The Wrong Germans to Lead the ECB

Germans now in the race to succeed Lagarde trumpeted TPI, which disqualifies them

The President of Germany’s Bundesbank, Joachim Nagel, last week stunned many by announcing his support for Eurobonds for things like joint defense spending. The Bundesbank has always staunchly opposed joint EU debt issuance, on the grounds that it further undermines fiscal discipline, so I can’t even begin to say what a huge shift this is. The key question, of course, is why Nagel is breaking with history now. The reason is that he’s hoping to position himself more favorably in the race to succeed Christine Lagarde as ECB President, whose term ends in 2027.

Germany has a troubled past at the ECB. Senior figures like Jens Weidmann, Axel Weber and Jürgen Stark all resigned because they resisted mounting pressure from high-debt countries to cap their bond yields. Their replacements - Isabel Schnabel and Joachim Nagel - learned that you need to acquiesce to get ahead. This is bad for Germany, but clearly better for their careers at the ECB. Germany, in other words, has a principal-agent problem at the ECB.

It’s this principal-agent problem that has Nagel sounding positive on Eurobonds and is why Schnabel cheered the controversial transmission protection instrument (TPI), a tool that allows the ECB to cap government bond yields if it thinks they’ve risen too high. These kind of no-strings-attached caps are the worst nightmare of those who worried the ECB would be subverted by high-debt countries to push the illusion their debt is sustainable.

This principal-agent problem isn’t unique to Germany. Klaas Knot, former President of the Dutch central bank, is also a cheerleader of the TPI and - coincidentally - also one of the leading candidates to succeed Lagarde. The vote to approve the TPI in July 2022 was unanimous, so none of the representatives from low-debt countries covered themselves in glory (though most of them aren’t campaigning to run the ECB).

Germany and other low-debt countries desperately need proper representation. That’s because war in Ukraine and China’s stepped-up mercantilism are putting pressure on fiscal policy like never before. As I noted back in November, the only way I can think for Germany to break this dynamic is for it to credibly threaten Euro exit. That may sound heretical - I get accused of being anti-European all the time - but it’s the only way to stop the dominance of high-debt countries. There’s lots of scare stories about how calamitous an end of the Euro might be, but those are just negotiating tactics and intimidation by high-debt countries who want to maintain the status quo that allows them to extract rents from Germany.

The truth is that things like TPI - the ECB under Lagarde has done many other things to help high-debt countries - weaken Europe. Things like TPI only give the illusion of fiscal sustainability. They don’t actually create fiscal space. It takes a real shock like Russia’s invasion of Ukraine to show this. The chart above shows that aid for Ukraine from Italy (IT) and Spain (SP) - including military, humanitarian and financial aid - is very small because there’s no money. So when a real shock hits, the TPI is exposed for what it really is: a “pretend” device that postpones needed adjustment and weakens Europe geopolitically. Extend and pretend is no good when Putin attacks.

I’ll say one last thing about what the TPI says about the current cast of Germans at the ECB. The TPI is a permanent facility. It’ll be around forever. People like Schnabel and Nagel waved through TPI in 2022 because they wanted to hike policy rates along with other central banks. They traded the creation of a permanent facility for hikes that - as the chart below shows - have since been reversed to a large degree. Leaving aside the fact that TPI weakens Europe, trading something permanent for something temporary is just bad negotiating. Schnabel, Nagel and Knot shouldn’t be rewarded for making a mistake like that.