Draghi Does His Best

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness

Two weeks ago I wrote a post about Mario Draghi and what appeared to be ECB’s step across the Rubicon into the arena of politics and fiscal policy in order to force Europe’s politicians to break the ‘chicken and egg’ stand-off that has plagued Europe for over a year. In that post I described his actions as a bluff called of both sides of the divide:

… the structure of what Mr Draghi has proposed is quite clearly jawboning of both sides of the economic divide to force a resolution. Although we have heard promises from Germany that they will support the periphery after they enact fiscal reform the ECB now appears to be calling their bluff. In open defiance of the Bundesbank and some in the German political camp the President offered the possibility of open ended and unsterilised bond purchases.

Meanwhile he is also calling the bluff of the periphery by making it very clear that this is completely dependent on compliance from southern nations on enactment of the fiscal compact.

This obviously wasn’t the first time the Mario Draghi had turned the screws on the politicians. I reported on another such time in July, but this was a significant move forward in the on-going politicking around the future of the Eurozone. I said in that piece that there were still some fairly large technical details to work through and, of course, the question was would the bluff call work.

Since I wrote those words there have been rumours that the ECB was looking at different strategies of how they could put a ceiling on Euro short term debt, specifically Italian and Spanish. This rumour saw a rapid correction in bond markets as they took on the news of future ECB support. This was, however, quickly unwound when the Bundesbank released a report questioning the ECB’s actions and stating that they were unsupportive of such moves. The ECB also later denied that any such action was about to take place.

The next day, however, Ambrose Evan-Pritchard wrote a piece claiming that there was some truth to the matter, and not only that, but Jorg Asmussen, Angela Merkel’s personal pick for the ECB board, was supportive of action by the ECB under the guise of insuring that the markets saw the euro was ‘irreversible’. Against opinions from the Bundesbank, Mr Asmussen stated that the ECB has the mandate to act because rising yields in the periphery are a reflection, in part, about the reversibility risk of the Euro and this in itself means that monetary policy transmission is being hampered.

I do personally think this is correct but, as I’ve stated many times previously, this is an issue of fiscal not monetary policy. That point aside, it now appears that Mr Draghi has called the bluff of the Germans and it has worked. Obviously I am taking this with a quite a bit scepticism , and it may just turn out that the Europeans have finally woken up to the fact that telling the markets what they want to hear would give them a free ride until the German constitution court decides on the ESM. But, at least at this stage, this does appear to be a genuine breakthrough.

There are , of course, two sides to this deal and we have heard nothing from Italy and/or Spain that suggests they are about to ask for a bailout via the ESM/EFSF which would trigger such a response from the ECB. In fact, by suggesting that the ECB may act the yields on sovereign bonds have fallen sharply. This has allowed Spain to sell €3.5 billion in 12-month bills at an average interest rate of 3.07 percent compared with 3.92 percent in the last such auction and €981 million in 18-month bills at a yield of 3.33 percent, down from 4.24 percent.

That’s not to say that I don’t think that both countries won’t eventually be forced to ask for help. Neither is on a sustainable path under the Euro with their current economic conditions, and it is very clear from the PMI data and other macroeconomic metrics that the situation is getting worse for both countries, particularly Spain. Incidentally we will get another round of PMI data tomorrow night.

There is, however, no doubt that, if true, this is a major step forward in European economics and the fact that the ECB may come to act like a real lender of last resort cannot be understated. The major issue of the Eurozone is the economic imbalance of the countries under a single currency and it appears the ECB is attempting to step into that breach where the politicians will not.

There are obviously a many more major steps to take on the road to a true economic union but this is most definitely a step in that direction, and the fact that the Germans appear to be supportive for the first time in years, if in fact it is true, should not be underestimated.

I do, however, still have major reservations about the way forward and I think there are significant political risks in Spain, Italy, Finland and Holland, amongst other nations, about taking the next steps because it will require a further loss of economic and political sovereignty. I also have considerable problems with the fiscal compact, as Yves Smith so eloquently put it in a lead in to a re-post at Naked Capitalism:

.. Draghi might have found a path through the Euro mess to keep it patched up long enough for to impose austerity on the periphery and drive all of Europe into a lovely depression.

But, as they say, while the sun shines.

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  1. Hugh

    As Yves has pointed out before, Draghi is doing a song and dance, indeed several songs and dances, to get Europe through to September 12 and the German constitutional court’s ruling on the ESM.

    Again in assessing such moves, we need to put them up against what Europe’s problems are:

    1) Lack of a democratic fiscal and debt union
    2) A weak, ineffective central bank
    3) A predatory and insolvent banking sector
    4) Mercantilist trade patterns within the eurozone
    5) Corrupt political classes
    6) A kleptocratic ruling class of the rich

    Do this, and you can see that the current discussion of what Draghi does or can do is, the ESM, austerity have nothing to do with any meaningful solution. They do have a lot to do, however, with continuing the status quo of looting.

  2. Can't Help It

    Actually why act at all? The market has shown quite a bit of willingness to believe promises to act, promises to have a plan to act, etc, etc and as the article has stated, a word from one of the Super Mario Brothers and yields go down immediately. This is a perfect solution for everyone involved, the northern countries would not need to print a cent, the equity markets keep roaring and as long as each of the problematic countries keep up the facade of doing austerity while doing the opposite, the party can go on forever irregardless of Sept 12 or George Soros’ 3 months deadline to save the Euro :).

    Incidentally, I was in Europe on a 10 countries tour a month ago, and granted I didn’t go to either Spain or Greece, but I could not see any signs of austerity in Italy and there were plenty of Spaniards around having the time of their life. Anecdotal for sure (and after all Spain must have its share of the 1 percent), but sometimes I wonder how real this so called crisis is.

    1. Gerald Muller

      The holiday season is not the best way to assess whether people are in a bad shape or not. And, as you said, you did not go to Spain nor Greece. I am not very familiar with either country but I do know France much better, a country not considered in such a bad shape as Spain or Italy. Well, the number of small businesses actually closing or about to is way above last year. Just wait until winter comes and even France will show its true face, that of looking more and more like Spain or Italy, especially since the only new ideas of Hollande are to increase taxes and scare the remaining rich out of the country with a 75% tax over one million euro income.
      Another short comment: if you go to Budapest as a tourist, you will not notice anything particular. The city is gorgeous and the Opera splendid. In reality the country is in terrible shape and I have to send money to old relatives of mine there so that they do not starve.

    2. AA+ Bonds

      LOL! You think the sort of Spaniards who vacation in Italy are a measure of Spain, even anecdotally? Ever heard of a bimodal distribution?

      Take your next vacation in Athens and try to avoid the flying police motorcycles if you notice any tripwires.

  3. jake chase

    The Eurocrisis is little more than a determined push to destroy national soverignty in the periphery, the only remaining obstacle to the kind of absolute banker control over Europe which we now experience in the US. Draghi’s strategy is to bribe the Spanish and Italian politicians with new cash at bargain rates, while simultaneously threatening northern Europe with potential loss of its captive export markets (and concomitant unemployment) if the Eurozone collapses because of a refusal to finance the continued bribes. Smart money is betting on the bankers. Smart money is generally right but occasionally wrong, catastrophically.

    1. Hubert

      Exactly. But they can be catastrophically wrong only once. After that, the rules will be changed drastically. So the way to bet is that the can will be kicked.

  4. Samuel Conner

    It may be that depression will have to come to Germany before the Germans will consent to a Continental pro-growth fiscal policy.

    1. Jim

      What obligation does a German have to a Greek or Spaniard? Why should a German suffer through inflation in an attempt to subvert democracy?

      Europhiles say the same thing, over and over.

      And so will I.

      The Eurozone is a ill-fated artificical construct which the majority of the people living in the continent of Europe don’t want. Don’t believe me? Then why are the Eurocrats in Brussels so nervous about a referendum in Germany?

      Furthermore, IMHO, there is a cognitive dissonance between those progressives who denounced the Bernanke/Bush/Geithner for “extraordindary” Fed operations and simultaneously praise Draghi for doing the same.

      In both cases, central bankers are arguing that all of their operations are designed to save the system. You can’t critize Bernanke for doing precisely what Draghi has engaged in.

      Yet, I’d be willing to bet that if Bernanke (or Warsh, should Romney win) subverted democracy in 2013, arguing that it’s necessary to save the system, most of you would be up in arms.

  5. Yesman

    Yes Dr. Aghi, the great hope…

    But wait didn’t all these Central Bank clowns get Europe and….

    …wait for it… the globe into the unstable mess we are in?

    Bring on the clowns!

  6. anton

    france,belgium,irland,spain,portugal,italy,greece are all finished and behind closed doors 68% of the people starve and are to weak to protest,but hungry and angry to tell…For sure many business will close this winter and many unemployed may leave going nowhere to starve…but the fate of euro will be in the next months…because broke countries and banks cant feed each other,but euro will be printed like crazy to kick the cane still..This was all by design…to create chaos,revolution like albert pike wrotte

  7. AA+ Bonds

    Who can believe the ECB anymore? Bundesbank has clearly shoved a lever in their ass and are cranking away.

    The only reason the bond markets respond is because their moribund dogma dictates that they may not listen to anyone else. Insulated from any serious consequences by groupthink and mass action, the traders gamble that as long as everyone listens to the wrong advice, they each stand a good chance of a soft landing on Doomsday.

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