“There cannot be a single currency without economic convergence, or the euro zone will explode.”
– Mario Draghi, European Central Bank president, Dec. 1
Last week, Mario Draghi, president of the European Central Bank, indicated a willingness to take more decisive action to save the euro zone and prevent a wave of national insolvencies that could plunge Europe into a depression.
This represents a change in policy. Heretofore, the central bank has been reluctant to increase its modest purchases of government bonds, approximately $269 billion since May 2010.
Unlike the U.S. Federal Reserve, the primary object of the ECB is to keep inflation around 2 percent within the euro zone. The ECB only has secondary responsibility for implementing monetary policy, conducting smooth operations of the financial markets and holding the exclusive right to issue euro banknotes.
The ECB, the only institution in Europe with enough financial firepower to defend the ability of member states to raise money on bond markets, now appears to favor a bolder intervention in the markets — if Europeans accept the more intrusive rules proposed by France and Germany.
Draghi called on euro zone governments to quickly craft a “new fiscal compact — the most important element to start restoring credibility.”
“What I believe our economic and monetary union needs is a new fiscal compact,” Draghi said. “It is time to adapt the euro area design with a set of institutions, rules and processes that is commensurate with the requirements of monetary union.”
ECB watchers interpreted his remarks as a possible quid pro quo. The bank could expand its intervention as a lender of last resort only after governments agree to strengthen the euro zone’s budget rules.
French President Nicolas Sarkozy and German Chancellor Angela Merkel on Monday endorsed Draghi’s position. They said they would push together to remake the European Union into a more integrated political and economic federation, with tighter legal restraints on how much debt national parliaments can issue.
They also said they would push for amendments to European treaties that would include centralized oversight over budgets and penalties on countries running a budget deficit in excess of 3 percent of gross domestic product.
Merkel warned that euro members would have to accept a loss of national sovereignty. These new regulations would effectively subordinate their economic sovereignty to collective discipline enforced by technocrats in Brussels.
The current turmoil in the euro zone bond markets shows striking parallels to the situation in autumn 2008, when the global financial services firm Lehman Brothers failed. After that happened, bank depositors lost confidence in the stability of the institutions holding their assets. Only a comprehensive government guarantee negated the threat of a run on the banks.
The euro zone now faces a similar crisis of confidence. On Dec. 1, deposits with the ECB rose to $422 billion. This showed that banks were so wary of lending to other banks that they would rather receive low interest of one half percent from the ECB.
Today and Friday, European Union leaders will hold a summit to save the euro. A plan could be unveiled that would:
Commit the euro-zone nations to greater political and monetary unity.
Fast track the creation of a permanent euro-zone bailout fund.
Grant the ECB a more central role in solving the crisis.
Merkel and Sarkozy need to convince the euro-zone member states to go along with their plans for a closer union if they want Draghi to step up the ECB’s response to the crisis.
Originally published in the Sarasota Herald-Tribune
