Work in Progress

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
Andrei Guter-Sandu, University of Bath

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

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) and the Financial Market Infrastructure workshop at Goethe Universität, Frankfurt am Main (06/2023).

Co-authors:
Alexandru-Stefan Goghie, Freie Universität Berlin
Matteo Giordano, School of Oriental and African Studies (SOAS)

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

A key objective of President von der Leyen’s “geopolitical” EU Commission is improving the international role of the euro. The Juncker Commission had put this old idea back on the agenda, motivated by crumbling transatlantic relations during the Trump Presidency and the desire to challenge the global USD hegemony. Geopolitics re-appeared stronger than anyone could have wished for in February 2022 when Russia attacked Ukraine and the West passed unprecedented financial sanctions—including the freezing of Russian FX reserves held at Western central banks. To assess what these changes imply for euro internationalization and concomitantly USD hegemony, we develop a theory of currency internationalization that—drawing on the conceptual framework of Murau and van ‘t Klooster (2022)—places the use and creation of private offshore credit money center-stage. In our view, euro internationalization must imply the political promotion of the use and creation of offshore euro rather than offshore USDs. We discuss the potential of an EU “monetary foreign policy” which focuses on the euro’s use as vehicle currency in global value chains; the denomination of key commodities (chiefly oil); the integration in central bank payment systems (notably TARGET2); and the availability of international lender of last resort facilities (notably EUR swap lines).

Presentations at the Annual Convention of the International Studies Association (ISA) in Montreal (03/2023) and the Annual Conference of the Political Economy Section of the German Association for Political Science in Witten (09/2023).

Co-author:
Jens van ‘t Klooster, University of Amsterdam

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, Berlin

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SocArXiv

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

In summer 1931, the collapse of two major banks pushed Germany into the nadir of its great depression. Large-scale credit creation programs were discussed but considered unfeasible due to the constrained macro-financial environment at the time, including restrictions imposed via the Treaty of Versailles. After being appointed president of the Reichsbank, Hjalmar Schacht invented the Mefo scheme in order to circumvent the Reichsbank’s legal constraints for credit expansion. Mefo stands for “Metallurgische Forschungsanstalt”, a letter box company set up by four German blue-chip companies, and operated by Reichsbank staff. Endowed with an equity of 1 million Reichsmark, Mefo issued commercial bills of the volume of 12 billion Reichsmarks, which eventually ended up in the Reichsbank’s asset book. Despite its historical significance, the Mefo scheme is insufficiently theorized from a monetary theory perspective. Moreover, it is an open empirical question whether the Mefo scheme played a significant role for manufacturing a system-wide financial expansion or was merely a side show with limited quantitative impact. We approach the Mefo scheme through the prism of the Monetary Architecture framework and perceive the Mefo company as an off-balance-sheet fiscal agency (OBFA), introduced to finance a politically desired large-scale transformation of capital stock—first to overcome the economic slump but soon to finance the rearmament for World War II. Mefo bills were a form of shadow money that functioned as close substitutes to bank deposits in a closed domestic payment system and facilitated industrial production while being backstopped by the Reichsbank. To investigate the Mefo scheme, we map its functioning and operations in a visualized web of interlocking balance sheets. We model the initial balance sheet expansion, the ensuing strategies for long-term funding in the system, and the different options discussed for a final contraction. Schacht’s original plan was a full contraction when the treasury repays the Mefo bills; the treasury suggested rolling them over on the treasury balance sheet and converting them into regular sovereign debt; in fact, however, the Mefo bills ended up on the balance sheet of Reichsbank where they were permanently funded until the collapse of all German state structures in May 1945. We connect our visual analysis to quantitative data related to the balance sheets of the Mefo company and the wider monetary architecture in order to draw conclusions about the significance of the Mefo operation for the financial expansion after 1931.

Presentation at the workshop ‘Building a Dataset for the OBFA-TRANSFORM project’ at Global Climate Forum, Berlin (07/2023).

Co-authors:
Armin Haas, Global Climate Forum, Berlin
Andrei Guter-Sandu, University of Bath
Matteo Giordano, School of Oriental and African Studies (SOAS)

This study analyzes the Primary Dealer model for the issuance and distribution of sovereign debt as a distinctive feature of today’s international monetary system, the Offshore US-Dollar System. Primary dealers are a group of private banks who have an oligopoly for purchasing sovereign debt on the primary market. Hence, not only do they form a transmission belt between central banks and treasuries, but they also control the distribution of sovereign debt within and across monetary jurisdictions, which is particularly relevant for sovereign debt with safe asset status that is in high demand, such as US and German bills and bonds. We argue that the Primary Dealer model is a historically specific and idiosyncratic institutional solution that originated in the US and by now has been adopted with only limited variation by most monetary jurisdictions around the globe. Combining institutionalist, legal and quantitative analysis of sovereign bond issuance, this study presents an in-depth analysis of the triangular structure between primary dealers, treasuries and central banks that exists in four quintessential cases: the United States, the United Kingdom, Japan, as well as Germany and the Eurozone.

Co-author:
Will Bateman, Australian National University