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Draghi dreams about monetary policy always within the (ECB) mandate. Whether he dreams in Italian or German, he can´t say.

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When Draghi was asked at an exclusive session of the World Economic Forum (WEF) by Philip Hildebrand, the former governor of the Swiss Central Bank and since October 2012 the Vice Chairman of Blackrock, whether he “dreams of monetary policy in Italian or German”,  his nightmares with the “pervasive German angst” suddenly entered the Davos session, judging from how he answered this somewhat mischievous question. ”It is hard to say in which language I dream, but the objective always is price stability, that´s our mandate, everything we´ve done so far is in the mandate”. (See:www.weforum.org)

Since the European Central Bank cut its main interest rate to 0,25 percent on Thursday 7.November 2013 – and two German members of the ECB´s 23-member governing council led a six-man revolt against this unexpected move- the strained relationship of the ECB leadership with the euro area´s largest member country worsened.

Although we were primarily interested in what Draghi had to say about where we stand on implementing the mega-project of European banking union, here a few  points he made in the Davos talking to the world´s business and banking leaders.

Facing never ending praise for his reset statement „in the struggle to avoid the break-up of European monetary union before the London investment conference at Lancaster House on 26. July 2012  –  that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro – and believe me, it will be enough” – Draghi was eager to deflect some of the glory for saving the euro to European leaders.

He argued that European leaders also deserve credit for the eurozone recovery, citing the commitment taken at the June 2012 EU summit. In his view the markets “have been vastly underestimating the amount of political commitment” that European countries have into making the euro a success”- That part of his London speech in the summer of 2012 had been widely ignored.  At Lancaster House Draghi said: “When people talk about the fragility of the euro and the increasing fragility of the euro, and perhaps the crisis of the euro, very often non-euro member states or leaders, underestimate the amount of political capital that is being invested in the euro”.

Looking back what has been achieved since his “whatever it takes speech” in the summer of 2012, Draghi pointed to rising stock markets – about 50% globally and 70-8o% for shares of financials while bond yields – and thereby borrowing costs – have fallen .. In his view risks have decreased all across the board, not only in core countries but also in the periphery. He specifically points to the fact that for Germany target II balances decreased by about 30%. And he sees “signs that the recovery is finally reaching the real economy, with encouraging surveys”, but he concedes that “hard data (on the real economy) is not so good”. His bottom line assessment:  He sees the beginning of a recovery that is “still weak, still fragile, and still uneven, still based on exports, but signs in recovery in domestic demand”. Unemployment, especially your unemployment, is still far too high. Youth unemployment in some member states of the periphery are an example “that labor markets must be reformed”.  And he realizes that “fiscal consolidation in the eurozone should be more growth-friendly”. He criticizes that countries took the easy way out by “raising taxes in a world where taxes are already high” with little progress on reducing government spending and huge cuts in capital expenditures”.

Draghi concedes that the eurozone inflation is below target and will remain below for some time. But he doesn´t  see deflation in the euro area, i.e. defined as a broad-based fall in prices. As Draghi explains, core inflation is being pulled down by the rates of the four programme countries, partly due to internal rebalancing in the euro area. Medium-term inflation expectations are firmly anchored at 2 per cent, said Draghi.

Draghi was more cautious than his interviewer Hildebrand who said that “there has been tremendous readjustment in peripheral euro countries in recent years”. Hildebrand reminded the audience that “Germany is the only country with a lower youth unemployment rate since the crisis started”.

Draghi is more circumspect  pointing to an OECD report, Economic Reforms: Going for Growth (http://www.oecd.org/eco/growth/going-for-growth-2013.htm) in which the so-called “program countries” in the eurozone like Greece, Ireland, Portugal and Spain (together with Eastland) were leading a list of OECD “reform champions”.  At the bottom range, Germany was listed before Slovenia, Belgium, Netherland and Luxembourg. Draghi put this into perspective arguing “that Germany is last because it made these reforms 10 years ago”.  Without giving names Draghi lamented that also some core countries need to reform  “not because they did it 10 years ago but because they they´ve not done it”. Did he only mean France or also Italy, where he shared some responsibility as deputy finance minister and central bank governor?

And how does he view the mega-project of European banking union – especially the ECBs new role under the Single Supervisory Mechanism (SSM), the upcoming Asset Quality Review (AQR) for the largest banks in the euro area (around 130) and the upcoming stress test by the London-based European Banking Authority (ABA)?

On that delicate issue Draghi sent mixed signals. He asserted that he did not know whether any banks would need to be shut down following a correct appraisal. That he does not have any expectation on the outcome of the AQR. He had good news but also dire warnings. When Hildebrand argued that European banks had raised about 500 billion Euros since the beginning of the financial crisis to strengthen their capital Draghi added “that one half came from public sources and the other half from private markets”

First, the good news: A return of confidence into the banking sector. Banks were able to issue bonds in significant amounts for some time and the difference between what banks are paying and non–financial firms pay to borrow have diminished to zero. This means that the high fragmentation of the eurozone banking sector – i.e. banks in the periphery paying more for credit than in the core – is being addressed.

Second, his warnings. “Shedding light on banks’ balance sheet should help them raise capital in the market. And of course, banks that should go, should go”. Draghi put banks on notice.

It gave Draghi a chance to show how much the euro area´s financial system had stabilized since his London speech on 26 July 2012 before the Global Investment Conference.

The Draghi -session was also another of those self-congratulation exercises where the finance industry got a chance to praise the top-central bankers who make sure that the bail-out euro billions at taxpayers’ expense are flowing so that banks and investors are able to cut their losses and again make a lot of money.

Klaus Schwab introduced Draghi as “the best educated, best experienced central banker in a critical role guiding us through the worst financial crisis since the Great Depression”, And he outed himself as an ardent supporter of European Monetary Union (EMU), Schwab recounted that he had made the prediction that the euro area would not break up in his recent book.

WEF-founder Schwab (whom I once characterized in a portrait for Handelsblatt as “the only human bein  on earth whom the Almighty would call from heaven if he wanted to speak to the world´s most important leaders) again showed his world-class matching skill :  A top-manager of the largest investor is questioning the top-central banker for the euro area who has been securing the investments in bonds and in equities. Since the “Economist” recently put “Blackrock” on its cover, more is known about the biggest investor in the world with $4,1 trillion of directly controlled assets (almost as much as all private-equity and hedge funds put together) and another $ 11 trillion it oversees through its trading platform.

One important message from the ECB s president exclusive Davos session is that German anxiety – expressed in the mass tabloid “Bild” by the president of Ifo Hans-Werner Sinn – that “Draghi abused the euro system by giving cheap loans to the southern countries, of the kind that they would not get on the capital market” or the characterization of the recent benchmark interest rate move  by Wirtschaftswoche as “diktat from the new Banka dÍtalia, based in Frankfurt” – must have some impact on the way how “Super Mario” is dreaming these days.

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