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BANKING
BUNKUM
Part 2: The European
experience
By Henry C K Liu
Part 1: Monetary theology
During the rise of
Europe in past centuries, industrial progress was not
made in a free-market system, but in a
government-support system that provided investment
capital through national banking. There are undeniable
data showing that any nation that did not adopt a
government-financed industrial policy had failed to
develop as an economic or military power in the 17th,
18th and 19th centuries.
The idea of a national
bank in modern times began in the Netherlands. Key to
the success of the Dutch economy in the 17th century was
the Amsterdam Wisselbank, which had been founded in 1609
to provide credit to the city of Amsterdam, to the
province of Holland and to trade through the funding of
the monopolistic Dutch East India Company. Wisselbank
was also responsible for coinage and exchange. Some
seven decades later, in 1683, it was further empowered
to lend to private clients. All large payments had to
pass through Wisselbank and it therefore was convenient
for the major finance houses to bank with it. Thus not
only was it in a position to oversee the Dutch financial
scene, it was also able to act as a stabilizing
influence. Its function was exclusively to enhance Dutch
national financial interests and, in that sense, it was
different from private banking, which sought profit
wherever opportunities existed within the law.
By the middle of the 17th century, the notion of
a national bank to provide needed liquidity to finance
national economic development and expanding trade had
gathered support in England. The perception of credit as
the seed of wealth creation in a capitalistic system was
gaining acceptance, leading to an awareness that money,
if backed by the state, needed no intrinsic value to
enable it to be useful in fueling and lubricating the
economy. The concept of a sovereign or national debt
being financed with paper money issued by fiat, backed
ultimately by national wealth, to support national
purposes, especially war, gradually gained recognition.
The Dutch model of national banking inspired the
Bank of England, founded in 1694 by William Paterson, a
Scotsman, with a capital of STG1.2 million, backed by
gold, which was simultaneously advanced (to finance the
war with France) to William III (1650-1702), who had
been crowned with Mary by the Glorious Revolution of
1688-89, which marked the triumph of parliamentary
authority over royal absolutism. The capital/loan came
from a syndicate of private investors/lenders who, in
return for holding government bonds, were given the
privilege of operating a national bank. This was the
origin of British national banking and the national
debt, which had not been necessary under absolutism
because the sovereign had absolute command of all wealth
in the royal realm. The Bank of England managed the
government's accounts and made loans to finance public
spending at times of peace or war. Operating also as a
commercial bank, it took deposits and issued notes.
John Law (1671-1729), Scottish economist,
gambler, banker and royal adviser, was renowned for two
remarkable enterprises he created in France: the Banque
Generale and the Mississippi Scheme. His economic legacy
rests on two major concepts: the scarcity theory of
value and the Real Bills Doctrine of money.
Exiled from Britain for participating in an
illegal, fatal duel, Law found himself welcome in the
French court through the patronage and friendship of
Philippe, the Duke of Orleans, regent of France during
the minority of Louis XV. Despite being a nation of
greater wealth than either Britain or the Netherlands,
the state of French finances after Louis XIV's death in
1715 was so dismal, because of France's neglect in
leveraging its national wealth through banking and
credit, that the regent eagerly accepted Law's proposal
to establish in 1716 a state-chartered bank, the Banque
Generale, with the power to issue paper currency.
Concurrently, Law also founded the Mississippi Company,
an enterprise intended for developing the then French
colony of Louisiana in North America.
Law was
granted a charter to create the Banque Generale with a
capital of 6 million livres, of which he raised 25
percent in cash and covered the remaining 4.5 million
livres with government debt (billets d'etat)
trading at only one-fourth of its face value. Law's
Banque Generale was authorized to issue interest-paying
bank notes payable in silver on demand. It soon had 60
million livres in notes outstanding. The Regime required
regional tax payments to be in the form of Banque
Generale banknotes to provide a ready market for them.
Because these banknotes paid interest and were
conveniently acceptable as for tax payment, they sold at
a premium over their face value, removing from the state
seigniorage (government revenue from the manufacturing
of coins calculated as the difference between the
monetary and the bullion value of the silver contained
in silver coins) and delivering it to the speculative
market. That was a major error, for interest payment
turned the national banknotes into a debt instrument,
indistinguishable from a government bond but with no
fixed maturity.
To develop the territories of
Louisiana in North America, Law was granted a charter
for the Compagnie de l'Occident with a 25-year lease on
French holdings in Louisiana. In return, the Compagnie
was required to settle at least 6,000 French citizens
and 3,000 slaves in the territories. The Compagnie was
also granted a monopoly on the growing and sale of
tobacco. The Compagnie acquired the Compagnie de
Senegal, which operated in West Africa, as a source of
slaves. It then merged with the French East India
Company and the French China Company to form Compagnie
des Indes, forming a virtual monopoly on French foreign
trade.
Law's Banque Generale, under the new name
of Banque Royale, tying it closer to the state, was
added to a monopolistic combination that Law called the
"System".
The Compagnie des Indes issued 200,000
shares at a per share price of 500 livres in 1716. By
1718 the share price had fallen to 250 livres. In 1719,
the Banque Royale pumped up the supply of notes by 30
percent. It also acquired the right to act as the
national tax collector for nine years. The Compagnie
stock doubled and redoubled in price.
Based on
new financial power from inflated market capitalization,
Law then offered a plan to pay off the troublesome state
debt, committing another fundamental error. The Banque
would issue notes paying 3 percent interest to redeem
the state debt. The banknotes could then be used to buy
stock in Law's Compagnie de Indes. The Compagnie share
price rose to 5,000 livres in August 1719 and 8,000
livres in October. Speculation in Compagnie stock went
wild, much like the dot-com shares in the 1990s. Stock
was being purchased on 90 percent margin. Fortunes were
being made overnight by speculators, with a street
beggar reportedly making 70 million livres.
John
Law became an international celebrity. The pope sent an
envoy to the birthday party of Law's daughter. Law
converted to Catholicism and was appointed
controlleur des finances by the Regime.
Compagnie des Indes shares peaked at a per share
price of 20,000 livres at the end of 1719. In January
1720, two royal princes decided to cash in their shares
of the Compagnie, prompting others to follow. Law had to
print 1.5 million livres in paper money to meet the
rising demand for cash. As controlleur des
finances, he tried to stem the tide by making it
illegal to hold more than 500 livres in gold or silver.
He devalued banknotes relative to foreign currency to
encourage exports and discourage imports. Nevertheless
Compagnie des Indes stock fell to 5,000 livres. As head
of both the Compagnie des Indes and the Banque Royale,
Law bought up stocks and banknotes to try to raise their
price, but by June 1720 he had to suspend all payments.
Law's note-issuing bank fell from being a
spectacular success to total collapse after a panic bank
run in 1720, plunging France and Europe into a severe
economic crisis, which set the economic stage for the
French Revolution. The impact of Law's banking schemes
on France was so traumatic that, until recently, the
term banque was largely shunned by French banks
in order to avoid memories of Law's unfortunate
institution. The common substitute term was
credit, as in Credit Lyonnais and Credit
Agricole.
In England, a similar scheme known as
the South Sea Bubble also burst at the same time, but
the South Sea Company and its banker, the Bank of
England, was bailed out by the government through the
British national debt, for which the people of Britain
assumed responsibility and which was made credible by
parliamentary control of finance. The failure of the
French national bank was caused by its tie merely to
whimsical royal credit rather than reliable national
credit. The failure left France without an adequate
banking system until Napoleon Bonaparte, who, to
replenish the nearly empty state treasury, transformed
the Bank of Current Accounts into the Banque de France
on January 28, 1800, as the first French national bank.
Napoleon III, whom historians saw as the
prototype of the modern dictator, was labeled the
bourgeois emperor by royalists and the socialist emperor
by the Saint Simonians, who were among the first in
modern history to conceive a centrally planned
industrial system, and who invented investment banking.
Under him the Credit Mobilier was founded in 1852,
established specifically for providing funds for
industry and infrastructure, and followed by other
banks. Despite the failure of the Credit Mobilier in
1867, these investment banks channeled savings into
essential investments in transport, communication,
agriculture and industry.
In 1860, Credit
Agricole was founded to supply credit for French
agriculture in its transformation from feudal estates
into a modern economic sector. Credit Agricole
eventually developed into one of the world's largest
banks, supplying financing to the largest agricultural
producer in Europe. During the early 1980s, it was the
largest, and in 1991 the sixth-largest. It has since
merged with the Banque de Indo Suez. On December 2,
1945, the banking and credit industries were
nationalized, and the state became the sole shareholder
of the Banque de France and of the four principal
deposit banks.
Reliance on the Bank of England
was such that when its charter was renewed in 1781, it
was described as "the public exchequer". By then, the
Bank was acting also as the bankers' bank and it had to
keep enough gold reserves to pay its notes on demand.
By 1797, war with France under Napoleon I had
drained British gold reserves and the British government
prohibited the Bank from paying its notes in gold. This
Restriction Period lasted until 1821. The 1844 Bank
Charter Act again tied the note issue to the Bank's gold
reserves, requiring the Bank to keep the accounts of the
note issue separate from those of its banking operations
and produce a weekly summary of both accounts, called
the Bank Return, which is still published weekly today.
The Bank's second century thus saw two key elements of
central banking emerge: 1) the concern for monetary
stability, born during the inflationary excesses of the
Napoleonic Wars; and 2) the institutional responsibility
for financial stability, developed in the banking crises
of the mid-19th century. Both elements were predicated
on the controversial assumption that long term
financial-stability rests on price stability, preventing
the fluctuation of prices from being a tool for managing
the economy.
In the 19th century, the Bank of
England took on the additional role of lender of last
resort, providing stability to the banking system during
several financial crises. In the early 1900s, the Bank
of England became the instrument of the ruling class as
distinguished from the nation. It could and did lower
prices and wages, increase unemployment and even set the
price of gold to protect private wealth gained from the
nation's global empire, which was unequally shared among
its citizens, let alone colonial subjects, in the name
of capital formation.
During World War I, the
national debt jumped to STG7 billion. The Bank helped
manage government borrowing and resist inflationary
pressures. As with the wars with France a century
before, the financial cost of World War I forced a break
in the British currency link with gold. An attempt was
made in 1925 in vain to return to the gold standard, and
in 1931, in the midst of worldwide depression, the
United Kingdom left the gold standard for good.
Britain's gold and foreign-exchange reserves were
transferred to the Treasury, while their day-to-day
management was and still is handled by the Bank. The
note issue became entirely fiduciary, not backed by
gold. Since then, the pound sterling has been a fiat
currency.
After World War II, the Bank of
England was nationalized in 1946 under a Labour
government with the passing of the Bank of England Act,
which shifted authority on monetary policy to the
British Treasury. The Bank then acted as the
government's bank, providing loans through ways and
means advances and arranging sovereign borrowing through
the issue of gilt-edged securities. The Bank helped to
implement the government's financial and monetary policy
as directed by the Treasury. It also was granted wide
statutory powers to supervise the banking system,
including the commercial banks to which, through the
discount market, it acted as lender of last resort. The
Bank remained the Treasury's adviser, agent and debt
manager. During and for years after the war, it
administered exchange control and various borrowing
restrictions on the Treasury's behalf.
The
anti-depression cheap-money policies in the 1930s
persisted in Britain after World War II, and during the
1960s, British monetary policy came under the influence
of the Radcliffe Report, released in 1959, which
concluded that monetary policy should give priority to
controlling the liquidity of the monetary system, and
not the quantity of money in the system. The report did
not dismiss the importance of the quantity of money, but
rather believed that given proper control of liquidity,
the quantity of money would self adjust. In external
policy, the report was supportive of fixed exchange
rates as set up in the Bretton Woods regime of exchange
controls, which alleviated the inherent contradiction
between fixed exchange rates with full convertibility
and domestic monetary-policy flexibility. The Bretton
Woods regime did not consider free international
movement of capital necessary or desirable and was aware
of the incompatibility of fixed exchange rates and the
lifting of exchange control.
As the apparatus of
postwar controls gradually lifted in Britain, the need
for a proactive monetary policy became more apparent,
and the high inflation of the 1970s and early 1980s
provided the catalyst for policy change. Monetary
targets were introduced in 1976, and reinforced in the
early 1980s. These proved unreliable as a sole guide to
policy; nevertheless a monetarist consensus emerged:
that price stability was deemed desirable in its own
right and a necessary condition of sustainable growth.
Inflation was singled out as the sole cause for stagnant
growth and other social costs.
Milton Friedman
asserted that inflation is everywhere a monetary
phenomenon; and without appropriate monetary measures,
inflation could not be properly brought under control.
Inflation was seen as not merely being destructive of
wealth, but also as causing unemployment in the long
run. Thus a theoretical justification was found to fight
inflation with unemployment. Lay off workers now before
inflation does it for you later, economists would tell
management. The outcome of this approach was a new
phenomenon known as stagflation, in which inflation and
unemployment rose together, as producers raised prices
to compensate for falling revenue from declining sales
volume, diluting the purchasing power of money, at the
same time laying off workers to cut costs to compensate
for a declining profit margin. Unemployment then led to
reduced consumer spending, forcing companies to lay off
more workers and raise prices to compensate for lost
sales in a downward spiral.
During the 1970s,
the Bank of England played a key role during several
banking crises of stagflation in Britain and again in
the 1980s when monetary policy again became a central
part of British government policy. The Bank of England
did not become a central bank until May 1997 when the
government gave the Bank responsibility for setting
interest rates to meet the government's stated inflation
target, a good decade after the Big Bang. That was the
term given to the financial deregulation on October 27,
1989, of the London-based security market. The Big Bang
was comparable to May Day in 1975 in the United States,
which ushered in an era of discount brokerage and
diversification into a wide range of financial services
using computer technology and advanced communication
systems, marking a major step toward a single world
financial market.
The Exchange Rate Mechanism
(ERM) was a fixed-exchange-rate regime established by
the then European Community designed to keep the member
countries' exchange rates within specific bands in
relation to one another. The purpose of the ERM was to
stabilize exchange rates, control inflation rates
(through the link with the strong and stable
deutschmark) and nurture intra-Europe trade. It was also
designed to enhance European world trade in competition
with the US, creating a so-called "United States of
Europe" and as a stepping stone to a single-currency
regime - the euro.
Britain joined the ERM in
October 1990 at a fixed central parity of 2.95
deutschmarks to the pound, an over-valued rate intended
to put pressure upon the British economy to reduce
inflation rather than institutionalizing international
competitiveness. British pride might have played a role
in insisting on a strong pound. This chosen rate, or any
fixed rate required by ERM membership, proved misguided,
because it tried to benefit from the effect of a single
currency for separate economies without the reality of a
single currency within an integrated economy.
During the 23 months of ERM membership, from
October 1990 to September 1992, Britain suffered its
worst recession in six decades, with the gross domestic
product (GDP) shrinking by 3.86 percent, unemployment
rose by 1.2 million to 2.85 million. The total price of
ERM fixed exchange rate for the United Kingdom had been
estimated to be as high as 13.3 percent of 1992 GDP. The
number of residential mortgages with negative equity
tripled, reaching a peak of 1.25 million, and company
insolvency rose above 25,000 a year.
The British
government of John Major sought to balance political and
macroeconomic considerations, only to fail in its effort
to "support the unsupportable" to prevent a devaluation
of a freely traded pound by market forces. If the UK had
not lost some STG8.2 billion defending the pound's
unsustainable exchange rate, it could have avoided
budget deficits, tax hikes, cuts in public spending, and
the unpopular value-added tax on fuel. Spending on the
National Health Service could have been more than
doubled for 12 months.
Withdrawing from the ERM
released the UK economy from persistent deflation and
provided the foundation for the non-inflationary growth
subsequently experienced. It enabled monetary policy to
be freed from the sole task of maintaining the exchange
rate, thus contributing to economic expansion by a
combination of rational monetary measures. While ERM
countries were compelled to maintain relatively high
real interest rates to prevent their currencies from
falling outside the permitted bands, Britain enjoyed the
freedom to benefit from lower rates. Hong Kong has been
facing the same problems in the past five years and will
not recover from economic crisis until its currency peg
to the US dollar is lifted. Waiting for an improved
economy before depegging is like waiting for death to
cure an infection.
The appropriate exchange rate
of currencies at any particular time is that which
enables their economies to combine full employment of
productive resources, including labor, with a
simultaneous balance-of-payment equilibrium. An
excessively high exchange rate causes trade deficits and
domestic unemployment, while a low one generates an
excessive buildup of foreign-currency reserves and
stimulates domestic inflationary pressures that lead to
a bubble economy. Thus every nation must retain the
ability to adjust the external values of its currency in
this unregulated global financial market and an
international financial architecture based on dollar
hegemony. To be fixated on a fixed exchange rate within
rigid limits is to court economic disaster in the
current international finance architecture.
The
ERM was a transitional regime whose problems were
finally removed once the EU moved toward a single
currency in the form of the euro. Still, the
anti-inflation bias of the European Central Bank
continues to create conflict with monetary policy needs
of national economies within euroland.
In a
fast-changing economic environment of unregulated
globalized markets, the value of the exchange rate that
facilitates full employment and a foreign trade balance
will frequently fluctuate. Speculative volatility must
be countered and the exchange rate managed by the
national bank to prevent disruption in the domestic
economy and in external trade. However, this does not
imply fixed, unchangeable bands as under the ERM. The
optimum strategy for cooperation between national
central banks on exchange rates requires a combination
of maximum short-term stability with maximum long-term
flexibility, the opposite of the effects of fixed
exchange rates.
Since, under ERM, Britain's
interest rate was pegged to that of Germany through the
fixed exchange rate, reduction in interest rates was not
available to deal with increasing unemployment and
declining growth in the UK. The fact that Britain had no
control over interest rates, coupled with the
questionable independence of the Bundesbank, Germany's
central bank, was an important factor in the final
decision to withdraw the pound from the ERM
fixed-exchange-rate regime.
The reunification of
Germany cracked open the structural flaw in the Exchange
Rate Mechanism because massive capital injection from
West to East Germany had produced inflationary pressure
in the newly unified in German economy, leading to
preemptive increases of interest rates by the
Bundesbank. At the same time other economies in Europe,
especially that of Britain, were in recession and not
prepared for interest-rate hikes dictated by Germany.
This interest-rate disparity magnified the overvaluation
of the pound in the early 1990s.
Along with the
European Currency Unit (ECU, the forerunner of the
euro), the ERM was one of the foundation stones of
economic and monetary union in Europe. It gave
currencies a central exchange rate against the ECU,
which in turn gave them central cross-rates against one
another. It was hoped that the mechanism would help
stabilize exchange rates, encourage trade within Europe
and control inflation. The ERM gave national currencies
an upper and lower limit on either side of this central
rate within which they could fluctuate.
In 1992,
the ERM was torn apart when a number of currencies could
not keep within these limits without collapsing their
economies. On Wednesday, September 16, a culmination of
factors led Britain to pull out of the ERM and to let
the pound float according to market forces. Black
Wednesday became the day on which George Soros,
hedge-fund titan, broke the Bank of England, pocketing
US$1 billion of profit in one day and more than $2
billion eventually. The British pound was forced to
leave the ERM after the Bank of England spent $40
billion in an unsuccessful effort to defend the
currency's fixed value against speculative attack. The
Italian lira also left and the Spanish peseta was
devaluated.
In order to curb German inflation,
an increase in German interest rates was necessary, but
if the Bundesbank were completely independent of German
political-economic interests as a dominant regional
central bank, it would not have adopted this policy, as
there were cries from all over Europe for a decrease in
interest rates. By adopting tight monetary policies in
response to domestic inflationary pressures that
followed German reunification in 1990, German short-term
interest rates, which had been rising since 1988,
continued to rise, reaching nearly 10 percent by the
summer of 1992. So, at a time when Britain needed a
counter-cyclical reduction in interest rates, the
Bundesbank sent the interest rate upwards, plunging
Britain deeper into recession through the ERM.
This was the fundamental problem with the ERM -
fixed exchange rates conflicted with the interest-rate
levels needed by different economic conditions in
separate member economies. The British interest rate
pegged to that set by the Bundesbank was crippling the
British economy because the UK was in a recession and
required low interest rates.
In 1997, the
British government announced its intention to transfer
full operational responsibility for monetary policy to
the Bank of England. The Bank thus joined the ranks of
the world's "independent" central banks. However, debt
management on behalf of the government was transferred
to Her Majesty's Treasury, and the Bank's regulatory
functions passed to the new Financial Services
Authority.
Germany has a vital banking tradition
that dates back to the great Fugger money-lending
network in the 15th and 16th centuries, and before that
the limited banking practices required by the Hanseatic
League (Hansa) of northern Germany in the 14th century.
Germany's first commercial bank was established in
Hamburg in 1619. The Giro bank lasted until its takeover
by the state-run Reichsbank in 1875.
By the
early 1800s Frankfurt am Main was a banking center under
the House of Rothschild. The Rothschilds, in fact, took
their name from the red (roth) shield
(Schild) on the front of their Frankfurt home
during the first years of the Jewish family's history.
Their banking dynasty soon extended beyond Frankfurt to
London, Naples, Paris, and Vienna.
On January
18, 1871, Otto von Bismarck proclaimed in Versailles the
German Empire. Between 1870 and 1872 several other
important German banks evolved, some of which are still
around in one form or another, despite political
interruptions associated with Germany being the
vanquished in two world wars.
Until the 1870s,
the financial regulation of German overseas trade had
been almost exclusively in the hands of London banks.
The historical structure of independent principalities
under the Holy Roman Empire presented an obstacle to
German unification and by implication the emergence of a
German national bank. The establishment in 1870 of the
Deutsche Bank at Berlin was a turning point. The
Deutsche Bank's charter identified the purpose of the
corporation as "to do a general banking business,
particularly to further and facilitate commercial
relations between Germany, the other European countries,
and oversea markets".
The founders of the
Deutsche Bank had recognized that there existed in the
organization of the German banking and credit system a
gap that had to be filled in order to render German
foreign trade independent of the English intermediary,
and to secure for German commerce a firm position in the
international market. It was rather difficult to carry
out this program during the early years because Germany
at that time had no gold standard and bills of exchange
made out in various kinds of Germanic currency were
neither known nor liked in the international market. The
introduction of the gold standard in Germany in 1873 did
away with these difficulties, and by establishing
branches at the central points of German overseas trade
(Bremen and Hamburg) and by opening an agency in London,
the Deutsche Bank succeeded in vigorously furthering its
nationalist program.
Later the other Berlin
joint-stock banks, especially the Disconto Gesellschaft
and the Dresdner Bank, followed the example of the
Deutsche Bank, and during the past decade particularly
the Berlin joint-stock banks have shown great energy in
extending the sphere of their interests abroad. The
German banks suffered the largest loss in the 1997
financial crisis in Asia, partly because, being
latecomers, they fell victim the classical
buy-high-sell-low syndrome.
The central bank of
Germany is the Deutsche Bundesbank, with its head office
in Frankfurt. It is a federal corporation under public
law, and also performs supervisory functions in the same
way as the Federal Banking Supervisory Office. Its
powers of authority are governed by a special law, the
Bundesbank Act. Until December 31, 1998, the Bundesbank
had the exclusive right to issue banknotes and coins and
had been assigned the task of maintaining the stability
of the national currency by regulating the money supply
and the amount of credit available to the economy. This
exclusive right was transferred to the European Central
Bank on January 1, 1999, with the start of the common
currency, the euro.
After the adoption last
April 22 of the Law on Integrated Financial Services
Supervision (Gesetz uber die integrierte Finanzaufsicht
- FinDAG), the German Financial Supervisory Authority
(Bundesanstalt fur Finanzdienstleistungsaufsicht -BAFin)
was established on May 1. The functions of the former
offices for banking supervision (Bundesaufsichtsamt fur
das Kreditwesen - BAKred), insurance supervision
(Bundesaufsichtsamt fur das Versicherungswesen - BAV)
and securities supervision (Bundesaufsichtsamt fur den
Wertpapierhandel - BAWe) have been combined in a single
state regulator that supervises banks, financial
services institutions and insurance undertakings across
the entire financial market and comprises all the key
functions of consumer protection and solvency
supervision. The new German Financial Supervisory
Authority is intended to make a valuable contribution to
the stability of Germany as a financial center and
improve its competitiveness.
The BAFin is a
federal institution governed by public law that belongs
to the portfolio of the Federal Ministry of Finance and,
as such, has a legal personality. Its two offices are in
Bonn and Frankfurt/Main. The BAFin supervises about
2,700 banks, 800 financial services institutions and
more than 700 insurance undertakings.
The
Deutsche Bundesbank, the central bank of the Federal
Republic of Germany, is an integral part of the European
System of Central Banks (ESCB). The Bundesbank
participates in the fulfillment of the ESCB's tasks with
the primary objective of maintaining the stability of
the euro, and it ensures the orderly execution of
domestic and foreign payments. It was established in
1957 as the sole successor to the two-tier central bank
system that comprised the Bank Deutscher Lander and the
Land Central Banks. At the time, the Land Central Banks
were legally independent bodies. Together, the
institutions in the central bank system bore
responsibility for the German currency from June 20,
1948, when the deutschmark was introduced, until the
Deutsche Bundesbank was founded.
As a result of
the Bundesbank's becoming part of the European System of
Central Banks (ESCB), the need to restructure became
increasingly evident. The Bundesbank's organizational
structure has now been changed by means of the Seventh
Act Amending the Bundesbank Act, which came into effect
on April 30. The Bundesbank's decision-making body, the
executive board, normally convenes in Frankfurt. It
comprises the president, the vice president and six
other members. Its mandate is to govern and manage the
Bundesbank.
The board will draw up an
organizational statute to establish how responsibilities
are shared out among the board members and to determine
the tasks that may be delegated to the regional offices.
The members of the board are all appointed by the
president of the federal republic. The president, the
vice president and two other members are nominated by
the German federal government, while the other four
members are nominated by the Bundesrat in agreement with
the federal government.
Until recently, the five
largest German banks are Deutsche Bank, Dresdner Bank,
Westdeutsche Landesbank, Commerzbank and the Bayerische
Vereinsbank. In 1994 Frankfurt won the heated contest to
house the European Monetary Institute (EMI), the
precursor to the current European Central Bank (ECB),
which began operations in Frankfurt in January 1999 with
the introduction of the euro. Until the ECB began
operation in 1999, Germany's Bundesbank, known as the
Buba to the financially literate, was Europe's most
influential central bank. For all practical purposes,
the Bundesbank was to Europe what the US Federal Reserve
Bank is to the United States; indeed, the Fed served as
a model for the postwar German central bank.
A
proposed Deutsche and Dresdner merger would have changed the playing field
not just in Germany but also throughout Europe. The
merger proposal was driven by two factors. First, banks fear
e-commerce will cut into already dwindling retail
profits. Second, the two banks want to get bigger so
they can compete with US banks globally in the more
profitable investment banking market. The bank merger proposal
followed the takeover of Mannesmann by Vodafone - the
first hostile takeover in Germany - and such deals
signal the changing face of German corporate culture.
The collapse of the Internet and telecom bubbles has
cast doubt on the validity of these mergers.
Germany's complex systems of cross-shareholdings
between major companies appears to be unraveling,
increasing the chance that some of it could fall into
foreign hands. The move marks a shift from retail
banking, which has proved to be an unprofitable headache
for many German banks. Deutsche Bank had planned to
invest up to 1 billion euros every year in Internet
ventures before the bubble burst. In 1998, Deutsche Bank
bought Bankers Trust of the United States for $10
billion, with highly mixed results to date.
Before the stewardship of Paul Volcker, since
the New Deal after the 1930 Great Depression, the
historic bias in the US Federal Reserve Board had given
a higher priority to jobs and growth than to price
stability. The ECB, which has inherited the German
obsession with inflation born out of the country's
hyperinflation experience of the past century, is still
fixated on its anti-inflation bias. Most neo-liberal
economists identify Germany, the growth engine of
euroland, as the root cause of the eurozone's weakness,
saddled with three interlinked problems of inflationary
pressures from unification, an uncompetitive conversion
exchange rate with the euro, and a policy inertia
against structural reforms. Yet neo-liberal reform
requires the wholesale abandonment of the historical and
cultural essence of German economic structure.
The ECB is working at cross purposes against its
member governments, which need relief from its strict
deficit rules in economic downturns. The ECB's
determination to demonstrate its independence from
eurozone political reality is preventing it from being a
constructive force in economic recovery.
The
classic error of central banks doing too little too late
now infects all three key central banks in the West: the
Fed, the ECB, and the Bank of England.
Next: The US Experience
Henry C K Liu is chairman of the New
York-based Liu Investment Group.
(©2002 Asia
Times Online Co, Ltd. All rights reserved. Please
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