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Business

Redirecting the ECB's financial firehose

A European Union advisory group representing nearly 400 business, labor and civil society organizations wants the European Central Bank to redirect its money creation powers toward funding new EU infrastructure.

Meeting in Brussels, a couple of dozen sober-suited economists and other experts have quietly called for a revolution in the way the EU runs its public banks - a revolution that would enable the EU to fund a massive, trillion-euro revitalization of its industry and infrastructure.

The core of the experts' proposal: The European Central Bank (ECB) should directly fund the European Investment Bank (EIB), either by means of cheap long-term loans or by simply printing judicious amounts of money and giving it to the EIB to spend. And the EIB should use the money to fund a European economic and industrial renaissance.

"Instead of wasting resources in the financial markets, EU monetary policy should focus on the productive economy," said economist Adrian Zelaia, convenor of the group of experts and stakeholders that met in Brussels under the auspices of the EU's European Economic and Social Committee (EESC).

Finance matters

The EESC isn't a decision-making body, and so the proposals put forward at EESC's Brussels round table were still a long way from becoming policy. But they could transform Europe if they're eventually adopted.

In essence, what was proposed at the Rue Belliard was that the European Union should embark on an enormous infrastructure construction program with money the European Union would borrow from itself, rather than from commercial banks or wealthy investors.

One way it could to this would be to have EIB borrow money directly from ECB. EIB and ECB are both public banks, owned by EU member nations.

Under some circumstances, debts owed by EIB to ECB could be canceled altogether, at times and in quantities that would be at the central bank's sole discretion. If ECB directors were to decide that partial debt forbearance is consistent with price stability and financial system stability, they could put repayments on ice indefinitely.

EIB building

Direct EIB funding by the ECB could be a game changer, some economists insist

In other words, the European public could borrow money from its own central bank, and then, if the central bank thinks it wouldn't cause problems like high inflation, its directors could say, in effect: "Don't pay us back, we're fine."

There's no risk of the ECB going bankrupt in the process: Unlike any other bank or company, a central bank cannot go bankrupt. It is, after all, the ultimate issuer of all the "base" money in the system, and has an almost infinitely flexible balance sheet.

Rule barriers

But the EU's own rules appear to prohibit what was proposed at the EESC meeting, despite the enormous short- and long-term economic benefits most of the experts present believed the policy would generate.

"Proposals for ECB to buy bonds directly from EIB in order to fund EIB project spending appear to conflict with two constraints under which ECB operates: No privileged access, and no monetary financing," said Benjamin Sahel, an ECB staff member.

Sahel is ECB's head of Division, Market Operations Analysis, and hence well-positioned to understand the rules under which the central bank operates.

Rules, however, can be changed - or worked around, suggested Andrew Watt, an economist at Düsseldorf-based Hans Böckler Foundation who presented a detailed proposal for ECB financing of EIB infrastructure spending.

'Printing' money

It turns out that the balance sheets of central banks can create money as easily as you or I can create Facebook entries. The ECB has been buying bonds from secondary markets at an enormous rate - 60 billion euros ($65 billion) a month - since March 2015 in an effort to stave off deflation.

Where did the ECB get all those billions? They simply entered the numbers into their balance sheet. Fresh electronic cash, created through keystroke entry.

The central bank has, under the rules established by European treaty law, some very special powers: It can create money on its own balance sheet and use it to buy financial assets like high-quality corporate or government bonds off secondary bond markets.

It generally does this in order to manage interest rates. But lately it has been doing it on a heroic scale in a controversial effort to pump up financial markets.

Waste not, want not

So why not use the-ECB's remarkable powers to create money with which to rebuild Europe - in amounts the ECB itself decides, and deems consistent with its core mandate to ensure price stability?

"It's not enough to inject fresh ECB money into banks by buying their bond portfolios off them. The money doesn't get into the real economy that way," said Adrian Zelaia, adding that the ECB is currently using its money-creation powers wastefully, just to pump up financial markets and inflate the prices of stocks, bonds and real estate - and "that has negative side effects," according to Andrew Watt, because it favors the wealthy owners of investible assets at the expense of everyone else.

Moreover, Watt said, flushing ECB money into the system by buying bonds off secondary financial markets - rather than directly from the issuers of fresh bonds - did little or nothing to stimulate real economic activity.

That's because institutional investors almost always buy existing assets with the fresh money the ECB gives them in exchange for bonds they've been holding. They don't invest in new factories or infrastructure projects, for example - that would be far too risky.

That's why economist Watt proposed the ECB should "work around" the rule against direct ECB financing of fiscal spending by buying EIB-issued bonds off - for example - pension funds shortly after the bonds had been issued and sold by EIB to those same pension funds. EIB would use the money it raised in this way to fund new infrastructure projects, and end up owing the money to the ECB.

Once in possession of EIB's infrastructure bonds, the ECB could, in essence, say: "Don't bother paying us back. We'll just extend the maturity date of your bonds to infinity." In that way, EIB could build new infrastructure in Europe on a sunk-cost basis, as if it were spending tax money.

Watt had first put forward his proposal in a research report published in May entitled "Quantitative Easing with bite: a proposal for conditional overt monetary financing of public investment."

It's too early to say whether some version of his ideas will gain traction, but similar proposals have recently been put forward by other experts, including Adair Turner, the former head of the UK Financial Services Authority, in a new book called "Between Debt and the Devil."

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