It’s been a gruesome week for the euro zone. Spain got blasted by a fusillade of bad economic data. Rumors keep persisting that Greece might get shoved out of the currency union. And the continent’s financial markets have been deteriorating rapidly. Doesn’t anyone have some good news to share?
One person might. On Thursday, the head of the European Central Bank, Mario Draghi, stepped up to the podium and pledged to “do whatever it takes” to save the euro. And that got many market-watchers seriously excited. Because Draghi is one of the few officials who actually does have the power to stanch the bleeding in Europe.
Let’s go to Bloomberg with a closer look at what Draghi actually said:
*DRAGHI: YIELDS DISRUPTING POLICY TRANSMISSION ARE IN ECB REMIT
*DRAGHI SAYS ECB WILL DO WHATEVER NEEDED TO PRESERVE THE EURO
*DRAGHI SAYS `BELIEVE ME, IT WILL BE ENOUGH’
*DRAGHI SAYS THE EURO IS IRREVERSIBLE
As FT Alphaville’s Izabella Kaminska notes, that first sentence might be the most critical, but it will take some unpacking.
Go back to one of the defining structural features of the euro crisis. Countries like Spain, Italy, Portugal, Ireland and Greece all have massive debts. But they don’t control their own currencies. So when these nations’ debts get too large, lenders start fretting that they’ll never get repaid. And that means the borrowing costs, or “yields,” for these countries start soaring. When this happened to Greece, Portugal and Ireland, those countries’ governments all needed bailouts. Now it’s happening to Spain. And Spain is too big to bail out.
In theory, there’s one institution that can step in to ease this problem. The European Central Bank technically has an unlimited supply of euros at its disposal. Mario Draghi could say, “Don’t worry, I’ll do whatever it takes to backstop Spain’s debts.” At that point, fewer people would question the Spanish government’s ability to repay what it owes. Investors could start lending to Spain again, and at reasonable rates. The cycle of doom would calm down. Spain and Italy would have time and space to address their budget woes. Indeed, that’s why some economists have called on the ECB to do exactly this.
So far, though, Draghi and the ECB have been hesitant to go this route. (The central bank has occasionally bought up limited supplies of sovereign debt, but that stopped four months ago.) ECB officials tend to give three reasons for their reluctance: 1) backstopping debt isn’t their job, it might be illegal, and the central bank should just focus on managing the continent’s money supply, 2) buying up debt and injecting more euros into the economy could cause inflation, and 3) backstopping Spanish and Italian debt would create “moral hazard,” at which point nations would feel less pressure to budget responsibly.
Today, however, Draghi appears to be changing his tune. When he says, per Bloomberg, that “yields are disrupting policy transmission,” he seems to be suggesting that the high borrowing costs for Spain and Italy are actually hindering the ECB’s ability to stabilize the continent’s economy. And if that’s the case, then maybe the central bank has the authority to do something about Spain and Italy’s high borrowing costs after all.
At least, that’s how financial markets appear to be interpreting matters. Stock markets in the United States and Europe are rallying mightily today. Granted, everyone could end up bitterly disappointed. Many German officials, including Angela Merkel, aren’t thrilled by the idea of the ECB intervening in the debt markets. They’ll have something to say about this, no doubt. For the time being, then, all we have are some ambiguous remarks by Mario Draghi, the one man who could, in theory, put a stop to the euro crisis. That’s cause for some relief. But it’s very far from a plan.