Hat’s off to Mario Draghi, who may actually be the smartest man in Europe. I know many people will not be fully agree with the action . But trust for the first time, the cup is half-full in the span of last 2 years, Europe has finally abandoned its hopeless strategy of mutual eurobonds backed by fiscal union (piling debt upon debt), and is moving toward the only possible solution: full-scale monetary rescue by the ECB.
Lets try to analyse the good part of it:
First of all, this action embodies fondest hope, which was that the ECB would finally ignore Weidmann and get on with rescuing the euro zone. Poor Mr. Draghi was forced to cook up an elaborate rationale explaining why buying peripheral bonds is in keeping with the ECB’s charter, which explicitly forbids exactly it. He knows that his rationale is completely bogus but he needs it to help the Northern governments sell it to their people. (Note that both the Finnish and Dutch central banks went along with the plan, which may not please their governments, especially Finland. We haven’t heard from any governments yet.)
This announcement effectively means that the South (or should I say Europe?) has hijacked the ECB and left the Bundesbank in the dust, which was absolutely necessary. Weidmann will now have to resign or shut up. Merkel certainly wants him to shut up. (Germany’s other board member voted for the plan, which further isolates Weidmann.)
The ECB staff was unable to come up with a transparent formula for deciding how to target bond yields for each country, which is perhaps understandable given the political sensitivity. However, without an announced target, the markets can only flounder around trying to figure out what the ECB’s secret target really is. This will cost the ECB a lot of money that it wouldn’t have had to spend defending an announced target.
Now, the problems.
It takes two to play the conditionality game and, for now, Spain isn’t playing. Rajoy’s position is that Spain has already launched a reform program and doesn’t need a new one imposed by the Troika. Draghi (meaning Merkel) left no room for compromise on this, so Rajoy will have to blink. When and how will he do so? He has run out of money except for the round-trip through his central bank. The ECB abandoned all collateral standards today, so in theory the Spanish banks can now pledge their paper clips and furniture, but I expect that Draghi will start closing the spigot. Rajoy will be forced to lose face or default. (This is not your father’s central bank!)
The austerity requirement is a big mistake, since it leads inexorably to depression. These economies need growth, not asphyxiation. but is an incrementalist. An even bigger mistake is the ECB’s ongoing monetary nonfeasance.
Draghi Statement : –
Turning to the monetary analysis, the underlying pace of monetary expansion remained subdued. The annual growth rate of M3 increased to 3.8 percent in July 2012, up from 3.2 percent in June. Economic growth in the euro area is expected to remain weak.
Euro area real GDP contracted by 0.2 percent, quarter on quarter, in the second quarter of 2012, following zero growth in the previous quarter. Economic indicators point to a continued weak economic activity in the remainder of 2012 in an environment of heightened uncertainty.
Looking beyond the short-term, we expect the euro area economy to recover only very gradually. The growth momentum is expected to remain dampened by the necessary process of balance sheet adjustment in the financial and nonfinancial sectors, by the existence of high unemployment, and by an uneven global recovery.
In plain English: “We don’t know when we will arrive at our destination because we are driving as slowly as we can and are taking frequent rest stops. Also, the motor may be broken.”
You might ask: won’t unlimited bond purchases stimulate monetary growth? Not for these scientists. Draghi made clear that all such purchases will be fully sterilized and that the notion of not sterilizing wasn’t even discussed .
Going forward, we will have to see what Rajoy says, what Monti says, what Merkel says, what happens to Spanish yields and–yes–what happens with Greece. But Spain is the crisis du jour.