In 2008, the ECB changed its approach to a “full allotment” system. “Those apparently meaningless words explain why the savings interest rate is currently zero percent. It is also a benchmark to watch for when the savings interest will rise again. That is a long way off, with all the social consequences that entails,” said Edin Mujagić, chief economist of OHV Asset Management and author of a book entitled Keerpunt 1971 (Turning Point 1971), in Dutch, published this month, in an interview with Fondsnieuws, Investment Officer Luxembourg’s sister publication.
“Full Allotment”
When the interbank market dried up in late 2008 and banks could no longer rely on borrowing from each other, the ECB changed its approach and extended unlimited credit to banks at a fixed interest rate. The changed approach came to be known as “full allocation”. According to Mujagić, this has been the most boring and at the same time most impactful policy change in the history of the euro.
“Full allocation basically means that everything banks want is financed by the ECB, nowadays at zero interest or even at negative interest, that is, they get money when they borrow from the ECB. Until 2008, the power of the central banks largely resided in the fact that they drew up the rules about the amount of money that commercial banks should have in cash. The possibilities to borrow from the ECB were limited and not having sufficient cash in hand was fined.”
“Commercial banks therefore had a reason to attract savings from private individuals. Because banks can now borrow almost unlimitedly from the ECB, the incentive to attract savings has lapsed. Logically, therefore, there is no reason for banks to raise interest rates on savings. Holding cash at a bank only becomes attractive again once that damned full allocation is off the table. Let that be the very last measure that will be suspended,” warned Mujagić.
“First of all, but they are not in a hurry either, the ECB will have to phase out its asset purchase programmes. Interest rates can then be raised very slowly. Only as a last resort can the entire allocation be abolished. So, before savings rates are due for a hike again, we’re just a decade further. That could have major consequences for European societies.”
Fear of excessively low inflation
The ECB is an institution whose mission is to keep the euro’s purchasing power stable. Mujagić therefore said he finds the dogmatic fear of too low inflation surprising. “Striving for inflation, or diminishing the purchasing power of our euro, affects ordinary men and women the hardest. What is that bank doing?”
“The ECB’s task is to ensure price stability, not to keep interest rates low, but the latter is exactly what the ECB is doing today, the bank itself has made clear,” said Mujagić. “Everything the ECB does must be in accordance with free market forces under the Maastricht Treaty. If you knowingly say that you want to keep the interest rates for all maturities low, that has nothing to do with the bank’s mandate.”
“We are aiming for 2 percent inflation to ‘grease the engine of the economy’, while the interest on savings is at zero. There are plenty of examples in the past where this has gone wrong. Anything you do in the economy have broad social implications. It’s no coincidence that I start Keerpunt 1971 with a quote from Johann Fichte about moving just one grain of sand from its place and you change the whole thing. What the central banks have been doing since 2008 and what President Nixon did in 1971 amounts to moving a lot of grains of sand!”
“Economics and society are conjoined twins”, said Mujagić, partly on the basis of his in-depth study for his book Keerpunt 1971, which has the revealing subtitle: “On national debt, working poor and new economic growth”.
According to Mujagić, we have been accepting more than we should from central banks for too long, because monetary economics is an esoteric affair. “My concern is that there will be a tipping point where a large group of people in the eurozone can no longer take it. That feeling will be taken into the voting booth. In an extreme case, the monetary union could collapse because of the ECB’s policy.”
The problem of our time: debt
In Keerpunt 1971, Mujagić wrote that the biggest problem of our time is the “debt-fuelled growth model”, a game that started in 1971. “That system has worked for fifty years, but now the debt is too high and the interest cannot be lower. The game is almost over.”
In addition to the solution that the ECB is aiming for, namely to reduce debt through inflation, there are two more ways to tackle the problem. According to Mujagić, the most ideal and at the same time most improbable is such a sharply accelerating economic growth, so that in the coming years the debt as a percentage of GDP will fall by itself. “A line can already be drawn through that, unfortunately that will not happen for the time being.”
A second, unpopular measure is debt write-off. By the way, writing off debt alone does not solve much, Mujagić thinks. “For debt write-offs to be effective, the entire economic model has to be adjusted. The incentive to create debt must then be completely eliminated from the system.”
“When you write off debt, you remove the incentive for continued inflation. In that debt-growth model, sustained inflation is a must. In essence, the debt is the problem, I see no other solution than that we write it off. If that is the route we choose, we must combat “moral hazard” through tax laws and regulations.”
“We have to say to countries like Italy, Spain and Greece: we are writing off the debt, but the price for that is that budgetary sovereignty is transferred to the EU.”
“That must be a democratically supported decision, but nothing is impossible. Chancellor Helmut Kohl also got the Germans involved in abolishing the holy German D-mark. If we succeed in writing off the debt and making fiscal reforms in Europe, we have a good chance of succeeding the dollar as a world currency.”
Watch part 1 of interview with author (in English)
Watch part 2