The more news comes out, the more it looks like Mario Draghi’s pledge that the ECB would do all it would take to save the Euro was a bluff. The best guess is that he hopes to appease the market gods until September 12, when the German Constitutional Court will render its decision on whether the “permanent” rescue mechanism, the ESM, is permissible. The assumption, of course, is the the ESM will be approved. I’d be delighted to be proven wrong, but in parallel to the lack of a Plan B when a private bailout of Lehman failed, there does not seem to be any Plan B in the works if the German Constitutional Court nixes the ESM. And the odds of that are not trivial.
The headfake earlier today was a photo op between Geithner and Finance Minister Schaeuble which was touted by Bloomberg as Germany supporting the Draghi move, when a more level headed reading would see this as a non-endorsement. Here is the opening para of the article:
U.S. Treasury Secretary Timothy F. Geithner and German Finance Minister Wolfgang Schaeuble backed a commitment by European leaders to do everything needed to defend the euro area while failing to mention its weakest link, Greece.
Um, that’s already qualified. And then we get to the critical part:
In a joint statement issued after they held talks on the German North Sea island of Sylt today, Geithner and Schaeuble “took note” of comments made last week by European leaders to “take whatever steps are necessary to safeguard financial stability” in the 17-nation currency area.
“Took note”? That actually a remarkable formulation. It’s an acknowledgment of Draghi’s remarks, not approbation. There is nothing concrete in the Bloomberg story that would lead a reader to conclude that Schaeuble had changed his position from the one he took over the weekend, that the existing facilities were adequate and that additional action was not warranted. My readers of the German press take this to mean that the ECB might intervene, but its game is to do as much as possible with happy talk and as little as possible with real action. The Draghi statement likely does indicate a willingness to buy bonds if absolutely necessary, but not on any real scale. The idea is to tide this all over through the low trading volume/Euroholiday month.
An article in Der Spiegel confirmed the skeptics’ reading. It depicts Draghi as having make his commitment without getting the support of the ECB council. One assumes he might have hoped to present them with a fait accompli, but that kind of approach can backfire. Per Der Spiegel:
Meanwhile, experts at the central banks of the euro zone’s 17 member states had no idea what to do with the news. Draghi’s remark was not the result of any resolutions, and even members of the ECB Governing Council admitted that they had heard nothing of such plans until then.
It isn’t hard to see where this is going. It’s not likely that the Fed will announce anything major this Wednesday; while the economy is softening, most Fed mavens think the deterioration is not clear cut enough to warrant pulling out the big guns. Markets expect the ECB to announce something concrete after their meeting this Thursday, but given that Draghi ambushed its Governing Council, and the northern country members remain opposed to bond buying, it’s probable that if any commitments is made this week, it will be underwhelming. And tellingly, Draghi is looking like a leader whose command of the situation is faltering.
A big source of discord is that the ECB’s past bond buying was, like pretty much everything the Eurocrats have done thus far, a temporary band aid. As we noted, the LTRO, which was a back door sovereign bailout, provided relief for a mere few months, when even its harshest critics assumed it would take pressure off for a year to eighteen months. Similarly, a Spanish bond buying program that began in August last year was only a short term palliative. While interest rates fell over 100 basis points initially, when the ECB stopped buying last November, yields were higher than when the program began. From the Der Spiegel account:
If the ECB starts buying up the government bonds of highly indebted euro countries again, it won’t just be yielding to the pressure of European politicians. It will also be resorting to a tool that, in the most recent past, has primarily produced one outcome: discord within the ranks of the ECB. As Germany’s central bank, the Bundesbank, noted last week, Draghi’s proposal is a “problematic” instrument.
If Draghi puts his concept into practice, the climate in Europe’s monetary authority could sink to a new low. The representatives of the northern European creditor countries fear that the ECB, out of consideration for the crisis-ridden south, is willing to sacrifice even the most sacrosanct principles to monetary policy. Representatives of the Mediterranean countries, on the other hand, suspect that the Bundesbank, in particular, doesn’t even want to defend the euro anymore and is secretly contemplating a return to the deutsche mark.
At this point, as Draghi acknowledged in his statement last week and we’ve been highlighting for some time, a big driver of the crisis now is defensive actions in anticipation of a possible Eurobreakup of some sort. Banks are increasingly lending only to the extent they have deposits and can secure funding from central banks. Funds are no longer flowing from the surplus countries to the deficit countries; what we have instead is a slow motion bank run via deposit flight to the core. So increased distrust of central bankers for each other is not noise; it feeds into this process and will reinforce their belief that ring fencing the banks in their countries is a prudent move.
And the particular program that Draghi apparently has in mind is contentious:
According to plans that were circulating among Europe’s monetary watchdogs last Friday, the ECB might buy the bonds of the threatened Spanish government again as a supplement to the purchases by the EFSF.
The plan envisions having the Luxembourg-based temporary bailout fund buy bonds directly from the governments because the ECB is not allowed to make such purchases on the so-called primary market. However, under Draghi’s plan, the monetary watchdogs will buy the securities of banks or investment funds in the so-called secondary market so as to drive down yields. This would double the firepower of the euro zone’s crisis weapons while simultaneously preventing Spain itself from having to resort to the bailout fund and accept stricter constraints on its reform programs.
But it is already clear that the plan will encounter resistance. Many monetary watchdogs — including Weidmann and, most of all, central bankers from the Netherlands, Belgium and Finland — have already been very outspoken in recent months about their opposition to new bond purchases.
The Der Spiegel summation is apt:
That’s the tragic aspect of Draghi’s rescue idea: What is intended to keep the monetary union together could actually drive it even further apart.
One telling theme in the article was Draghi becoming uncharacteristically angry when colleagues told him the ECB might be exceeding its legal authority. Draghi appears to be far along in the “this is an emergency, we must break glass thinking, which means he may eventually take radical action. But given how vocal the northern countries have been in making their objections known, that may not happen until a full blown crisis allows him to override them.
The Eurozone is increasingly looking like a zero sum exercise to its members: that there are no win-win strategies, only dividing up a fixed pie. And with austerity on in full force, it’s actually worse than that: the power that be are haggling over a pie that is shrinking before their very eyes. There’s declining trust and no willingness to consider alternatives that would put economies on a better trajectory. There’s now lip service being given to the need for growth, but the neoliberal budget-cutting religion is very much intact: the only alternatives under consideration are delaying the wearing of hairshirts, not considering completely different options.
It’s hard to see any happy outcomes from this situation, but Mr. Market is convinced there is. I wish him and the Europeans luck.