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Update on Europe: ECB Only Trying to Fix One of Several Crises

Mario Draghi has boosted global stock markets and sent many commentators cheering for his elimination of tail risk from Europe. However, he also subverted the democracies of multiple countries in Europe, according to those wild-eyed liberals at CNBC.

With its OMTs the ECB is setting politicial pre-conditions (the often-used buzz word “conditionality”) for executing monetary policy in order to safeguard price stability and the functioning of monetary transmission processes as laid down in its mandate. In other words, the ECB is saying, we will only do our job if certain political conditions are met.

It’s really that simple: either bond purchases of euro countries where yields are blowing up in a fashion that threaten the functioning of the markets are within the ECB mandate. Then the ECB should embark upon them whenever it sees fit. Or they are not within the mandate; then it should jolly well stay away from them, because it would be illegal. Period. End of argument.

But to say “we are acting within our mandate”; but we shall only do so, if you (the country in question) deliver on certain political conditions; then — I am sorry — the ECB is taking on a role it was never designed for and that is certainly outside its mandate.

The bigger problem, according to Silvia Wadhwa, is that the ECB could pursue the bond-buying if they wanted to without the conditionality. But instead, Draghi is holding onto his leverage, in an attempt to force new fiscal conditions on countries that resist them. Gideon Rachman explains how this is playing out. The left-right divisions within the politics of some countries are breaking down in favor of regional/national boundaries. The southern sovereigns are seeing their parties unite against German-led drives to force them deeper into austerity. In Germany it’s the opposite.

Mariano Rajoy explicitly rejected the conditions for bond-buying yesterday by vowing not to seek a bailout. Politically, he’s trapped; allowing the troika to meddle in Madrid’s business would be political suicide. The good news is that Spanish 10-year bond yields did not spike as a result. That suggests that merely the mechanism the ECB put in place could be enough to hold off the bond vigilantes.

In addition, there are indications that German Chancellor Angela Merkel will not only cave on letting Greece stay in the euro, but she will ensure that the troika (the EU, ECB and IMF) will cook their books in order to make that a reality, giving Greece a pass for its budget work. Merkel has bought into the idea that a Greek exit could trigger a set of dominoes falling across Europe.

So if the Grexit gets delayed, and if the expectations channel holds off the Spanish and Italian debt yields, the only real stumbling block comes from the German constitutional court, which will rule on the legality of the new European bailout fund as soon as this week. However, there’s a new lawsuit against the legality of the ECB bond-buying scheme that will have to be adjudicated.

Assuming this all works out, it’s still just a temporary condition, removing the element of crisis, but not the element of a depressed economy. The conditions in the southern countries leading to spikes in suicides and cascading economic suffering remain, and without fiscal transfers to turn this into a true United States of Europe, you’re not going to see much change. As George Soros puts it:

Whereas Germans think they’re already incredibly on the hook for peripheral finances, the fact of the matter, says Soros, is that from the beginning, Germany has only done “the minimum.” […]

Had Germany stretched itself further in the beginning, the reforms would have worked, and Germany would not have lost any money.

Now, he says, “It’s 5 minutes past midnight.”

And in the Germans’ obsessiveness about avoiding inflation (owing to the trauma of the Weimar era), they have now created a housing bubble in Germany, thanks to the rush of safe-haven flows into the German republic.

The ECB is only concerned with staving off one crisis. There’s another one out there.

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David Dayen

David Dayen

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