As the Eurozone trembles at the prospect of Greece defaulting on its debt, the winds of change are at work at the European Central Bank (ECB).
ECB President Jean-Claude Trichet will step down in November after an eight-year term, leaving the institution at a time of great uncertainty for the 17 Eurozone member countries.
Headquartered in Frankfurt, the ECB has had exclusive control over Eurozone members’ interest rates since 1999, when the euro was introduced as a currency.
It presides over 17 countries with a combined GDP of over 9.2 trillion euros ($A12.59 trillion) and holds more than 500 billion euros ($A684 billion) in reserves.
The ECB presidency is arguably the world’s second-most important banking appointment, surpassed only by the US Federal Reserve chairmanship.
The president is a member of the secretive but influential Bank for International Settlements (headquartered in Basel, Switzerland), which largely determines global central banking policy and establishes the framework for commercial banks’ capital reserve requirements – the Basel Accords.
The president is also a member of the powerful Wolfsberg Group, an elite coterie of G-10 central bankers who determine global banking regulations, such as countering money laundering, combating terrorist financing and implementing anti-corruption measures.
As France’s central bank chief in the 1990s, Trichet worked closely with his German opposite number, then-Deutsche Bundesbank President Hans Tietmeyer, to maintain the “franc fort” policy to prepare France for entry into the Eurozone.
This meant maintaining disciplined monetary policy, keeping the lid on French inflation and compelling successive governments in Paris to rein in spending. Trichet succeeded on all counts.
Trichet arrived at the ECB in 2003 as part of a political deal – as is the norm in European Union politics. The first ECB president was Dutchman Wim Duisenberg, who served an abbreviated term.
Trichet almost never assumed the office, as he was charged in relation to a banking scandal in early 2003, although he was cleared in time to become the ECB’s second president.
Historians are likely to remain divided over Trichet’s legacy.
Had he retired by 2007, he would have presided over a rapidly appreciating euro that was gaining acceptance as a global reserve currency.
Monetary policy was fairly disciplined for much of his tenure, although the powerful EcoFin Council, comprising finance ministers from all Eurozone member countries, also has a considerable say on interest rates, alongside Trichet’s own Executive Board at the ECB.
But critics would also point to instances where the ECB and EcoFin failed to act.
Throughout 2003–05, both Berlin and Paris ran lax fiscal policy, resulting in substantial budget deficits, well outside the (non-binding) limits imposed by EU’s the Stability and Growth Pact.
Trichet let Germany and France get away with it.
Cracks in Greece’s corrupted financial reporting were evident as early as 2004–05, but again, Trichet was less-than-rigorous in pursuing the matter.
But when Spain and Italy copied the French and Germans by exceeding their fiscal deficit targets, they were chastised severely. It appeared as if there was one rule for northern Europeans and another for the south.
The cracks in the Eurozone became a chasm in 2007 and a canyon in 2008. Quietly, the ECB attempted to stem the trickle of potential bank defaults in 2007 as the US sub-prime mortgage catastrophe began to have an impact upon EU financial institutions.
The ECB and the Bank of England injected more liquidity into the global economy in 2007 than did the US Federal Reserve or the Bank of Japan.
But as the extent of the losses at Bear Stearns and Lehman Brothers became apparent by late 2007 and early 2008, Trichet and the ECB dramatically understated the exposure of EU banks to the US sub-prime crisis.
It was only after Swiss bank UBS – not headquartered in a Eurozone country – admitted the awful truth and wrote off $US10 billion in 2008 that other European banks confessed to their dependence upon risky sub-prime assets.
Just days after Bear Stearns closed its doors in March 2008, European financial institutions had already written down $US68 billion in losses.
Since the global financial crisis, Trichet and the ECB have essentially fought a rearguard action as the Irish and Greek crises have compelled them to inject fresh tranches of funds to rescue debt-riden Dublin and Athens from default.
Trichet has been widely criticised for permitting these massive injections of capital into European debt markets to take place, while failing to confront threatening inflation demons head on.
His successor, Bank of Italy governor Mario Draghi, assumes the ECB presidency during a period of great uncertainty in the European and global economy.
Unlike Trichet and Duisenberg, Draghi does not possess the CV of a typical Eurocrat. He is US-educated and a former vice-chairman of influential investment bank Goldman Sachs.
Draghi, 63, appears initially to have accepted Italy’s central bank governorship, and now the ECB presidency, as merely gloss on a not-inconsiderable international career.
After all, Eurozone bank governors have little influence upon either EcoFin or their own governments these days, having conceded most of their powers to the ECB.
By the end of this year, the entire ECB board will have been cleaned out inside two years – an unprecedented occurrence in the bank’s short history.
Based upon the revolving executive board’s member terms, Italy would have had two members on the board (including president-designate Draghi) and, for the first time, France would have no representative. Unsurprisingly, there was a change at five minutes to midnight and Italy’s Bini Smaghi will make way for a French appointee. That was the price of getting Draghi the ECB presidency.
German chancellor Angela Merkel appears convinced Draghi will be tough on inflation and maintain the traditional Bundesbank line on price stability.
Quizzed by European parliamentarians earlier this year on his prospective appointment, Draghi took some heat in relation to his former employment with Goldman Sachs, denying any connection with dubious debt deals during his tenure at the investment bank.
Given the challenges Draghi faces in Frankfurt, the banker already nicknamed “Super Mario” is mooting a “structural overhaul” to EU banking, designed to introduce more efficiency and greater competition.
And given that Draghi’s first order of business is likely to be stage-managing an orderly Greek partial default, a structural overhaul will probably be the least of his problems.