Saturday, July 28, 2012

Vox Clamans

Draghi comments from London have risen high expectations from global markets. Basically, he said that ECB would do whatever it takes  to save the euro by any means. This needs to be interpreted since ECB powers are limited by the EU Treaty. Maybe we should understand that it would go beyond its remit by anticipating the June European Council decision, which gave the power to the ECB to purchase directly bonds in euro-zone members.

The reaction of markets was positive as Spanish and Italian bond yields were brought down, but still remain high. But just after the hawks of the Bundesbank warned against any intervention of the ECB, markets retrenched immediately. The German conservative newspaper, Die Welt, said that Mario Draghi, is the "Trojan horse of the indebted South, who wants to transfer resources from the rich and productive North to the continental South". 

Markets are not driven by moral sentiments. The finance world is neither a land of sudden and lasting miracles. The recent speculative attacks - concerted between the most powerful US and European banks - aimed to test the resilience of most exposed countries of the euro-zone and to bet on the inability of  EU institutions and national governments to set out an effective strategy to counteract them. Lately, Europe has given its worst image: after the announcement of unanimously agreed measures to tackle the euro crisis at the June council, some countries put in question the agreement with contradictory declarations with the sole consequence of feeding international speculation in a growing political decay. The perfect storm ! 

Under these conditions, the final assault to the crumbling fortress of the euro-zone was to be expected. In his statement, Mario Draghi has warned against the risk of disintegration and  explained that the ECB was ready to mobilize all the instruments at its disposal  to stop speculation. The (temporary) retrenchment does not mean that speculators will surrender, but they know that they will have to deal with a genuine federal institution which is determined to defend the euro-zone at any cost. But it cannot remain alone in this final battle and governments should,  without any ambiguity, play their role, for example by bringing additional resources into the European financial stability fund, and then into the European Stability Mechanism (ESM) which will enter into force in September 2012.

Progressively, the ECB will have to turn in a sort of Federal Reserve. Economists are divided over its performance on managing the crisis in the US economy. Some argue that its policy of 'quantitative easing' (easy credit) inflated the bubble while others believe that the Fed's interest rate cuts since the bubble burst have been a success as they prevented a much more severe recession. Others think that the Fed has merely postponed the day of reckoning. 

Ch. Kindleberger, a famous economist who wrote a history of financial crises, in "Manias, Panics and crashes " (1978)  believed that , in certain conditions, markets needed help from a lender of last resort. He understood both the danger of inaction by such a lender and the “moral hazard” that its mere existence can create, by encouraging investors to be reckless in the belief that they will be bailed out if all goes wrong. Thus, he argued, a “lender of last resort should exist, but its presence should be doubted.” It should always come to the rescue, but “always leave it uncertain whether the rescue will arrive in time or at all, so as to instil caution.” this is precisely what we need in Europe, not just a firefighter.


  1. P. Krugman argues that lowering interest rates on government bonds is just part of the response to the crisis. He pledges for more inflation so that peripheral countries can regain competitiveness. Better than deflation, indeed, but low income groups will pay the price unless wages rise at the same pace.

  2. Merkel, who is somewhere in Süd-Tirol has approved the ECB intervention to buy government bonds in heavily indebted countries. I thought the ECB was independent,but the important thing is that pragmatism has won over ideology.

  3. August 2, Florence
    The way forward is to enhance coordination between FED and ECB to resolve Europe's debt crisis. The WSJ (1 August) reports that both central banks are largely alone and that their intervention will not be enough to solve economic problems in the US and Europe. It can at best ease financial conditions. the issue is whether buying more government bonds, as they did in 2009 and 2010, will have this time an impact on the real economy