Draghi’s ‘big bazooka’
Sep 13, 2012
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Last week the president of the European Central Bank (ECB), Mario Draghi, unveiled his “big bazooka” – a bond-buying plan. This came on the heels of his promise to do “whatever it takes” to save the euro. For once, markets were impressed.
The ECB will buy troubled peripheral countries’ bonds with a maturity up to three years in unlimited quantities – provided the country has officially requested help from the eurozone’s rescue fund. So in return for its bond yields (borrowing costs) being kept at reasonable levels by ECB purchases, the country must agree to a bail-out that would come with tough conditions.
The ECB also said it is foregoing the seniority status it held for its previous, limited purchases of peripheral debt. So it shouldn’t “scare off potential private investors through fear that they will be at the bottom of the list to be repaid in the event of a default”, says Capital Economics.
The ECB has taken a huge step towards quantitative easing (QE) as it will print the money to buy bonds. It says it will then remove the printed money from the system by taking deposits from commercial banks. This is a “sop” to the Germans, whose historical fear of inflation makes them anxious about increases in the money supply, says James Mackintosh on FT.com. But it’s “pointless” as long as the ECB continues to let banks borrow as much as they like. This amounts to QE by the back door.
Lead indicators for Britain's economy
So what does this mean for the euro? The ECB “is promising to take away the risk of a euro break-up, the biggest threat hanging over the world economy”, says Mackintosh. A key worry has been a country defaulting as its borrowing costs spiral to unmanageable levels, triggering a Lehman-style meltdown as it bankrupts banks across the continent. By promising to keep bond yields down, the ECB has contained this risk.
However, while Draghi can alleviate symptoms of the crisis, he can’t solve it. He can’t close the growing political divide between the south, tired of having austerity imposed on it, and the north, sick of pouring money into a black hole. Nor can he address the gulf in competitiveness between the periphery and the core. A meltdown may be off the table, but, as Roger Bootle of Capital Economics puts it, “there’s lots more drama to come”.
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