Meet the World's Worst Central Banker

By Matthew O'Brien
Bundesbank chief Jens Weidmann gets basic facts wrong and thinks his colleagues are the devil.

PerplexedWeidmann2.jpg
(Reuters)

Have you heard of "inflation"? Good. Have you heard that "inflation" can make your borrowing costs appear ... inflated? Yes? Congratulations, you know more about money than Bundesbank president Jens Weidmann.


As Germany's member of the European Central Bank's (ECB) governing council, Weidmann has opposed doing anything to solve the euro crisis. Because, inflation! (Pay no attention to the core inflation behind the curtain of 1.5 percent in September). Weidmann is one of those people who thinks it's always 1923 -- that Weimar hyperinflation is always just around the corner. Despite this preoccupation with anything resembling a price increase, Weidmann mysteriously develops amnesia about inflation when it comes to figuring out real government borrowing costs. Here's what he had to say about rising bond yields in Europe's periphery, via Linda Yueh of Bloomberg.

Government borrowing costs over 7 percent haven't caused the end of world in the past and the euro zone wouldn't fall apart if some had to temporarily pay such rates.

This is just a basic fallacy. Weidmann is confusing real and nominal rates. It's easy to pay 7 percent to borrow when inflation is high, but not so much when inflation is low. The chart below compares unadjusted and inflation-adjusted Spanish borrowing costs since 1978.

(Note: I used headline CPI as the deflator).

SpainBorrowingCosts.png


I'm not sure how many words this picture is worth, but there are two big stories here. First, Spain used to pay much more than 7 percent to borrow in nominal terms, but that was back in its pre-euro days when inflation was much higher. Second, Spain even used to pay more than 7 percent to borrow in real terms, but that was back when it actually had real growth. It's a bit harder to pay 7 percent when growth and inflation have both flatlined.

In other words, you can't pay your debts if you have no income. The chart below looks at Spain's borrowing costs less its nominal GDP growth rate -- that is, real growth and inflation together. When the blue line runs up, borrowing outpaces income growth. Spain today is what insolvency looks like.

SpainNGDPBorrowing.png

Now, positive rates here aren't themselves a sign of doom. Far from it. We did for much of the Great Moderation. But rates above 5 percent? That's doom territory. It sets off a debt trap. Spain's national income can't support its borrowing costs, so they have to do austerity -- austerity that only pushes its income down and its borrowing costs up even more. 

Weidmann doesn't think this is a problem. The opposite, actually. He thinks it's a good thing, because it pushes Spain to do the austerity and labor market reforms the ECB wants it to do. But the ECB thinks this austerity is a punishment. Weidmann thinks it's actually a medicine. In other words, the ECB thinks austerity is the price Spain should pay for the ECB to push its borrowing costs down, and Weidmann thinks austerity alone will push its borrowing costs down. The former has become the ECB's de facto policy -- a policy it's fair to say Weidmann does not like. He implied it shows the ECB is now under the influence of the devil. As in the one with the pitchfork.

That's not the kind of argument you make when the facts are on your side.

This article available online at:

http://www.theatlantic.com/business/archive/2012/09/meet-the-worlds-worst-central-banker/262866/