The unbearable lightness of a Eurozone led by the ECB
This is no economic tale, though it does revolve around economics. Nor is it a financial narrative, despite its concerning the world of finance. What you are about to read is a story about power and politics. The setting is the Eurozone. The main character is Mario Draghi, president of the European Central Bank (ECB) and his many antagoniststhat could prove overwhelming.
- Monday, 05 January 2015
As in any self-respecting tale of power, one has to kick off with the main character’s main virtue: his Machiavellian smarts. Whoever writes the Italian central banker’s biography will probably compare him to that Niccolò di Bernardo del Machiavelli who in 1513, 500 years before Draghi, produced new standards for political doctrine. It would be only fitting. This said, not all tales have happy endings.
When Mario Draghi was appointed president of the ECB, on 1 November 2011, the sceptics and conspirators viewed him as the lynchpin of a corrupt financial system bent on destruction rather than innovation. These detractors have however had to eat humble pie, seeing as the Italian central banker has managed to hold together an economic area that was on the verge of collapse. Mainly through his words, rather than his actions. One thing should be clear, it’s not that all the solutions that have been fielded to preserve the euro are of no consequence, but it’s been Draghi’s political, diplomatic and negotiating skillsthathave come to the rescue in situations which seemed to have got out of hand. To realise what was going on, one has to go back to the torrid days when Italy was almost banished from the bond market. Days in which even Christine Lagarde, director general of the International Monetary Fund (IMF), announced to the financial community that without decisive action the Eurozone had but three more months to live.
Draghi’s political mettle was revealed in all its power on two occasions. The first dates back to 2012. With the Eurozone at the height of its financial crisis, Draghi resorted to a ploy in order to overstep the limitations of his ECB mandate. He exploited the manifest breakdown of Eurotower’s monetary policy transmission mechanism to launch the Outright Monetary Transactions (OMT), the conditional treasury bond acquisition plan that lowered interest rates for the countries under the most pressure, Italy and Spain. After all, the weapons deployed up to then – mainly actions on the ECB’s three main interest rates, refinancing, Marginal Lending facilities and deposits – had not achieved the hoped-for results. The more the ECB cut the cost of money, the less the credit institutions of the peripheral euro area lowered interest rates to companies. A destructive picture both in the short and the long term. With the protective shield of the OMTs, these countries could breathe freely once more. And it’s worth underlining that the OMTs have never been used. This announcement policy, employed as an integral weapon of the ECB’s monetary policy, has turned out to be Draghi’s trump card.
Then, seeing as the Eurozone crisis is not a stand-alone event but is instead part of a process involving a global review of production factors within mature economies and the imbalances between economic areas, he had to come up with a further stratagem to breathe some life back into the euro area, hit by low inflation, anaemic growth and high debt. He therefore launched the Targeted longer-term refinancing operation (TLTRO), long term targeted refinancing operations through which it can lend banks as much as 1,000 billion euro with auctions up to 2016. On the one hand he set up a low cost liquidity crutch for credit institutions, on the other he imposed constraints (weak ones, to be honest) in favour of private sector funding. And that’s not all. On June 5 last Draghi, at the TLTRO presentation, reiterated that they were part of a process. Therefore, as a single action, it was impossible to assess. After a few months, with inflation staying low and growth still below par, he launched an acquisition program involving covered bonds and securitized securities, meaning Asset-Backed Securities (ABS) and Residential mortgage-backed security (RMBS). All operations designed to expand the EBC’s budget by about 1,000 billion euros, from the current 2,000 billion.
How? Simple really. The only explicit target the EBC has to meet is the inflation rate, that must stand at around 2% a year. Currently, with the 0.4% figure for October, the monetary institution based in Frankfurt is way off target. A fact that is not under dispute. Not even by Jens Weidmann’sBundesbank, considered with some degree of truth as Draghi’s nemesis. With the first being as much of a hawk as the latter is a dove. Despite not being vested with the powers afforded to the Governor of the Federal Reserve, who’s mandate includes price stability and full employment, Draghi has managed to field actions reminiscent of the American Quantitative Easing (QE). But we have some way to go before we can actually speak of QE. Mainly due to strife within the ECB board, which the Italian banker is laboriously trying to appease. In part because he’s not completely sure that this is the right way to get clear of the quicksand.
Recent indiscretions, initially reported by Reuters, that speak of a number of differing opinions within the EBC board, are true. However, as a top flight EBC manager explained, they take issue with Draghi’s communication methods, not his final decisions. Translation: some members of the EBC have a hard time tolerating the covert nature of Draghi’s decisions. “It’s as if he’d got us all used to continuous drama. He turns up at meetings without discussing things with anyone and presents his measures, backing them with incontrovertible data”, the manager admitted. He’s right. This is the former Bank of Italy Governor’s innovation on the communication front. But only at the end of August did he step up this strategy, which continued with the announcement of the launch of securitized bond acquisitions. At the Federal Reserve’s economic symposium at Jackson Hole, Draghi, without mentioning it to anyone in advance, spoke of fiscal stance aggregation. In other words, if a state has a balance of payments with acapacity for expansion, as is the case with Germany, they should decide to expand, rather than continuing to consolidate. A message of solidarity in a fragmented economic area such as the euro, with its 19 different economies, its 19 different needs and 19 national interests, all at odds with each other. A message that was not well received by Germany, which would prefer to see more effort towards fiscal consolidation in those countries, with Italy very much in the cross-hairs, that have promised much but delivered little.
Germany calls for a little give-or-take – reforms in exchange for fund transfers – but in actual fact so does the ECB. Draghi often underlines that “the EBC cannot replace governments”. And he’s right. Yet up to now the one who’s stood up and faced the music (and the risks) more than anyone else is the ECB. It has (virtually speaking) borne the brunt of the failings of the individual nations and tried to move forward. Draghi has tried – and the actual results will only be visible a few months from now – to inject new credibility into a very opaque banking system such as the euro area by launching the broadest micro-prudential supervisory operation ever, the Comprehensive Assessment, the results of which were published on 26 October last. So, along with the Banking Union and the European Stability Mechanism (ESM), the foundations have been laid for a safer eurozone, in which an event like the exit of one of its members could be managed more successfully than three years ago. At least in theory, seeing as in reality situations of this kind could have unforeseeable repercussions.
Draghi’s Machiavellian operations are not without purpose. If, as many ECB sources point out, he is managing to convince even Weidmann that, if expectations regarding inflation don’t improve, the fully fledged launch of the QE, which would include the acquisition of government bonds according to the ECB’s capital subscription key, would no longer be an impossibility, then he now holds the most important position in the Eurozone. “Governments can change, the leadership of the European Commission can change, what is important is that Draghi stays in charge of the Eurotower”, an UBS banker openly admittedproviding he could remain anonymous. Recent eurozone history will be increasingly linked with Draghi. But up to what point? To what extent will the ECB manage to continue acting as the fulcrum of a wavering economic area that’s not prepared to act as a unit? In the long term, we can only be sure of one thing. Without a last-ditch effort by national governments, the newly achieved normality will regress into the same fierce state of crisis experienced between 2011 and 2012. And then, even the ECB will be helpless.