As Draghi Drags the European Crisis On

It’s been a busy couple of weeks for central bankers. They’ve been doing nothing, causing all sorts of kerfuffles.

European Central Bank President Draghi stole the spotlight from his American counterpart Bernanke by talking the talk last week. Like some sort of Winston Churchill quote, his words will never be forgotten:

‘Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.’

Cue decision time yesterday and Mario Draghi, like Ben Bernanke, did nothing. This disappointed the markets, to say the least. There was carnage in the foreign exchange market, the stock market and the crucially important European bond market. Our favourite part was this move in bond yields, pointed out by

‘Spanish sovereign bond spreads blew almost 60bps wider today — that is the single-largest absolute move in spreads on record. Almost the entire gain in bonds post-Draghi ‘Believe’ speech from last week has been retraced in a mere few hours. Swiss, German, and Dutch short-dated bond yields all dropped to new record low rates.’

Only a few days ago, Mario Draghi was touting the convergence of the different parts of the Eurozone. Now he is sending bond yields to record divergence by not following up on his empty promise. BNP economist Ken Wattret points out the obvious: ‘…the sense that he [Draghi] jumped the gun last week, at a cost to his and the ECB’s credibility, will linger.’

It’s odd that central bankers have been resorting to big mouths and small actions. It only creates instability. One popular explanation is that the Germans at the ECB have been reigning in Draghi’s gung ho attitude.

They don’t like Draghi’s idea of more government bond purchases, because it rewards the wrong kind of behaviour. It’s bizarre to hear German economists preaching capitalist concepts as applied to government finances, but there you go.

We have a different theory explaining why Draghi was all talk and no action. You see, if he doesn’t have any credibility the next time he makes a grandiose statement, the markets won’t anticipate him actually doing anything. But then, if he does do something, it will surprise the markets into a big reaction. Draghi has been crying wolf in an elaborate ploy to lull investors into a false sense of security…or insecurity, we’re not sure which.

But having central bankers do something is not a great thing for the economy. This video featuring a former Federal Reserve banker shows just why. Central bankers are clueless, erratic and self-centred — exactly the three things they aren’t supposed to be. But what is the alternative to letting them mess about with the economy and the financial markets asks John Maynard Keynes in this economics rap video?

So what would you do to help those unemployed?
This is the question you seem to avoid
When we’re in a mess, would you just have us wait?
Doing nothing until markets equilibrate?

Keynes’ intellectual opponent, Hayek, explains what should be done:

I don’t want to do nothing, there’s plenty to do
The question I ponder is who plans for whom?
Do I plan for myself or leave it to you?
I want plans by the many, not by the few.
Let’s not repeat what created our troubles
I want real growth not a series of bubbles
Stop bailing out losers, let prices work
If we don’t try to steer them they won’t go berserk

Even by doing nothing, Draghi has been steering prices. And yesterday they went beserk.

At some point all of this European bond market stuff will matter right here in the lucky country. Things are so bad over there, you have to wonder whether Australia will be buoyed or pulled down by the mess when it unfolds. Greg Canavan reckons we’re in trouble.

That’s probably right in the short term, because Australia is seen as a ‘risk on’ bet by money managers. They invest when times are good and run for the US dollar when times are bad. But what happens when the fundamentals come into play?

The real question is what those fundamentals will look like when the dust settles. Will the Aussie government have to bail out banks, for example? Will China escape a recession?

It’s pretty tough to invest when you’re faced with this kind of environment. The downside risks are enormous, but doing nothing is extremely costly because interest rates around the world are so low. What makes matters worse is how long the eye of the storm could last. Delaying the crisis is the game policy makers are playing. But at some point the game will be up.

It’s an investor’s nightmare in the meantime though, because the investments that perform well before the crash aren’t the same ones that perform well during it. Investment manager Jeremy Grantham, of Australian housing bubble prediction fame, expressed how just about everyone except policy makers is feeling:

‘The economic environment seems to be stuck in a rather unpleasant perpetual loop. Greece is always about to default; the latest bailout is always about to save the day and yet never seems to; China is always about to collapse but instead teases us by inching down; and I swear the Financial Times is beginning to recycle its reports! In the U.S., the fiscal cliff looms along with debt limits and the usual election uncertainties. The dysfunctional U.S. Congress continues for the time being in its intractable ways. The stock market rises and falls and rises and falls again. It is getting difficult to find anything new to say at client meetings. I, for one, wish that the world would get on with whatever is coming next.’

Be careful what you wish for.

Tomorrow we’ll explain just how the European crisis will finally become unstuck. And no, there will be no hint as to when, just how.


Nick Hubble
for Markets and Money

From the Archives…

How China is Still Making Steel, But There’s No Real Demand
27-07-2012 – Greg Canavan

Governor Glen Stevens and the Art of Central Bank Speech-making
26-07-2012 – Greg Canavan

Australian Mining Tax Policy to be Abolished, Pigs to Fly
25-07-2012 – Nick Hubble

24-07-2012 – Satyajit Das

Has Australia Blown the China Boom?
23-07-2012 – Greg Canavan

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

Leave a Reply

Be the First to Comment!

Notify of
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to