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Monday, Sep. 17, 2012
Mr. Draghi's decision
Mr. Mario Draghi, president of the European Central Bank (ECB), has made the boldest move yet to halt the economic crisis that threatens the solvency of European governments, the future of the euro and the very dream of a European Union.
The week before last, Mr. Draghi announced that the ECB will buy unlimited amounts of government bonds in an attempt to provide confidence — and a ceiling on interest rates — to countries being swamped by debt. It is the right move, but its success depends on the commitment of politicians, not just bankers, to the European Union and joint action. Despite Mr. Draghi's bold move, that commitment is not assured.
As Europe's vulnerable economies struggle to cope with mountains of debt, triggered by spending that far exceeds revenues, the key question has been the sustainability of recovery packages that focus on austerity measures as unemployment mounts.
To put it simply, efforts to cut government spending have only exacerbated economic downturns, depressing demand, increasing joblessness, cutting tax revenues and undercutting the political legitimacy of those governments trying to balance the books.
Economies slow even more, making balance even more difficult and distant. This raises still more questions about the commitments of governments and their creditors to restructuring and interest rates rise yet again.
The decision by the ECB is intended to end that downward spiral. Mr. Draghi strong-armed the other representatives on the 23-member governing council — one government, Germany, dissented — to approve the plan to buy unlimited quantities of European government bonds, a proposal called "Outright Monetary Transactions." The bank's readiness to provide help comes with conditions, however.
Before the ECB steps in, the government selling the bonds must agree with other European governments on plans to make its economy competitive, restrain public debt and address financial weaknesses. In other words, ECB purchases will backstop a broader recovery program.
If debtors renege on the plans, then the ECB will end the purchases. In addition, the bond purchases will be "sterilized," which means that for every euro in bonds bought, an equal amount will be withdrawn elsewhere in the financial system to keep the money supply constant and avoid inflation. Bonds to be purchased will be limited to three-year maturities.
Significantly, the ECB will not demand seniority over other bond purchasers. That means that there is no danger that other bond holders will flee the market in fear that their holdings will get pushed to the back of the line in the event of a default.
Mr. Draghi explained that the move was intended to end discussion of Europe's commitment to the euro.
At a press conference announcing the new policy, Mr. Draghi called the currency union "irreversible." Reaction to the decision — "a potential game changer" in the words of one analyst — was overwhelmingly positive.
U.S. stock indices posted their largest gains in weeks, with the S&P 500 reaching a four-year high. European indices rose as well: The Stoxx 600 Europe Index rose 2.3 percent, and French and German indexes each rose about 3 percent.
The euro appreciated and, significantly, interest rates on three-year and 10-year bonds of Spain and Italy fell as the market anticipated ECB intervention.
While long-overdue and much welcome — Europe's woes are the source of economic uncertainty worldwide — the fundamental concern remains. A ceiling on interest rates (which is what the move provides) buys European governments time, but it does not stimulate growth. And growth is desperately needed.
The ECB has lowered its economic forecast for the 17-nation eurozone economy, concluding that, overall, the regional economy would shrink between 0.2 percent and 0.6 percent in 2012.
Six eurozone countries are in recession — Greece, Spain, Italy, Cyprus, Malta and Portugal. Unemployment across the entire region has reached 11.3 percent, with spikes as high as 24.6 percent in Spain and 24.4 percent in Greece. These situations — one-quarter of the working population unemployed, with levels even higher among some age groups, such as youth — are unsustainable, politically or morally.
Yet the record of those same governments to take seriously the commitment to balance their books is poor. Accounting gimmicks and outright lying are the norm, rather than politically difficult choices. The result is the situation that now exists — inescapable pain, intensified by the refusal to do the right thing under more favorable circumstances.
The response of the Spanish and Italian governments to the announcement throws some doubt on its success. Spanish Prime Minister Mariano Rajoy would make no new commitments to trigger the ECB plan, and Italian counterpart Mario Monti applauded the proposal but dismissed an Italian request for aid as "premature."
If Madrid and Rome do not avail themselves of the plan, then pressure on them is unlikely to ease and the future of the euro itself will remain uncertain.
To work, Mr. Draghi's decision must be matched by equal boldness among Europe's political leaders. They show no such inclination.