Scrapping the €500 bill highlights ECB-Berlin policy rift

Scrapping the €500 bill highlights ECB-Berlin policy rift

Anti-ECB sentiment grows in Germany as the Central Bank gets rid of €500 banknotes.

As the European Central Bank continues to spark debates due to the loose monetary tools it uses in an attempt to boost inflation in the eurozone, the recent decision to scrap the €500 banknote — permanently stopping its production and issuance by the end of 2018 — has led to renewed tensions with Berlin.

The most vocal opponents to the ECB’s policies, Germany — who are attached to fiduciary money — fear that Frankfurt is initiating a move that would lead to a cash-free society.

Banknote addiction

According to an ECB survey, Germans do not top the list of EU citizens who are addicted to cash (see table below). However, Germans use high denomination notes a lot more regularly than, say, the French — 72% of the French never had a €500 or €200 banknote in their possession against 34% of Germans — and consider their ability to carry cash as a sign of freedom and independence from banks, technology and fees.

Such values are fundamentally opposed to proponents of a cash-free society, such as Peter Sands, a former Group Chief Executive of Standard Chartered Bank who wrote a paper for the Harvard Kennedy School on eliminating high denomination notes. He argue that banknotes play a crucial role in the underground economy but little in the legitimate one.

While the freedom argument is also relevant in neighboring Austria, reasons for citizens to prefer cash are different in Italy or Spain, where a rampant distrust in banks has been enhanced by banking crises. The mafia in Southern Italy is also thought to be a major user of cash, which leads to the ECB’s main argument for stopping the production of the €500 banknote.

The criminal argument

High denominations are indeed suspected of feeding illicit activities throughout the continental union, as banknotes are easily transportable and carry great value considering the strength of the euro (worth approximately 1.14$). As of 2016, the €500 banknote accounted for 2.3 per cent of banknotes in the eurozone and represented almost 30 per cent of their value.

The Euro has quickly become one of the most popular currencies in the world of crime, thanks to its important diffusion and high value.

Illicit activities that are suspected of using those banknotes range from terrorism to drug dealers and money launderers. While combating drug dealers has always been a top security priority, the case for weakening the business model of terrorist organizations has been made more urgent by the enduring threat of attacks from the Islamic State on European territory.

The case of Luxembourg, which, as a recognized destination for fiscal optimization and whose tax practices are largely assimilated with evasion in public perceptions, has raised eyebrows. The country issued bills worth €87.5bn in 2013 (equivalent to around twice its GDP) with a great proportion in high denominations. Considering the recent Panama Papers revelation, disrupting the business model of money launderers is another priority that has given the scrapping of €500 banknotes more legitimacy.

Reducing the risk of bank runs

Thus the case for stopping the production of the note seems legit for both economic and security reasons. But the German Central Bank suspects the ECB of using this decision also as a way to serve its own purpose. Cash is indeed one of the main risks for a central bank as it experiments unconventional monetary policy tools.

With the objective of boosting inflation in the eurozone, the ECB has continually lowered interest rates, with the deposit rate now at -0.4%. This means that, typically, depositors would have to pay for leaving their money in banks. So far, banks have carried the cost of those negative rates, thereby reducing their margins. But if the rates remain too long or are pushed further into negative territory, bankers could be forced to pass on the burden to their depositors.

This could in turn trigger a natural reaction for depositors to withdraw cash, a feared prospect for any central bank that eventually results in economic paralysis as banks stop functioning and playing their investor role and thus boosting economic growth. By reducing the amount of cash in circulation throughout the eurozone, the ECB could then reduce the risk of bank runs if this kind of crisis arises.

Rising anti-ECB sentiment

It is understandable that Bundesbank president Jens Weidmann is not eager to support a measure that could eventually reduce the risk of a policy he has been constantly tackling. But, more importantly, the main reason for Mr Weidmann to oppose the scrapping comes from the fear that the ECB is trying to abolish banknotes altogether.

Should that impression be confirmed, it could trigger a stringent battle between Germany (and other northern countries) and the European institution. Although the ECB denied any intention to move to a cashless society, Germans are already angered at the institution’s ultra low interest rates policy which hurts insurance and banking sectors in the country, and their attachment to banknotes gives them another reason to dislike it.

With general elections in Germany coming up in 2017, the policy choices the ECB will make in the coming months could have a dramatic impact on voters. German Finance Minister Wolfgang Schaeuble has been challenging Mario Draghi by arguing that the ECB’s rates policy has triggered the rise of AfD — an anti-establishment party originally created on an anti-bailout platform — in recent regional elections.

The strong anti-ECB sentiment will doubtlessly intensify (already deep) frictions between Berlin and Frankfurt, as parties adopt hard-line rhetoric against Draghi and his monetary medicine. The Italian central banker will probably be able to remain on track until Germans go to the polls. But depending on the outcome, he could be forced to reevaluate both his policy and position if under pressure from the most powerful country in the European Union.

Categories: Europe, Finance

About Author

Julien Freund

Julien is an analyst with a focus on Europe. He has worked as a lobbyist in Paris and Brussels and has written extensively on the rise of nationalist parties. He holds two master's degrees in geopolitics and international relations and in European relations, and received his BA in economics and social sciences from the Catholic Institute of Paris.