seminal speech

Whatever it took is whatever it will take

Mario Draghi Holds Final Press Conference In Old ECB Building
Happy feat: Mario Draghi saved the euro by making a promise that investors never tested. Source: Getty Images

Even critics of Mario Draghi’s actions in the euro-zone debt crisis concede that the president of the European Central Bank may have been instrumental in saving the single currency by uttering three little words five years ago: The ECB was prepared to do “whatever it takes” to save the euro, Mr. Draghi dropped into a speech before somewhat surprised bankers in London on 26 July 2012.

Although it would take the central bank two months to flesh out what he meant, the investors on the global financial markets heard what many of them had wanted to hear since the Greek sovereign debt crisis metastasized into a full-blown euro-zone crisis in the course of 2010: The ECB was finally willing to print money to buy the sovereign bonds of euro-zone governments beset by ever-rising public debt levels.

Financial-market bets that crushing sovereign debt would soon force Greece or Portugal or Italy out of the euro zone – and quite possibly unravel the whole currency – suddenly looked less of a cert. Global investors quickly reverted to regarding Italian or French government bonds almost as safe as German ones, much as they had done since the introduction of the euro at the beginning of 1999.

“What Draghi did back then was a psychological masterpiece.”

Johannes Müller, Chief Investment strategist for Germany at investment fund Deutschen Asset Management

Intense investor pressure on the euro zone – expressed by the “spread” between interest rates on 10-year German government bonds (then less than 2 percent) and those on bonds considered less safe (Italy: 7.5 percent) – dissipated with a three-word promise, one that investors thereafter never sought to test.

“What Draghi did back then was a psychological masterpiece,” said Johannes Müller, chief investment strategist for Germany at investment fund Deutschen Asset Management. “Without spending a cent, he managed to stabilize the entire system.” Marcel Fratzscher, head of the German Institute for Economic Research (DIW) even called Mr. Draghi’s pledge “the greatest monetary-policy success in decades.”

But not everyone in Germany agrees or agreed. Jens Weidmann, head of the Bundesbank, Germany’s cautious national central bank, was the sole holdout against the Outright Monetary Transactions (OMT) program, as it was by then called, when it was presented to the ECB’s Governing Council for approval in September 2012. He regarded the proposed emergency purchase of sovereign bonds “as being tantamount to financing governments by printing banknotes,” the Bundesbank thundered in an official statement.

Mr. Draghi had roused the specter of Weimar Germany, which suffered crippling ultra-inflation in the 1920s as successive governments printed money to pay off sovereign debts incurred during and after World War I, inadvertently laying the ground for Hitler. In 2013, 136 German economists signed a petition against OMT, and two politicians, from the right and the left, won 12,000 supporters to file a suit – ultimately unsuccessful – before Germany’s mighty Constitutional Court. But OMT survived, despite all its faults.

“The OMT program was half-baked,” said Jochen Andritzky, general secretary of the German Council of Economic Experts. “’Whatever it takes’ marked a turning point in the crisis, but it did pose risks.” For one, investors willfully or ignorantly saw the program as a financial backstop that could disperse money with no strings attached – when in fact the central bank was adamant that the scheme would only ever be triggered as part of a comprehensive program involving economic reforms in return for money from an emergency fund.

Either way, OMT called into question the role of the European Stability Mechanism, a €500 billion rescue fund that the euro-zone countries had agreed upon in stages since 2010 to provide stricken countries with emergency funding only under the strictest conditions. On top of that, by taking the pressure off spreads, the program took the pressure of governments to finally commit to reforms to deal with their excessive public-debt loads.

25 p29 ECB The day of famous speech and its consequences-01

Even EU officials privately concede that 2012 marked a big shift in the responsibility for dealing with the euro crisis from euro-zone governments – their democratically elected parliaments – to the unelected members of the ECB’s governing council. Member states’ last big reform decision – to unite their national banking systems in an EU “banking union” – came a month before Mr. Draghi’s July 2012 speech.

“It’s high time the politicians finally table some new ideas,” said one official in Brussels. “That’s why everyone is so focused on what [Chancellor Angela] Merkel and [French President Emmanuel] Macron will present at the end of the year.” The leaders of the euro-zone’s largest economies plan to put forward proposals to strengthen the euro zone after Ms. Merkel’s expected re-election in September.

Not only do Ms. Merkel and Mr. Macron have to give euro zone politics new momentum; Mr. Draghi now has to extricate the ECB from its outsize role in the fate of the euro zone. OMT is less of a problem than the ECB’s bond-buying program, started in 2015,  to spur lending and stoke inflation. Having also lowered its key lending rate to zero in 2016, the central bank has flooded financial markets with money.

“The ECB needs to keep the markets on side – and investors have got very used to the comfortable environment the ECB has made for them,” said Mr. Müller at Deutsche Asset Management. “Market expectations regarding Mr. Draghi’s abilities are huge.” They expect nothing less of Mr. Draghi than to organize a painless phase-out of easy money throughout 2018 – that’s all it will take.

 

Andrea Cünnen is a finance correspondent and Jan Mallien covers monetary policy for Handelsblatt. Gerrit Wiesmann is an editor at Handelsblatt Global. To contact the authors: cuennen@handelsblatt.com, mallien@handelsblatt.com 

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