Draghi does his best

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 eliquantly 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. the market is going to love whatever Mario does on the 6th Sept. In a contracting world however, how long will the cool aid last for?

    personally, I think this will go a long way, but unless the EZ spends within it’s means it will be shown to fail eventually; I don’t see real change it that regard. So the saga will go on. I hope I’m wrong.

  2. This is a very bad idea as it at best only keeps the Euro on a knife edge of stability all the while inflating money supply.

    It is also a bailout for politicians and there is no way that countries won’t overall ease back on austerity once their yields are low again.

    Lastly, being in such a precarious situation just means that the collapse will either be delayed or brought on the moment another problem comes up. This could be China, Japan or the US. These countries could possibly doom its people to high inflation to keep the party going with another stimulus. THe point is, such open ended QE plans have no exit strategy, not even the one-off QE1,2 & 3 do!

  3. I tend to the view they will be forced soon….

    At the moment you have the Monti end holding up the prospect of the Italians maybe walking out the Euro door and actually being quite competitive with a new currency. That IMHO is what the Germans are listening to, and I tend to the view that it is Monti who has called Merkel’s bluff rather than Draghi, and it is political bluff not monetary or fiscal bluff.

    The Spanish are adding to that bluff with the prospect that they too could walk out the euro door (not that they actually want to – but they dont want 24% unemployment for the foreseeable fututre either).

    Then there is Greece – utter basket case, but if it doesnt get some slack from lenders (the troika) then it too could walk, the EU is more prepared to risk the Greek bluff because unlike the Italians the Greeks have no exporting sector, and unlike the Spanish they arent big. But their threat is that if they go then they are the first out the door and then the exit path is potentiall on more realistically for others, while global financial markets digest the new Euro outlook.

    That is to some extent the pro-loosen end of the equation

    The pro-austerity end is however pretty strong as well.

    The German constitutional court is a real threat to Germany here, as is the longer term prospect of a German pension system issue for their public finances. In the short term you have the Finns and Dutch asking why they have been disciplined if others are allowed to get away with being ill disciplined. and it is a fairly trenchant public in both nations on the subject (as it is in a lot of Germany – dont underestimate the ‘why should we pay for them’ mood)

    But negative real rates across the EU (northern half) mean that effectively markets are punting on a post euro euro which is stronger north than south – no matter how the politicians dress it up.

    And all the while the general economic outlook in the EU is steadily deteriorating (undermining the austerity plans already in place).

    Either way the next few weeks are likely to come out with something that will seriously move markets – if they can cobble somehting credible together then it could easily be buiy buy buy. If they come out with more hot air someone will reach for the axe and smash the alarm.

  4. ” Mario Draghi step(s) across the Rubicon into the arena of politics … (in)order to force Europe’s politicians….” What right has he to do that? This unelected official, to supersede democratic process and blackmail, or whatever else the term may be, sovereign nations into doing his bidding? Whether Draghi has the right economic policy answers or not is immaterial to this exercise. That is whether we, Europe, are prepared to stand by and pass our electorial voices to officials unelected. If so, let’s move Tony and Julia on, and get Glen to run our parliament.

    • You are being a bit tough on Super Mario….

      He is only the guy charged with holding inflation down and keeping the euro together (to the extent that he can), and everyone knows that ultimately it will be a political deal which holds it together or not, and he doesnt really get a look in on the politics – just the chance to let the politicians know that plan X or Y may or may not work and have X and Y implications….

  5. Sure Merkel might agree but a court challenge would be inevitable, if not from Germany then from Finland, Austria or the Netherlands.

    Within Germany this would be seen as a violation of basic law and a referendum would provably be needed at some stage.

    Lastly, this will not help Greece in the least.