For the second time, Mario Draghi is revolutionizing the map of the euro. As President of the ECB in July 2012, he averted its bankruptcy with the words: “I will do whatever it takes” to save it and “believe me, it will do”. He immediately created a mechanism to help vulnerable countries, Direct Money Transactions (OMT, for its English acronym), through which he would buy their debt, but only under strict conditions, that is, with a full bailout request from the affected country. It hasn’t got used to it. His mere but powerful incantation was enough of a magic wand against speculators to put an end to the South’s sovereign debt crisis. And from there it accelerated its expansionary monetary policy.
Exactly ten years later, the stability of the euro zone once again depends on him – this time as Italian Prime Minister. If he confirms today his announced resignation from office, tomorrow the Governing Council will be forced to – on the 15th or carryover protection mechanism (of monetary policy).
But even if Draghi reverses course and stays at the Palazzo Chigi, his knock has the same implications: he has already dramatically visualized the danger of a return to eurozone “fragmentation”. It is enough for it to be withdrawn for the risk premium, or incremental cost, of Italian debt relative to German debt to rise rapidly (in 10-year bonds); and thus the additional return of investors in Italian government securities; or the difference that an Italian company or family has to borrow compared to an identical German one: these are the three faces of “fragmentation”. When this occurs, it results in monetary policy’s inability to “propagate” itself to achieve similar outcomes (equivalent rates or very close) across all Eurozone countries, making the central task of the Eurozone impossible makes the ECB, which is supposed to develop a uniform policy for everyone.
Since the Italian government crisis was simmered ten days ago, the premium is up ten percent, nearly twenty basis points (0.2%) above 200 (2%). It has doubled in the past year. Since September, the profitability of the Well it rose from 0.5% to 3.3%. At the smell of rising interest rates, the markets become obsessed with debt (150% of GDP in Italy; 69% in Germany), they demand more profitability to buy it and therefore higher interest rates make it all the more of a strain on your electricity bills; although all government bonds have taken advantage of the interest rate boom to replace old securities with cheaper ones with longer maturities, thus reducing their immediate costs. All of this will only get worse in the face of a collapse of the Draghi government. Except…
… Unless it triggers the immediate creation of the mechanism. That’s what Frankfurt stands for. There are signs that the Italian tap is causing a sudden consensus to emerge between his two prevailing sensibilities. On the basis of the hawks getting a bigger rate hike (eg 0.5% in September or even more or even sooner) their fear of tightening will be satisfied, albeit gradually. And that the dovish are facilitating it, giving in to concerns about the potential recessionary implications of a rally, but in return avoiding what they immediately see as worse: fragmentation. And because higher rates and the establishment of the anti-fragmentation mechanism (against unjustified premiums according to the fundamentals of the respective economy) go hand in hand.
The design of this mechanism poses serious dilemmas. First, at what threshold is a premium considered excessive: there is talk of a reference basket of healthier debt and an implied percentage on top of it (German Joachim Nagel fears this is arbitrary, arguing that it is “practically impossible” to to calculate). .
Second, what size or fire capacity should it have: Belgian Pierre Wunsch, not very expansionist given his country’s debt, calls for it to be “as unlimited as possible”, beyond reinvesting the bonds of the pandemic program that have accrued to him at the end, about 200,000 million annually, judged to be insufficient.
Thirdly, the conditionality must be easy, even the Bundesbank speaks of “strictly defined conditions” but not of “strict conditions”; Otherwise, it will either not be used, or the ECB will be entrusted with an inappropriate task of directly controlling the fiscal policies of the 19 governments. The idea of an appeal to the digestible requirements of Brussels for the approval of the recovery and resilience plans of the Next Generation EU program or a specific validation of the Commission (Risk of fragmentation in the euro area: no easy way out for the ECBBruegel for the European Parliament, June 2022).
And four, which validates the assets [colaterales] used as collateral?Rating agencies, as was customary?: “All valuation‘ claims former CEO Lorenzo Bini. And it is an unsustainable privatization of part of monetary policy, which by definition is public.
reduced by 50 percent
Exclusive content for subscribers