Draghi's Pledge: ECB Divided over Efforts to Save Euro
ECB head Mario Draghi wants to save the euro at all costs. But the pledge has created discord within the bank's governing council. Many oppose plans to buy up sovereign bonds from troubled euro-zone member states, fearing it could just make things worse.
It was an illustrious meeting that British Prime Minister David Cameron was hosting on the evening before the opening of the Olympic Games in London. Prince Charles joked with International Monetary Fund Managing Director Christine Lagarde, while top chef Tom Aikens served up Scottish salmon and Yorkshire goat cheese. The heads of global corporations like Google enthusiastically applauded the videotaped appearances of English celebrities, from Victoria Beckham to Richard Branson.
It was meant to be a day of glamour, but then Mario Draghi, the president of the European Central Bank (ECB), made a seemingly trivial remark -- but one that ensured that the 200 prominent guests were swiftly brought back to gloomy reality. His organization, he promised, would do "whatever it takes to preserve the euro."
The audience treated the remark as just another platitude coming from a politician. But international financial traders understood it as an announcement that the ECB was about to buy up Italian and Spanish government bonds in a big way. So they did what they always do when central banks suggest they might soon be firing up the money-printing presses: They clicked on the "buy" button.
Stock and bond prices shot up within minutes, and the yields on some southern European debt securities saw a considerable drop. Newspapers and online news services called it an act of liberation, and market speculators quickly concluded that the ECB was apparently prepared to provide them with what one banker called "excellent gains in share prices" in the coming months.
Meanwhile, experts at the central banks of the euro zone's 17 member states had no idea what to do with the news. Draghi's remark was not the result of any resolutions, and even members of the ECB Governing Council admitted that they had heard nothing of such plans until then.
Europe's leaders, on the other hand, reacted with relief. The situation on the financial markets had come to a head in the preceding days, and Spain, in particular, was coming under more and more pressure. German Finance Minister Wolfgang Schäuble demonstratively supported Draghi's announcements, and both German Chancellor Angela Merkel and French President François Hollande repeated the words of the ECB president almost verbatim. Germany and France, they announced in a joint statement, would do "everything to protect the euro zone."
A Crisis of Nerves
This comes as no surprise, given that their own recent efforts haven't exactly been crowned with success. Although the latest euro summit in Brussels had delivered copious statements of intent, it yielded almost no concrete resolutions. As a result, the risk premiums for Spanish government bonds quickly shot up again to reach record levels.
Now Draghi is apparently prepared to lend a hand to the hapless politicians. Under his plan, which essentially creates a new form of cooperation between governments and monetary watchdogs, both of Europe's bailout funds -- the temporary European Financial Stability Facility (EFSF) and the permanent European Stability Mechanism (ESM) -- and the ECB will intervene jointly in the bond markets in the future to bring yields down.
What sounds like a great success is actually a sign of weakness. If the ECB starts buying up the government bonds of highly indebted euro countries again, it won't just be yielding to the pressure of European politicians. It will also be resorting to a tool that, in the most recent past, has primarily produced one outcome: discord within the ranks of the ECB. As Germany's central bank, the Bundesbank, noted last week, Draghi's proposal is a "problematic" instrument.
If Draghi puts his concept into practice, the climate in Europe's monetary authority could sink to a new low. The representatives of the northern European creditor countries fear that the ECB, out of consideration for the crisis-ridden south, is willing to sacrifice even the most sacrosanct principles to monetary policy. Representatives of the Mediterranean countries, on the other hand, suspect that the Bundesbank, in particular, doesn't even want to defend the euro anymore and is secretly contemplating a return to the deutsche mark.
A deep-seated feeling of mistrust has taken hold at Frankfurt's Eurotower, the ECB's headquarters, and even Draghi, who is normally seen as the epitome of level-headedness among central bankers, has recently shown signs of nervousness. At a dinner in early July, the ECB chief and his fellow governors were discussing the question of whether the ECB's loans to Ireland's government-owned "bad bank" were consistent with the bank's current bylaws.
It was a debate among experts, like many before it, but then something unusual happened: Draghi raised his voice. Such questions, he snapped at his opponents, could not always be discussed in exclusively legal terms.
Bringing Peace then Worries
The ECB president has become thin-skinned and easily irritated by criticism, especially when it comes from Germany. "Draghi is availing himself of the language of politics," says Jörg Krämer, the chief economist of Commerzbank, Germany's second-largest bank. The ECB, he points out, has now "clearly exceeded its own scope of responsibility." And Bundesbank President Jens Weidmann, the unofficial spokesman of the northern camp, recently said publicly that it did not reflect his understanding of politics "when politicians deliberately avoid decisions and the a central banks are forced to take up the slack."
When Draghi came into office, he seemed to have what it takes to become something of an angel of peace in the euro crisis. The engaging Italian had a way of making everyone he spoke with feel that he was on his side. In interviews with the German media, he rarely forgot to quote an important Bundesbank official. And when he met with politicians from southern Europe, they were left with the feeling that he would interpret the ECB rules more flexibly than the Germans would.
Draghi's diplomatic manner and stoic objectivity also appealed to Weidmann. In meetings of ECB Governing Council, Draghi would listen to the others before speaking -- unlike his predecessor, the Frenchman Jean-Claude Trichet. He also preferred to sound out the situation along the fronts of the euro zone in one-on-one telephone conversations before meetings.
Draghi's artful diplomacy was also successful at first. When he took office, he accomplished the feat of doling out responsibilities within his directorate in such a way that Germany and France were equally satisfied -- while simultaneously maximizing his own power. Although the Bundesbank opposed his economic strategy to prop up European banks with loans worth about 1 trillion ($1.2 trillion) -- known as "Big Bertha," the nickname commonly used to describe a big howitzer used by the German army in World War I -- Draghi managed to placate his critics by guaranteeing that the especially controversial purchases of southern European government bonds wouldn't go on forever.
Growing Internal Resistance
But now Draghi's maneuvering is starting to annoy many central bankers. "You never know where he stands," complain representatives of creditor and borrower countries alike.
Even more critical is the fact that, with his most recent plan to rescue the euro, he is jeopardizing the fragile equilibrium between north and south in the ECB Governing Council. According to plans that were circulating among Europe's monetary watchdogs last Friday, the ECB might buy the bonds of the threatened Spanish government again as a supplement to the purchases by the EFSF.
The plan envisions having the Luxembourg-based temporary bailout fund buy bonds directly from the governments because the ECB is not allowed to make such purchases on the so-called primary market. However, under Draghi's plan, the monetary watchdogs will buy the securities of banks or investment funds in the so-called secondary market so as to drive down yields. This would double the firepower of the euro zone's crisis weapons while simultaneously preventing Spain itself from having to resort to the bailout fund and accept stricter constraints on its reform programs.
But it is already clear that the plan will encounter resistance. Many monetary watchdogs -- including Weidmann and, most of all, central bankers from the Netherlands, Belgium and Finland -- have already been very outspoken in recent months about their opposition to new bond purchases.
Many members of the ECB Governing Council view the purchase program that quietly expired at the end of last year as expensive, risky and generally counterproductive. Fewer and fewer central bankers are willing to do the work of the politicians and add more risks to the ECB's balance sheet.
Moreover, the purchases made to date have not proven very successful. When the ECB bought a large number of Spanish government bonds last August, yields declined by more than a percentage point at first. But, soon thereafter, when the ECB cut back on its purchasing program, yields promptly shot back up. In fact, by mid-November, the Spanish government already had to offer investors higher bond yields than before the ECB's emergency measure had begun.
In the case of Greece, the effect has completely evaporated. When the situation escalated there in early May 2010, the monetary watchdogs intervened and, within a few weeks, bought Greek sovereign debt worth dozens of billions of euros. Yields were cut in half after that, declining from more than 14 to about 7 percent for five-year bonds. But then they shot back up above 10 percent within the next month and a half. And when the ECB terminated its purchasing program, the yields on Greek government debt reached new record highs. Today, the situation in Greece is more hopeless than ever.
There is also another reason why the ECB cannot bring lasting calm to the market by buying sovereign debt: The central bank is merely fighting the symptoms of the crisis rather than its causes. But the financial markets only regain confidence in a country's government bonds if its government decisively implements reforms and things start changing for the better.
Not surprisingly, Draghi's most recent plan is being viewed critically in Germany, by monetary watchdogs and politicians alike. Carsten Schneider, the parliamentary budget expert for the center-left Social Democratic Party (SPD), calls the plan an "unconditioned and unauthorized intervention." Critics are also speaking out within the governing coalition, made up of Merkel's center-right Christian Democratic Union (CDU), its Bavarian sister party, the Christian Social Union (CSU), and the business-friendly Free Democratic Party (FDP). Norbert Barthle, the CDU's chief budgetary expert, says that it is "not the central bank's job to buy up government debt." And his colleague with the CSU, Hans Michelbach, is "speechless that Draghi is catering to the comprehensive-coverage mentality of the southern countries." For this reason, says Michelbach, the euphoria in the markets could "quickly turn into depression once again."
That's the tragic aspect of Draghi's rescue idea: What is intended to keep the monetary union together could actually drive it even further apart.
Translated from the German by Christopher Sultan
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