Europe stands between two events. Last Thursday the European Central Bank decided to back up any future bailout of Spain or Italy with unlimited bond-buying. On Wednesday this week the German Constitutional Court rules on the legality of the European Stability Mechanism.
Markets have decided they love the ECB’s policy and that the German judges will not rock the boat. That should ring alarm bells — the market is often wrong, and many things it loves are bad and dangerous.
But more fundamentally, these two events symbolise that the roiling debate over what to do about the euro is now simplifying. A plan is on the table and the players are dividing themselves into two camps — for and against it.
ECB fills the gap
In the absence of decisive action by politicians, Mario Draghi, the ECB president, has taken the initiative, first with the €1tr longer term refinancing operations to flood banks with cash, and now with his plan for outright monetary transactions — or buying the short term debt of ailing states.
As EuroWeek pointed out in its leader on Thursday, the ECB’s move is not the fairy godmother wand-wave that many bankers and investors had stridently and unrealistically demanded.
Europe’s problems cannot be magicked away by monetary policy. If they want EU help, politicians in the struggling countries will have to take responsibility for committing to reform programmes. And the governments of rich states will have to man up, set the conditions and enforce compliance.
But the ECB’s action is still daring, as well as both politically and legally questionable. It has already divided European public opinion, and this division is likely to become deeper.
Much of the German press has vilified Draghi and the ECB — while elevating Jens Weidmann, the Bundesbank president who was the only ECB council member to vote against the OMT plan, to national hero status.
Some believe this is the moment when Germans will start to turn against the European project. Many are horrified by the undemocratic way in which the unelected ECB plans to print money to lend to Spain or Italy, debasing the currency and creating a huge theoretical liability for the ECB’s backers, ultimately the national central banks.
Words to justify the means
Draghi’s master stroke has been to create a justification for unlimited bond-buying as a means of repairing the broken channels of monetary policy transmission. Whether or not this makes intellectual sense is debatable. Whether it is legally within the remit of the ECB may end up being challenged in court.
But the important point for now is that large sections of European public opinion have gone along with it — not necessarily because they understand and accept the argument, but because they want Draghi to go ahead. The argument sounds clever and respectable enough that politicians, commentators and businesspeople who will basically benefit from the idea can accept it without looking foolish.
The real purpose of the policy, of course, is precisely to take responsibility away from politicians in the rich EU states, who have repeatedly shown that they are too cowardly to offer support to Italy and Spain in the kind of size they need.
German chancellor Angela Merkel and the others — though not the supremely selfish UK — have signed up to the European Financial Stability Facility and the European Stability Mechanism. But their combined resources of roughly €1tr are inadequate to the problem, and governments have not dared to ask their electorates for more, either in the form of cash loans or guarantees, which would not cost anything unless the beneficiary defaulted.
As a result, the existence of the EFSF and ESM has not convinced markets that there is a viable rescue mechanism for Italy and Spain, causing their yields to rise to levels that make it more difficult for them to achieve the adjustments needed. The rescue plan had a huge piece missing.
Now, at last, Europe has one, complete plan. It will involve a degree of facing up to reality and visible risk-taking by the rich countries, and plenty of austerity by the borrowers. But some of the pain will be taken away by the ECB’s monetary sleight of hand.
Some Germans angry, others pragmatic
The choice Europe faces is whether to implement this plan. To judge by the ECB governing council votes, and by the media noise, most countries are roughly on side, except Germany.
And some German market participants say Germany is willing, too.
The business community and the bulk of both the Christian Democrats and the Social Democrats want the euro saved, they argue; Jörg Asmussen, the other German on the ECB board, voted for OMT; and Draghi discussed the plan with Merkel beforehand, presumably winning her approval. Weidmann, these observers say, is acting as a safety valve for public opinion to let off steam.
If German support for Draghi’s plan can be consolidated, Europe may at last begin to hope that the light at the end of the tunnel is not round too many more corners. Confidence about the future is absolutely the most important thing Europe’s economy needs now.
The best outcome would be that the mere existence of a more credible bailout mechanism proves enough to ease investors’ fears about Spain and Italy, so that their yields fall and they never need to seek assistance.
Market participants should stop stressing about whether Spain uses the bailout or not. If the promise of aid is there, that is good for Spain, and if it can manage without it, so much the better.
However, less good outcomes are also possible, including a bailout going ahead — one that is potentially very large.
If that happens, Draghi’s plan will be tested in the fire. No one really has any idea how a multilaterally owned central bank helping to bail out a hugely indebted member sovereign would work out.
There are many dangers — up to and including violent populism and nationalism, and break-up of the EU. Europe will have to choose between solidarity and fragmentation, trust and mistrust. This will be a political battle, fought through every parliament, newspaper and TV channel in the union.
But, because the politicians ducked the task, the terms of the battle and its constitutional content have now been defined — by the unpolitical ECB.
