Grand Strategy for Europe or just Muddling Through? By Elisabeth Hellenbroich On November 21 the 24th European banking congress took place in Frankfurt. It was organized by the Frankfurt ECB Office and the Maleki Group. Several hundred European bankers were present as well as representatives from U.S., Asia, Latin America, Russia and the Mideast. The dominant mood among the bankers was characterized by the concern that Europe has to initiate more economic stimulus programs to get out of the economic paralysis which at present is characteristic for the Eurozone. The crisis manifests itself in economic GDP imbalances among the EU member states, too much debt overhang, increasing youth unemployment and above all lack of economic investments in the real industrial sector. This year’s debate concentrated attention on the specific monetary measures which must be taken in order to prevent a repetition of the 2008 financial crisis. What was however noteworthy for the author, who participated at the Congress, was the lack of taking into account strategic developments which in the last twelve months have been a contributing factor of deterioration of the investment climate i.e. taking into consideration the Ukraine/ Russia crisis which had a dramatic effect on Europe’s export, as well as other geopolitical crisis in the Mideast. The only reference made to “geopolitics” was the remark by German Finance Minister Dr. Wolfgang Schäuble during the last panel, who mentioned almost accidentally that the bleak economic situation in the Eurozone was due to “geopolitical reasons.” “Reshaping Europe” This was the title of this year’s conference which includes specifics measures such as the stress test and the supervision done for banks in the Eurozone since one year under the leadership of the Supervisory Director of the ECB Danièle Nouy. The stress test involves 130 banks, out of which approximately 20 banks have turned out to be in problematic shape. There was a general consensus among the bankers that the Eurozone stability is under high pressure and that there be must be a stronger nexus between governments and the monetary sector. As the chairman of the Board of Managing Directors,Commerzbank, Martin Blessing stressed in his introductory remarks, the European Central Bank (ECB ) with the measures of injecting massive liquidity into the system, tries to only “buy time” for politics to do its own job i.e. creating jobs and use the time to invest in the real industry. He spoke of an underlying “demand weakness” in the EU economies, stating that while the present low inflation could have an effect on the debt overhang, a too long period would be critical and should not yield into wages. He pointed in particular to the fragile “labor market” in Europe. “We will do whatever we have to” European Central Bank (ECB) chairman Mario Draghi in his keynote address emphasized that the economic situation in the Euro area will remain difficult and that the inflation situation in the Euro area has become “increasingly challenging”, while confidence in the overall economic prospects is fragile, feeding into low investment. He indicated a further “easing” of monetary policy by the ECB (the Euro right stands at 1,242 to the Dollar- the lowest level since August 2012) and expressed his main concern about the “excessively low short term inflation expectations”, (which corresponds to the underlying concern among financial experts who warn that a deflationary spiral may lead to a further contraction in the industrial investment): “We will do whatever we have to do, in order to increase the inflation expectations as quick as possible”, Draghi said. He warned that “we must be attentive and watchful so that the low inflation (headline- inflation for November was at 0.4%) does not begin to spread into the entire economy and thus deteriorates the economic situation and the inflation outlook”. He explained that the ECB had to act by purchasing bonds and Asset backed Securities (ABS) which will expand the balance sheet of the ECB to 3 Trillion Euro and pump 1 trillion Euros into the markets. Draghi reminded the audience that two years ago, at the height of the Euro-crisis, Europe faced a critical and bleak situation. Since then governments and the ECB have taken steps to address “fragmentation” as result of which the financial situation in the Euro area has improved. Draghi spoke about the process of “cleaning up the banking sector” and underlined that despite these positive developments in the financial sphere, they have not transferred fully into the “economic sphere.” “The economic situation in the euro area remains difficult”, he warned, and “the underlying growth momentum remains weak. Unemployment is only falling slowly and confidence in our overall economic prospects is fragile and easily disrupted, feeding into low investment.” In reference to the European Purchasing Managers Index released on November 20, he predicted that a stronger recovery is unlikely in the coming months, with new orders falling for the first time since July 2013.” The aim of the ECB in the long term is to bring inflation back towards 2%. Commenting the ECB’s unconventional and unprecedented measures, Draghi pointed to the decision taken in the ECB Governing Council to initiate purchases of Asset –backed securities (ABS) and covered bonds and emphasized that the “purchases of ABS will encourage banks to create more loans and increase the credit supply.” Draghi stressed: “We are committed to recalibrate the size, pace and composition or our purchases as necessary to deliver our mandate. This is why the Governing Council has tasked ECB staff and the relevant Euro-system committees with ensuring the timely preparation of further measures to be implemented, if needed. What is needed is to create a business environment where new investment is attractive.” In the following panels moderated by Linda Crane from “Deutsche Welle” several digital votes were taken from the audience. In one of the votes the audience, when being asked whether they expected “a grand strategy for the Eurozone economy, a quantum leap or just muddling through”, answered with 79.8% that they expected Europe just to be just “muddling through” the crisis. This response was interpreted by the panelists( Guntram Wolff, director of Brueghel Institute Brussels, David Lidington, British Minister of Sate for Europe Foreign and Commonwealth Offcie London, Stefan Krause ,one of the chief managers of Deutsche Bank, et al) as a manifestation of “skepticism” and “pessimism” in the Eurozone which itself is a result of the economic decline in the Eurozone. In the Middle Ages: bankers were punished with “bread and water” The second keynote was given by Bundesbank chairman Jens Weidmann. The title of his speech was “Banking union and Regulatory Reforms. Mission accomplished?” Unlike ECB chairman Draghi, Jens Weidman focused his remarks on the need to further regulate the banking sector. He reminded the audience that during the Middle Ages regulatory measures were quite draconian. In 1300 the Spanish economist Huerta de Soto outlined a detailed set of regulations to control banking established in Catalonia. “Bankers who went bankrupt were forced to live on a strict diet of bread and water until their depositors had been fully reimbursed”, he said. “In 1321 Catalonian banking regulation was tightened. Henceforth a banker who failed to meet his clients’ demands faced the threat of being beheaded in front of his bank.” Under such conditions, which caused some amusement in the audience, as Weidmann stressed, banking was really a risky business and the draconian punishments given at the time only underline the urgent need today for “regulatory measures”. Such regulatory measures should become effective if a commercial bank fails, since this could become a “systemic event”. According to Weidman the financial crisis 2008 demonstrated that “the rules of the banking system were insufficient.” Weidman outlined the most important regulatory measures taken for the future, which include the introduction of “stricter capital requirements and new liquidity rules under Basel III. With the full implementation of Basel III, the capital requirements will be significantly higher and tougher than under Basel II and the financial system will be more stable than before”, Weidman said. A typical credit institution will have to achieve a capital ratio of 8% plus various buffers. He mentioned several studies which have been done recently which do suggest more radical measures, such as an 11% capital ratio requirement. Weidman pointed however to a paradox. Excessively high capital requirements may not only curtail the bank’s ability to provide credit to the economy, but that the stricter overall regulatory landscape has induced “regulatory evasion” i.e. financial activities are being shifted out of the regulatory banking sector into the “unregulated shadow banking sector.” According to Weidman the “growing shadow banking sector is something regulators have to watch closely” and shadow banks can thus become a source of “systemic risk, especially when they are highly interconnected with the regular banking system. From a financial stability perspective it is therefore important to closely monitor shadow banks’ activities and regulate them adequately. The Bundesbank therefore supports the global regulator initiative on shadow banking under the leadership of the Financial Stability Board FSB.” Weidman also spoke about the establishment of a “European Banking Union” whose main pillars are the “Single Supervisory Mechanism” (SSM- involving the ECB directed supervision of the Eurozone banks) and the Single Resolution Mechanism (SRM- setting up a clear liability cascade for failing banks, where investors will be asked first to shoulder the costs of bank failures). He qualified these initiatives which will be fully implemented by 2016 as an “institutional milestone on the path that leads to greater financial stability in the euro area.” And gave special praise to the work done by the ECB and qualified the assumed responsibility for the supervision of the Euro area banks (chaired by Danièle Nouy) in concert with national supervisors, as a “Herculean task”. If a crisis occurs, EU treaty change could come very quickly Finance Minister Schäuble who spoke during the last panel instead of presenting a speech was this year interviewed on the panel by “Die Welt” editor Eigendorf. Schäuble was expressing optimism while cautioning at the same time. He referred in particular to the “European restructuration Fond” (55bn Euro) established by the Financial Stability Board for the Eurozone and announced that the “European Banking Union “would come into being by 2016.” His main message was to assure that in case of future bank failures “taxpayers can be calm” since we “have rules in European law and obligations for all 28 members.” In case of conflict he said, member states will take the liabilities. Schäuble also stated that as long as the European Treaty is not changed, the ECB is the only institution that can act on a European level. “We need a treaty change for Eurozone”. When being asked when this would be the case Schäuble answered “if we have a next major crisis, this can go very quickly.” The most important aspect of the interview was his urge for “more investments in public infrastructure”, which as he put it, “have lacked due to geopolitical problems”. He pointed the attention of the audience to the recently announced investment package by EU Commission president J.C Juncker , including 315 bn Euro investments in the field of infrastructure and support for the medium size industry.
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