- State Finance Beyond the Core Budget. Off-Balance-Sheet Fiscal Agencies in Germany’s Fiscal Ecosystem (with Gregor Laudage, Armin Haas, and Andrei Guter-Sandu)
The state as a financial actor is commonly imagined to be a unitary entity that interacts with the wider financial system via its core budget operated by the treasury that generates inflows via taxes and outflows through government spending. However, an emerging literature places increasing emphasis on off-balance-sheet fiscal agencies (OBFAs)—financial entities that are separate from the treasury but carry out activities on behalf of the state which could also run via the core budget while often receiving explicit or implicit fiscal backstops. This gives rise to a “fiscal ecosystem” of national and sub-national treasuries and OBFAs that is different in each country, historically specific, and inherently opaque. Fiscal ecosystems are subject to constant transformation that is driven by political, economic, and legal concerns, with ample path dependencies. In this article, we use Germany as a case study to develop a methodology that combines scholarship in law and political economy to categorise and empirically map its contemporary fiscal ecosystem. Throughout its turbulent history, Germany has developed a highly complex web of OBFAs across various layers of its federal system. Their number ranges in the tens of thousands. We place them in a coordinate system and depict their proximity or distance to the core budget by drawing on their legal status, revenue model, and characteristics of their issued debt (if there is any). Moreover, we carve out the conditions under which OBFAs are subject to Germany’s constitutional debt brake and the EU fiscal rules. If and how OBFAs are affected by debt brakes has been notoriously opaque but is a matter of great political salience since Germany’s constitutional court has objected in November 2023 to the financial treatment of special funds (Sondervermögen), which created a budgetary crisis and a spending freeze.
Co-authors:
Gregor Laudage, Universität Göttingen
Armin Haas, Global Climate Forum, Berlin
Andrei Guter-Sandu, University of BathDownload link:
OBFA-TRANSFORM Working Paper No. 1-EN - ‘Decoding Dollar Dominance: The Global Credit View on the Monetary System in International Political Economy’ (with Herman Mark Schwartz)
This article contrasts the Sovereign Currency View (SCV) and the Global Credit View (GCV) on the monetary system in International Political Economy (IPE) regarding four crucial assumptions: endogenous credit creation versus transaction costs and loanable funds; the co-evolution of public and private credit rather than metallism vs. chartalism; interlocked balance sheets in global finance rather than a ‘triple coincidence’; and a focus on gross flows rather than net flows in global payments. By mobilizing a 2×2 “Matrix of Monetary Thought,” we show that the SCV’s monetary theory of credit leaves critical issues about the global money and credit system unexplained compared to the GCV’s credit theory of money. Viewing the credit money system as subject to a co-evolution of public and private liabilities/assets in which a central public actor repeatedly validates excess private credit creation explains the hierarchical structure of national credit systems connected through interlocked balance sheets, and crisis dynamics within those systems. This approach reverses our understanding of the current account deficits and net foreign debt that SCV authors identify as fundamental problems for the dollar, or more precisely, for dollar-based credit systems backed by a hegemonic US state. These are features, not bugs, of credit systems, and help offset capitalism’s inherent deflationary tendencies. The GCV also helps unify academic analyses that suffer from the fallacy of composition, an excessively unit-level analytic framework, or incoherence in their theoretical premises.
Presentations at the symposium “The Political Economy of International Money” in Berlin (01/2024) and a special issue workshop in Lillehammer (05/2024).
Co-author:
Herman Mark Schwartz, University of Virginia - ‘A Feature, Not a Bug. The US Dollar in the European Monetary Union’ (with Torsten Ehlers)
The European Monetary Union (EMU) is often seen as an attempt to shield Europe from USD dominance. However, as BIS data shows, the USD’s volume and share in EMU cross-border payments has been constantly rising for 15 years. To explain this puzzle, we adopt the New European View and posit that the EMU has systematically incorporated the USD into its monetary architecture rather than competing with it. We trace the origins of this setup by investigating the evolution of institutions for clearing and settlement of cross-border payments in Europe. We find that the USD’s integral role results from a process of “subordinate financial integration” after 1945 when the European Payments Union connected non-convertible European currencies and defined them as promises to pay USD on the BIS balance sheet. After 1958, a parallel structure emerged: The “domestic currency channel” allowed making cross-border payments in European currencies but subject to exchange rate fluctuations; private agents organized first resort clearing, central banks provided last resort clearing via the BIS. In contrast, the “key currency channel” facilitated cross-border payment in USD deposits created offshore; clearing shifted from London to New York in the 1960s after setting up CHIPS. The 1999 EMU introduction boosted the “domestic currency channel” by providing an integrated payment system and eliminating exchange rate fluctuations, but the Eurocrisis reinvigorated the legacy structure of the “key currency channel”. Handsomely backstopped via Federal Reserve swap lines, the USD currently has a revival in the EMU as a feature, not a bug.
Presentations at the symposium “The Political Economy of International Money” in Berlin (01/2024) and a special issue workshop in Lillehammer (05/2024).
Co-author:
Torsten Ehlers, Bank for International Settlements and International Monetary Fund - ‘Re-assessing Fragmentation of the Euro Area Banking System. Offshore Channels for Cross-Border Banking Activities’ (with Torsten Ehlers)
It is an established assessment that since the Eurocrisis, the Euro area banking system has been fragmented. Representing the Eurozone’s monetary architecture as a web of interlocking balance sheets, we carve out four different types of fragmentation that pertain to different parts of banks’ balance sheets and a different set of counterparties. The first type affects the size, scope, and business model of EA banks; the second the cross-border interbank lending among EA banks; the third the monetary policy transmission via EA banks; and the fourth the harmonization of public backstops for EA banks. We argue that the first two types of fragmentation can in principle be mitigated by using ‘offshore channels’ for cross-border banking activities. Euro area banks are not restricted to using EUR-denominated instruments inside the Eurozone monetary jurisdiction but may carry out cross-border activities in other units of account than the EUR (notably the USD) and in other booking locations (notably via their branches in the United Kingdom and the United States). Using data derived from the BIS’s international debt securities and locational banking statistics, we analyse whether the use of these offshore channels warrants a re-assessment of established findings on the fragmentation of the Euro area banking system.
Presentations at the workshop “Offshore Finance in International Political Economy” at Freie Universität Berlin (09/2023) and the workshop “Continuity and Transformation in the (Shadow) Banking System since the Global Financial Crisis” at the European University Institute (10/2023).
Co-author:
Torsten Ehlers, Bank for International Settlements and International Monetary Fund - ‘Encumbered Security. Conceptualizing Vertical and Horizontal Repos in the Euro Area’ (with Alexandru-Stefan Goghie and Matteo Giordano)
Despite the paramount centrality of repurchase agreements (repos) in today’s market-based finance regime, both conceptual and empirical questions about European repo markets are insufficiently explored as contradictory legal and accounting treatments make their on-balance-sheet representation intricate. Drawing on the literature on monetary hierarchy, we make three connected conceptual arguments: First, we argue that the balance sheet mechanics of repos vary if the counterparties involved are on hierarchically different levels (“vertical repos”) or on the same hierarchical level (“horizontal repos”). While the vertical repo mechanism implies money creation, the horizontal repo mechanism only lends on pre-existing money. Second, we provide a coherent representation of the security posted as repo collateral, which—as to contemporary regulations—does not leave the balance sheet of the repo borrower but changes its status from being held outright to being “encumbered”. Third, we introduce an on-balance-sheet notation of the collateral framework as a means of the repo lender to alter the elasticity of the funding provided. Applying our methodology on two cases—vertical repos created by the Eurosystem for monetary policy implementation and horizontal repos used in the European interbank market—offers an innovative and consistent way to represent changes in the collateral frameworks that affect the elasticity space in the Euro area’s monetary architecture. Our analysis yields two main contributions: We offer an innovative understanding of different mechanisms for repo creation based on monetary hierarchy, and we put forth a data-driven empirical analysis of repos in Europe aimed at supporting our conceptual elaborations.
Presentations at the Third Money View Symposium (01/2023), the Financial Market Infrastructure workshop at Goethe Universität, Frankfurt am Main (06/2023), and the 26th Annual Conference of the Association for Heterodox Economics in Bristol (07/2024).
Co-authors:
Alexandru-Stefan Goghie, Freie Universität Berlin
Matteo Giordano, School of Oriental and African Studies (SOAS)Download link:
SOAS Economics Working Paper 262 - ‘Transformation of the Eurozone Architecture. On Crises and Institutional Change in the Offshore US-Dollar System’ (with Alexandru-Stefan Goghie, Matteo Giordano and Friederike Reimer)
The Eurocrisis was a make-it-or-break-it moment for the EMU with a profound impact on the transformation of the Eurozone architecture. However, its underlying macro-financial causes remain insufficiently understood. While dominant narratives emphasize excessive sovereign debt issuance, weaknesses of the Stability and Growth Pact, or lacking supranational supervision, they cannot convincingly explain how and why the US-centric run on shadow money spilled over to some EMU treasuries and disregard the critical role of EMU repo markets and the Eurosystem’s collateral framework. Drawing on the macro-financial model developed in Murau (2020), this paper analyses the crisis-driven transformation of the Eurozone architecture from the Global Financial Crisis to the Asset Purchase Programmes in 2014. We argue that the contagion dynamics across private and public balance sheets of the Eurozone and US monetary architectures should be understood as “endogenous forces” that critically determined the EMU’s transformation towards its contemporary shape. We operationalize it with a novel methodology that combines structured process-tracing with balance sheet visualization of crisis dynamics. Drawing on primary and secondary sources as well as private and public sector data, we apply an analytical scheme that starts with on-balance-sheet contractions, followed by the activation of inbuilt elasticity provision mechanisms; where these fail, innovation occurs which can materialize via enhanced elasticity space, new instruments, or even new institutions. As a result, we provide a novel perspective on the process of financial integration in the EMU and derive hypotheses for a theory on the endogeneity of crisis-driven change in modern monetary architectures.
Presentations at the symposium “Crises Capitalism. Shadow Banking, Central Banks, and New Configurations of State-Financial Market Entanglements” in Hannover (06/2023), the workshop “Money in Open Economies” at Leeds Business School (09/2023), and at the Annual Conference of the Political Economy Section of the German Association for Political Science (09/2023).
Co-authors:
Alexandru-Stefan Goghie, Freie Universität Berlin
Matteo Giordano, School of Oriental and African Studies (SOAS)
Friederike Reimer, Global Climate Forum - ‘Rethinking Currency Internationalisation. The Euro’s International Monetary Governance and Offshore Money Creation’ (with Jens van ‘t Klooster)
Successful internationalisation of the euro has eluded EU policymakers since its introduction. This article provides a novel explanation for the puzzling subordinate position of the single currency. Drawing on the most recent International Political Economy scholarship on money and finance, we develop a conceptual framework for currency internationalisation that acknowledges the credit nature of money while emphasizing the crucial role of the politics of international monetary governance. We argue that internationalising a currency requires actively fostering the offshore creation of private credit money denominated in the currency. By approaching internationalisation as an entirely market-driven process, EU policymakers have discouraged rather than incentivised the expansion of offshore euro creation and thus undermined the objective of euro internationalisation. This concerns the failure to recognize the importance of offshore euro creation in fostering cross-border value chains, the prohibitive provision of international lender of last resort facilities for offshore euros, as well as the constant undersupply of euro-denominated safe assets.
Presentations at the Annual Convention of the International Studies Association (ISA) in Montreal (03/2023), the Annual Conference of the Political Economy Section of the German Association for Political Science in Witten (09/2023), and the symposium ‘The Political Economy of International Money’ in Berlin (01/2024).
Co-author:
Jens van ‘t Klooster, University of Amsterdam - ‘Green Macro-Financial Governance in the European Monetary Architecture. Assessing the Capacity to Finance the Net-Zero Transition’ (with Andrei Guter-Sandu and Armin Haas)The Green Transition to net-zero carbon emissions in Europe requires massive financing efforts, with estimates of 620 billion EUR annually, but the headwinds are substantive. Central banks seem overstretched and busy tightening to combat inflation; treasuries are subject to austerity-inducing fiscal rules; and banking systems are afflicted by non-performing loans, fragmentation, and risk aversion. We employ the framework of ‘monetary architecture’ to analyse the EU’s monetary and financial system as a constantly evolving hierarchical web of interlocking balance sheets and study its capacity to find ‘elasticity space’ to meet the financing challenge. To this end, we draw on a four-step scheme for green macro-financial governance along the financial cycle of balance sheet expansion, funding, and final contraction. We find that, first, Europe’s monetary architecture still has ample elasticity space to provide a green initial expansion due to its developed ecosystem of national, subnational, and supranational off-balance-sheet fiscal agencies. Second, as mechanisms lack to consciously organise the distribution of long-term debt instruments across different segments, its capacity to provide long-term funding is limited. Third, institutional transformation in the last two decades have greatly improved the capacity of the European monetary architecture to counteract financial instability by providing emergency elasticity. Fourth, the capacity of the European monetary architecture to manage a final contraction of balance sheets is limited, which is a general quandary in modern credit money systems. Our analysis points to the need for further investigations into techniques for monetary architectures to manage long-term funding and balance sheet contractions.
Presentations at the workshop “Off-Balance-Sheet Fiscal Agencies and the Role of the State in Financing the Green Transition” (09/2023) and the 35th Annual Conference of the European Association for Evolutionary Political Economy (EAEPE), University of Leeds (09/2023).
Co-authors:
Andrei Guter-Sandu, University of Bath
Armin Haas, Global Climate Forum, BerlinDownload link:
SocArXiv - ‘Macro-Financial Innovation in Times of Crisis: The Role of the Recovery and Resilience Facility in Transforming the Eurozone’s Monetary Architecture’ (with Friederike Reimer, Andrei Guter-Sandu, and Armin Haas)
The Recovery and Resilience Facility (RRF), introduced as EU’s main macro-financial response to the Covid-19 pandemic, has been hailed as Europe’s Hamiltonian moment and raised great expectations for future fiscal integration. Despite its promised radicality, the actual status of the RRF in the Eurozone architecture remains ambiguous. On the one hand, it is integrated into the EU budget and therefore can be understood as the biggest joint debt-financed program on the EU ‘Treasury’ balance sheet. On the other hand, the RRF’s status as a temporary extra-budgetary fund allows it to be read as yet another off-balance-sheet fiscal agency (OBFA) that allows policymakers to eschew fundamental questions about the EU’s future as a common fiscal space. Building on the emerging critical macro-finance literature, we scrutinise the radicality of the RRF and investigate how it transforms the Eurozone’s monetary architecture. First, we clarify the position of the RRF as an ‘institution’ within the Eurozone’s web of interlocking balance sheets. Second, we discuss the conceptualisation of RRF debt as ‘instruments’, looking at similarities and differences with sovereign bonds and their implications for the emergent EU Primary Dealer System. Finally, we look at the intersection with the central banking segment, discussing their potential to function as European safe asset and implications for TARGET2 balances. We argue that given the EU’s propensity for governing through OBFAs, the RRF can be read as auguring a form of ‘quiet radicality’ in the EU’s evolution.
Co-authors:
Friederike Reimer, Global Climate Forum
Andrei Guter-Sandu, University of Bath
Armin Haas, Global Climate Forum, Berlin - ‘The Mefo Operation. A Macro-Financial Analysis of Hjalmar Schacht’s Shadow Money Scheme’ (with Armin Haas, Friederike Reimer, and Andrei Guter-Sandu)
In the summer of 1931, Germany faced the nadir of the Great Depression. After the Machtergreifung of the Nazis in 1933, Hjalmar Schacht was appointed president of the Reichsbank and invented the “Mefo operation” to circumvent the Reichsbank’s legal constraints for credit expansion and finance German rearmament against the terms of the Treaty of Versailles. Mefo stands for “Metallurgische Forschungsgesellschaft”, a letterbox company set up by five German blue-chip companies and operated by staff from the Reichsbank and the military. Endowed with an equity of 1 million Reichsmark, Mefo was the debtor of commercial bills amounting to 12 billion Reichsmark. Despite its historical significance, the Mefo operation is still insufficiently theorised from a monetary theory perspective and is often explained away through the myth of “financial wizardry”. We approach the Mefo operation through the prism of the Monetary Architecture framework and perceive the Mefo company as an off-balance-sheet fiscal agency introduced to finance re-armament as a politically desired large-scale transformation of capital stock. We divide the Mefo operation into three distinct periods—the covert monetary financing stage (July 1933 to February 1936), the shadow money stage (February 1936 to March 1938), and the consolidation and war finance stage (April 1938 to May 1945)—and use balance sheet methodology to re-construct the underlying financial mechanics. On the one hand, we provide transactional balance sheets for an idealised depiction of flows and sketch stocks via snapshots of the monetary architecture as webs of interlocking balance sheets. On the other hand, we discuss how expansion, funding, backstopping, and contraction was planned ex ante and played out ex post. We find that against Schacht’s original plan, the Mefo bills ended up on the Reichsbank balance sheet where they were permanently funded until the collapse of German state structures in May 1945. We connect our balance sheet analysis to quantitative data of the Mefo company and the wider macro-financial environment in order to draw conclusions about the significance of the Mefo operation for the financial expansion after 1931.
Presentations at the workshop ‘Building a Dataset for the OBFA-TRANSFORM project’ at Global Climate Forum, Berlin (07/2023) and the workshop ‘Creative Accounting to Finance the Transformation? Exploring the Mefo scheme’ at Forum New Economy, Berlin (03/2024).
Co-authors:
Armin Haas, Global Climate Forum, Berlin
Friederike Reimer, Global Climate Forum, Berlin
Andrei Guter-Sandu, University of Bath