Putting Draghi in Perspective

Global investment markets rallied strongly Friday after European Central Bank President Mario Draghi said the ECB would “do whatever it takes” to preserve the euro. That excited investors more than it should have, but I think it’s main effect was to cause a bunch of short sellers to take their profits for now. Often overlooked in the reports on Draghi’s statement was his qualifier “within the ECB’s mandate.” That’s always been the sticking point between the ECB and people who want it to be more aggressive in saving the European economy. The ECB doesn’t have as much flexibility as the Federal Reserve.

More importantly, central banks can solve only a liquidity crisis. Europe has a solvency crisis. The ECB can solve that only if it is able and willing to buy all the bad loans and take the losses itself. It doesn’t want to and isn’t allow to anyway. This article puts Draghi’s words into context, pointing out that the ECB (and the Fed) use public statements to move markets so they can delay having to real action. Also, in the past the ECB’s actions have had temporary benefits for the markets, and things ended up worse after the ECB’s actions wore off.

But then, what did we think Draghi was going to say? That the euro is doomed, and there’s nothing to do about it? It’s all part of the script Europe’s leaders have been following for three years now: “Don’t worry, we got this.” And yet here we are, stuck in the most recent cycle of unraveling. The latest trend was pretty dire, as the yield on Spain’s 10-year bonds had risen to 7.69 percent by Tuesday. Italy’s had reached 6.5 percent. The contagion appeared even to be creeping into Germany, whose safe-haven status was called into question earlier this week when Moody’s announced it was placing the nation’s AAA rating under review. If the Germans aren’t safe, who is?