No Limits: ECB President Draghi Reaches for the Bazooka

By in Frankfurt

European Central Bank President Mario Draghi has taken a bold step this week to contain the euro crisis. The ECB is now planning unlimited bond purchases in order to prevent an escalation of the euro's woes. The step marks a fundamental shift in efforts to save the common currency -- and comes with plenty of risks.

A sculpture of the euro symbol stands in front of the European Central Bank headquarters in Frankfurt: The ECB is pulling out the bazooka to save the common currency. Zoom
AFP

A sculpture of the euro symbol stands in front of the European Central Bank headquarters in Frankfurt: The ECB is pulling out the bazooka to save the common currency.

The big moment almost fell through at the last minute. Thirty minutes before Mario Draghi planned to announce a turning point in the two-and-a-half year drama to rescue the euro, the fire alarm in the Euro Tower in Frankfurt went off. The elevators in the entire European Central Bank headquarters were placed out of service and two fire trucks arrived at the scene. It turned out to be a false alarm and the emergency vehicles drove away a short time later.

It added a bit of tension that the central bankers could well have done without. There had already been enough pressure in the run-up to what may have been the most important meeting in the ECB's history. The 22 members of the ECB's Governing Council had to decide on a program that many experts believe is no less than the solution to the euro crisis -- but which others are viewing as the greatest sin yet committed within the common currency zone.

Following Thursday's decision, the ECB now plans to purchase sovereign bonds from crisis-plagued euro-zone countries in unlimited quantities. Given that the ECB can literally print money, it essentially has unlimited means to buy bonds, thereby, it is hoped, driving down yields on those securities and lessening the interest rate burdens of the affected countries. ECB President Draghi said the Governing Council had approved the plan with an "overwhelming majority". Jens Weidmann, the head of Germany's central bank, the Bundesbank, had opposed the move, but he was ultimately outvoted.

Merkel Airs Concerns

Reactions to the ECB's move varied on Thursday. Financial markets and the International Monetary Fund welcomed the decision. But skeptics of the plan, particularly those in Germany, expressed their reserve. Chancellor Angela Merkel declared that such measures could "not replace" political activities within the currency zone. Bundesbank officials also expressed their displeasure with the development. Weidmann has been warning against the program for weeks now, and on Thursday he became the only member of the Governing Council to vote against the bond-buying program. In Weidmann's view, bond purchases through the ECB "are too close to state financing via the money presses," a Bundesbank spokesman said.

The debate over the purchase of sovereign bonds may at first appear to be a technical one, but in truth it is about something far more fundamental: European unity. Of course, it is also about money. In the future, will the euro remain the currency in which we pay our electricity bills and our mortgages? And what value will the euro still have over time if the central bank is able to make money materialize out of nowhere -- the same money most Europeans work very hard for -- and then pass it on to financially troubled governments?

Draghi: 'Euro Is Irreversible'

Draghi has obligated himself to answer the first question with a "yes". "The euro is irreversible," the Italian said, and he wants to make that clear to investors and financial markets with the new bond-buying program. A kind of self-fulfilling prophecy had taken hold on the financial markets in recent months -- everyone was expecting things to get worse, and so they did. That led to the situation where countries like Spain and Italy were forced to pay ever-higher interest rates when they attempted to borrow money by issuing bonds.

The ECB president said the high yields are the product of "unfounded fears" on the part of many investors. Now, he said, the ECB needs to "break these expectations." The first evidence that it may succeed in doing so could be seen in recent weeks after Draghi first hinted at the possibility of a bond-buying program at the end of July. Since then, bond yields have been slowly dropping. The bank is calculating that just the prospect of a large-scale ECB intervention will be enough to lower interest rates and that, in the best case scenario, it won't actually have to buy bonds. The announcement itself could be enough to calm investors.

But what if it isn't? Then the ECB will be forced to go down a path that is paved with risks. Europe has never seen a program like this before, and it is almost impossible to predict the consequences. Critics of the program are focussing on three main points:

  • The ECB is relieving crisis-ridden countries of fiscal responsibility because the bond buying could threaten to eliminate pressure for them to reduce their deficits and control their spending.
  • If it conducts mass bond buys, the ECB will flood the economy with money and risk causing a devaluation of the currency -- in other words, inflation.
  • The central bank will violate its mandate because it is effectively financing states, which it is expressly prohibited from doing under current European Union treaties. This, they argue, will make it the stooge of euro-zone governments, jeopardizing its independence.

On Thursday, Draghi attempted to refute all of these points. Indeed, the new program has been tailored in a way that it already addresses much of the criticism.

  • In order to ensure that pressure for reforms is still applied to countries like Spain and Italy, strict conditions will be attached to the bond purchases. The ECB will only intervene in the first place if a country agrees to submit to a structural adjustment program administered by the European Stability Mechanism, the permanent euro bailout fund that is expected to begin operating soon. In other words, the central bank will only provide assistance if countries commit themselves to strict austerity.
  • The ECB also countered fears of inflation with the announcement that money that is pumped into the economy will later be removed at other places -- through the sales of securities or through regular lending to banks, for example. The problem here, however, is that the more money the central bank pumps into the system, the harder it becomes to get it back later.
  • The arguments made by the ECB president to counter critics were perhaps weakest when it came to the claim that the bond-buying program is tantamount to providing direct financing to states. Draghi said the primary purpose behind the bond purchases is to make monetary policy in the euro zone functional again. "We are sure that we are acting within our mandate," he said. The crisis, he said, has distorted the mechanisms the central bank generally uses to ensure that money gets pumped into the economy -- and the "monetary policy transmission mechanism" needs to be repaired. To emphasize that, he said the ECB would only be purchasing short-term bonds with maturities of one to three years. He also said that European treaties explicitly prohibit the purchase of bonds on the primary market, but not on the secondary market, as the ECB plans.

'The ECB Will Retain Its Independence'

He also took pains to address concerns the ECB is giving up its sovereignty in decision-making. "The ECB will retain its independence throughout," Draghi said on Thursday. It almost sounded like a mantra. Still, it can't change the fact that the central bank is actually yielding a piece of its independence. That is inevitable -- the simple fact that the ECB is linking its market interventions to the ESM's restructuring program makes it vulnerable to pressure from member governments. But that is probably the minimum price Europe will have to pay to save the euro.

It is also still uncertain whether the plan can actually be implemented for legal reasons. The answer is likely to come next week when, on Sept. 12, Germany's Federal Constitutional Court is expected to rule on complaints against the creation of the permanent ESM bailout fund. The ECB's bond buying program can only commence if Germany's highest court rules that the ESM is compatible with the German constitution. If the court rules against the ESM, those seeking to save the euro will have to go back to square one and drum up new ideas.

Asked by a reporter on Thursday what he would do if the court rejects the ESM, Draghi offered an unsurprising answer. "We really have taken these decisions with total independence," he said.

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1. Unlimited purchase bonds to debt relief
gladiool 09/08/2012
Zitat von sysopEuropean Central Bank President Mario Draghi has taken a bold step this week to contain the euro crisis. The ECB is now planning unlimited bond purchases in order to prevent an escalation of the euro's woes. The step marks a fundamental shift in efforts to save the common currency -- and comes with plenty of risks. http://www.spiegel.de/international/europe/0,1518,854481,00.html
gladiool;07-09-12 To which degree is states' debt covered by states' bonds, not even per se performing past obligations emissions. Infinite puchase to a few existing states' bonds ? States' obligations performing states'debts to be transformed to EU bonds could consequence debt relief if purchased by ECB.
2. Draghi’s "de facto" political unification is overruling Germany's jurisdiction
titus_norberto 09/10/2012
Even though Aristotle spoke about three types of possible political systems (and three corrupted counterparts) in reality there are only two: 1- sovereign state-nations; and 2- a worldwide government and empire. Since the real glue for both, nation and empire, is MONEY, the financial technocrats are in fact taking very serious decisions on behalf of all of US, I mean the populace, either based on technical conundrums or in plainly bad faith. In the way I see the world, which is not how the vast majority sees it, it is obvious that Draghi has just vastly overstepped his position (in a similar manner that Bernanke and his predecessor Alan Greenspan did in USA), and this is how revolutions have been done in the past, the radicals take over by force over the vast majority. Draghi had decided for all of US without consultation that the world will go for the global empire, the Euro is just a mere step forward. Now, the victim this time is the most trusted Judiciary system in the planet, namely the German... The real issue is how this Mephistophelian proposal will be answered by the German people: 1- taking advantage of a unified European currency (it is clear that the Euro vastly favoured German economy so far) by relinquishing SOVEREIGNTY to European COMMISSARS, or; 2- the German High Court will reassert Germany's independence and the RULE OF LAW, I mean Germany’s law, not "world's law", that oxymoronic abstraction to justify OPPRESSION. Behind the Scenes there is a fight for supremacy in Europe and Germany is in the back-foot, Hollande’s France wants to be regarded as the girl with the prettiest legs of the continent while playing second fiddle to the UK (especially in overseas adventures…). UK holds an ambiguous non-committal position of “wait-and-see” supported by USA. Caveat emptor, if perfidy Albion supports but does not commit there is a high risk about… I have noted in the past that no semi-permanent aggregation of nations hidden behind the suspicious banner of an acronym such as "USSR", "US", "UK" and others have been completed without blood..., and that includes USA (Secession war), the UK after the Dutch invasion of 1688, and France (which it is not an acronym but behaves like one, Paris and the rest, especially after Le Revolution) to prove the rule. I do not believe that the situation in Europe has reach this point YET, but Draghi’s unilateral and AUTHORITARIAN decision (with implicit backing from the southerner states plus France et al) is a warning sign… The REAL DECISION is between a coalition of sovereign nations LOOSELY coupled in which the two main principles yielding global peace are universally respected: 1- sovereignty; 2- jurisdiction; or a single global empire ruled through MONEY for which Europe is just the PROTOTYPE. Let US say that Latin America, Japan, China, Russia, India and many more countries, in fact the vast majority, have chosen the path of sovereignty and preserving national jurisdictions. All sovereign nations are eager to revamp the UN (probably basing it outside the US) as an able forum to peacefully resolve conflicts between equally entitled nations. In Germany people does not seem to see the problem in its real dimension, EU membership collides with NATO, UN, IMF, UK and USA, it is difficult to understand how analysts can overlook this evident fact... All these acronyms are self-contradictory, they cannot survive in the long-run without conflict. Who is responsible for the financial rescue in Europe, the IMF, EU, UN, FED, USA, UK, even NATO ? Ridiculous, this situation cannot not resist a rational analysis. As a computer system, this melange of contradictory actions violate the basic priciples of systems in general: 1- separation of concerns; 2- loosely coupling between components (nations); 3- span of control; 4-clear assignment of responsibilities and so on. This "system" is heading for a major crash... Amazing, reality is far more fantastic than fiction. Are we creating a race condition towards WAR as we did in WW I with "mobilization schedules" overriding common sense? Nonsense, spurious financial interests cannot rule the world, SHOULD not rule the world. Spurious financial interests are geared towards a worldwide empire ruled by usurers in the model of USA’s “sovereign” states, and the EU experiment…, global usury DEMANDS imperial power Draghi style; it is as simple as that; fees, interest, commission and capital MUST be collected one-way-or-the-other…. The vast majority of nations have already decided against the “Big Brother” solution; let US say that the odd-balls are USA, EU, IMF, International Court of La Hay, NATO, et al. It is up to Germany to decide soon… Norberto
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