I read Draghi’s speech today and a few articles parsing it. Draghi is the head of the ECB, and his main job is to maintain the stability of the euro via the support of monetary policy. The main task of stabilizing the euro falls to the national governments of the eurozone who must undertake drastic reforms in order to be able to compete with each other. The PIIGS are widely derided as having sclerotic internal economies, but the northern tier is no better. Try buying anything on a Sunday afternoon in Germany, and you’ll see what I mean.
Since the national governments will not reform themselves, the whole task of saving the euro falls to the ECB. In the long run, these efforts will be insufficient, but in the meantime they can certainly buy time. In this context, you must understand that Draghi is damned if he disobeys his mandate to save the euro and damned if he does not act.
Draghi avers that OMT will not cause inflation. This may be true in the short-term. Over time, we simply do not know what the effects of the bond buying scheme will be. Whenever governments in the past embarked on debt monetization, inflation was usually the result. In the present case, the ongoing deleveraging since the onset of the financial crisis in 2008 has seemingly kept a lid on inflation. No one knows how long this situation will persist.
Draghi’s fears of deflation are unfounded. Prices for food and energy have risen. In the periphery, particularly in Spain and Ireland, housing prices have fallen. These price decreases can be attributed to the bursting of housing bubbles not a deflationary trend. He is using the specter of deflation to justify his bond buying program.
OMT is a program by which the ECB buys sovereign bonds on the open market to support their prices. While the ECB will not be directly financing governments, it will be doing so indirectly. By clearing inventory off the open market, the governments will be able to issue new bonds. Perhaps, OMT does violate letter of the law, but it certainly violates its spirit.
As such, the ECB will be taking much periphery debt onto its balance sheet. No matter what Draghi says, there is a risk to the European taxpayer. If any of these countries defaults, the ECB will lose money on the bonds it is holding. With the economic implosions occurring in periphery, it is not inconceivable that one or more of these countries will default, and the taxpayer will be left holding the bag.
Draghi claims that the conditionality of the program ensures the independence of the ECB. I do not agree. The conditions for OMT, just like the Greek bailout, are being dictated by the Germans. While the ECB may be free from periphery interference, it is dependent on the Germans for both political and monetary support. There is a reason why Draghi is addressing the Bundestag and answering their questions today just like Ben Bernanke does with Congress.
The situation is only going to get worse. Draghi forecasts improving conditions in 2013 but with the Eurozone entering a recession this quarter, Spanish and Greek depressions and a slowdown in China, that is a pipe dream.
Draghi is doing his best, but believe me, it will not be enough.