How the ECB came to control the fate of the world economy
from Mark Weisbrot
World stock markets and European bond markets rallied last week in response to three words that came from the mouth of Mario Draghi, the head of the European Central Bank (ECB): The ECB would do “whatever it takes” to preserve the euro. This was widely interpreted as a promise to intervene in the sovereign bond markets to push down borrowing costs for Spain and Italy.
What does this all mean to the average person in the eurozone, or in Spain where unemployment just hit a record 24.6 percent? Or in developing Asia or Africa or Latin America – or even the U.S.? Most importantly, it means that the ECB has always had, and continues to have, the power to end the immediate crisis in the eurozone, but has refused to do so. Not for any of the economic reasons commonly believed – such as worries about sovereign debt or inflation. Rather, they have refused to end the crisis for a nefarious political reason: in order to force the weaker economies of Europe to accept a regressive political agenda – including cuts in minimum wages and pensions, weakening of labor laws and collective bargaining, and shrinking the state.
The ECB and its allies feared that if they stabilized these bond markets, their leverage over the peripheral countries would be reduced. So for more than six months now the ECB has refused to buy Spanish bonds, which would push down yields as it did in similar crises last year. This is a nasty and dangerous game of chicken, because the ECB obviously doesn’t want to reach a point where the crisis spins out of control. What happened last week is that the ECB finally blinked, in the face of mounting fears of a worsening recession, and political pressure. According to press reports, some of this pressure came from President François Hollande of France, who was elected by anti-austerity voters, and some even from within the IMF itself. The IMF is part of the Troika (with the ECB and European Commission) that determines economic policy in the eurozone, but it is a subordinate partner. The Obama administration has also been pressuring the European authorities not to be so extreme, since the sluggish U.S. economy is hurting his re-election chances.
While the financial markets that rallied yesterday and today are not the same thing as the world economy, the economic uncertainty that has been created and exacerbated by the European authorities has been tanking not only these markets but also real economic growth in much of the world economy, from South Korea to Brazil. The world economy is expected to grow by just 3.5 percent this year, as opposed to 5.3 percent in 2010. This is a difference of tens of millions of jobs worldwide, and more than a trillion dollars of lost income. While there are home-grown weaknesses in various countries and regions – including the world’s two largest national economies, China and the United States – it seems that the mess in Europe is currently the biggest drag on the world economy.
The epicenter of the storm has recently been Spain, first because of severe problems in its banking system. But then the markets began to speculate against its sovereign bonds, with Italy also under threat. These too-big-to-fail governments – in terms of their sovereign debt – have watched their sovereign bond yields rise to record levels that have generated increasing fear and uncertainty in European and world markets. And it is here that one institution, granted “independence” by its founders, holds the key.
With just three words Mario Draghi pushed the yields down on Spanish and Italian bonds, and they continued to fall on Friday as Hollande and Merkel issued a joint statement seen as backing Draghi, “to do everything to protect” the euro.
The benchmark Spanish 10-year bond is now down more than a percentage point from its record last week, to 6.6 percent. This is still too high, but fears that these would reach the level where Spain would no longer be able to borrow on private markets – as happened to Greece, Ireland, and Portugal – have subsided.
Of course, the markets have been grossly exaggerating the probability that Spain could default on its debt. Spain has about 94 billion euros of debt to roll over next year, so even if it had to borrow at today’s high interest rates it would not add very much to its overall debt burden. And it can increase its short-term borrowing as well. Spain is currently paying about 2.4 percent of GDP in interest on its public debt, which is quite reasonable.
It is really the actions of speculators in financial markets that have driven Spanish bond yields to these high levels. But the ECB was letting it happen, in order to achieve its political purposes. What Draghi did yesterday was to inform the speculators that their bet against these bonds could be a two-way bet – i.e. they could lose money when the ECB intervenes. Now we will see whether, and to what extent, the ECB is committed to stabilize these bond markets.
Within less than 24 hours the German central bank tried to pour some cold water on Draghi’s statement by declaring its opposition to sovereign bond purchases. Although it represents the most powerful country in the eurozone, the Bundesbank cannot necessarily veto such a decision by the ECB’s 23 member board. But it has a lot of weight and its opposition indicates that there will be continued struggle among Europe’s rulers as to how much the ECB will do to contain the current crisis.
Of course containing and even resolving the immediate crisis is one thing; pulling the eurozone out of recession and back toward higher levels of employment are another. The ECB could end the immediate crisis by simply setting a reasonable ceiling on Spanish and Italian sovereign bond yields, thereby ending fears of sovereign debt default in these countries. But to bring about an economic recovery in Europe, the European authorities would have to reverse their destructive fiscal policies – the budget tightening that has pushed the eurozone into its second recession in three years. That is what people with common sense are fighting for in Europe.
Meanwhile, former Greek Prime Minister George Papandreou announced this week what he wouldn’t say when he was in office, but what some of us have suspected: that the intention of the Troika’s policies in Greece were even worse than forcing the regressive policy changes as I described above. “There was a sense: ‘Punish them,” he said. “’We have to be careful that if we make it too easy for a bailout, others will want similar things.’ ” That seems to be one of the reasons that the European authorities have destroyed the Greek economy. Clearly, it is not for lack of resources that the Troika is heading for another showdown with Greece as the economy shrinks a projected 7 percent this year: the few billion euros at stake in the forced budget tightening for the next two years are pocket change for the European authorities but will mean more pain and unemployment for the Greek people.
There is still some way to go before the European authorities put an end to their destructive social engineering and the collateral damage it is doing to the world economy.