economies. Another European country at greater risk is Italy, as the nation is reliant on ECB central bank bond purchases.

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The ECB put out a press release on May 5, 2020:

“The Governing Council received a preliminary briefing by the governor of the Bundesbank and by the legal department of the European Central Bank (ECB). The ECB takes note of today’s judgment by the German Federal Constitutional Court regarding the Public Sector Purchase Programme (PSPP).

The Governing Council remains fully committed to doing everything necessary within its mandate to ensure that inflation rises to levels consistent with its medium-term aim and that the monetary policy action taken in pursuit of the objective of maintaining price stability is transmitted to all parts of the economy and to all jurisdictions of the euro area.

The Court of Justice of the European Union ruled in December 2018 that the ECB is acting within its price stability mandate.”

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The European Commission is the European Union’s primary governing body. On Bloomberg TV, Executive Vice President of the European Commission’s economic unit Valdis Dombrovskis said: “We have provided major liquidity support to companies, but as the economy is in such a deep recession, we also need to see how we can provide a direct or rather indirect equity response.” Age old problems are rearing their heads once again, with echoes of Greece’s mandated austerity measures from a decade ago rising. The wealthier north, particularly Germany, has never been interested in bailing out the free-spending south. In the EU, despite the euro currency, fiscal authority tends to fall on member states, which is why countries have varying levels of financial stability. Some of the EU members have never fully recovered from the global financial crisis of 2008.

Not Going to Take It

Keeping money flowing in Europe isn’t easy, especially when banks don’t want to accept the European Central Bank’s money. Europe once had a vision of the euro currency overtaking the U.S. dollar as the world’s reserve currency. The odds of that happening are failing every day. Many European banks are still dealing with bad loans left over from the last financial crisis in Europe. These banks have turned the ECB down. The program in question is known as Targeted Longer-Term Refinancing Operations (TLTROs). With US$ 919 billion out in long-term loans already, European banks are uninterested in taking a chance on endangered businesses. As a result, the ECB can’t play as large of a role as it would like to in lending to various European businesses.

Greece

The Guardian checked in on Greece at the ten year mark and the results of the EU’s work there have apparently been disappointing: “Paradox is a Greek word for good reason: today’s Greece proves that it is perfectly possible for the state and for the majority of citizens to be sinking deeper into insolvency while the oligarchy makes a mint from trading in their assets.” Greece also needed to rely on emergency funding due to coronavirus-related troubles. The EU’s new “solvency support instrument” is in the works and it could prepare US$ 216 billion in ammunition for certain companies. According to Bloomberg, “Euro-area debt is predicted to increase to 102.5% of economic output.”

Central banks are now making accommodations for newer junk debt, rated BB+ or lower. That doesn’t necessarily mean they plan to rescue individual low-quality companies who lure investors in with high yields. However, junk bond ETFs will also be purchased and help could come to lower-quality companies in that form. The Federal Reserve will buy junk bonds from individual companies if the company had a higher than junk rating before coronavirus hit the U.S. in late March. Historic companies such as Ford Motor Company will be on the list of eligible targets, now called fallen angels. The fallen angels camp in the U.S. and Europe could swell to become over a US$ 600 billion market. The ECB is expected to follow suit. The details of Europe’s next moves are still being worked out, but some preliminary information is available.

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