Mario Draghi Sings ‘Flight of the Bumblebee’ for the Eurozone Crisis

September is the latest ‘save the euro’ deadline. Europe’s politicians will come back from their holidays and face a rather large set of issues to deal with; court rulings, elections, austerity and bailout negotiations, and debt refinancing. In fact, the issues may be too large.

There is one man they can turn to. European Central Bank President Mario Draghi. So what does the resident money printer of the Eurozone think about all this?

In case you haven’t realised, the speeches of the world’s policy makers are utter rubbish. And that tends to be rather annoying if you do bother looking. On the ill-advised suggestion of Greg Canavan, we read Draghi’s recent speech — the one which sent stock markets soaring on Thursday. Sure enough, it was an exasperating experience.

But why do you care about Draghi’s ramblings? Well, we may have uncovered Mario Draghi’s little ruse when it comes to saving the politicians from themselves. In his desperation, the ECB President may have revealed the ECB’s trump card. The ‘get out of jail’ that will allow the institution to print money, despite it being forbidden. That would mean Europe’s debt crisis is about to get flooded with cash to put out the fires.

If you think Thursday’s global rally was big, imagine if Mario Draghi walked the walk instead of just talking the talk.

Speech by Mario Draghi, President of the European Central Bank

at the Global Investment Conference in London

26 July 2012

‘I asked myself what sort of message I want to give to you; I wouldn’t use the word “sell”, but actually I think the best thing I could do, is to give you a candid assessment of how we view the euro situation from Frankfurt.’

Huh? Every bit of that opening sentence is bizarre. Is he hinting that everyone should ‘sell’ everything they’ve got? And since when has any central banker been candid? Next up, things get even stranger, with some sort of ‘birds and the bees’ analogy. Presumably telling investors they’re fu…errr…stuffed.

‘And the first thing that came to mind was something that people said many years ago and then stopped saying it: The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does.’

If bumblebees are the first thing on Draghi’s mind during a sovereign debt crisis on his watch, well, ‘I wouldn’t use the word sell’ either. I’d use the word ‘panic’.

‘So the euro was a bumblebee that flew very well for several years. And now — and I think people ask “how come?” — probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis. The bumblebee would have to graduate to a real bee. And that’s what it’s doing.’

Paper planes fly too. Even ones made of euros. But PIIGS do not. Realising his weird bumblebee tangent is a complete waste of time, although it shifts the blame for the euro’s troubles away from Draghi and onto atmospheric conditions, Draghi comes back to the point:

‘The first message I would like to send, is that the euro is much, much stronger, the euro area is much, much stronger than people acknowledge today.’

Saying ‘much, much stronger’ over and over again won’t make it so. Unless you think like a self-centred central banker. In reality, you measure a currency’s strength in what it can buy. Our guess is that the euro could never buy less. It is, after all, Draghi’s job to ensure this. He must maintain a steady rate of inflation — a weakening of the euro. As for the strength of the euro area, it’s falling apart at the seams. That’s what all the hubbub is about.

‘Not only if you look over the last 10 years but also if you look at it now, you see that as far as inflation, employment, productivity, the euro area has done either like or better than US or Japan.’

The unemployment rate in the Eurozone is almost three times Japan’s and 3% higher than the US’. Aside from that, Draghi is comparing the Eurozone to the two developed economic basket cases of our day! One has had persistent deflation and the other only narrowly avoided a Great Depression!

Not only that, but he’s comparing the euro area to individual countries, not continents. Throw in the rest of North America and Asia, and things start to look a little different. What’s remarkable is that Europe is so badly stuffed despite lower inflation, unemployment (according to Draghi) and the rest. Despite these things, the place is the one in trouble.

Perhaps it’s to do with the massive deficits the European governments have been running up? Apparently not…

‘Then the comparison becomes even more dramatic when we come to deficit and debt. The euro area has much lower deficit, much lower debt than these two countries.’

A serious point at last! Draghi points out that the Eurozone as a whole isn’t the worst rotten apple. But he is completely ignoring the imbalances within the Eurozone. The euro chain is as strong as its weakest link. And the weakest links are significantly weaker than America and Japan.

It is precisely the divergence between the parts of Europe that is so dangerous. The fact that they are stuck under the same currency system with completely different needs is exactly the source of the Eurozone’s instability. You can’t just take the ‘average’ if the extremes within it are the danger.

‘And also not less important, it [the Eurozone] has a balanced current account, no deficits, but it also has a degree of social cohesion that you wouldn’t find either in the other two countries.’

Has Draghi lost the plot? Again, he completely ignores the imbalances within Europe. And this time the most glaringly obvious ones. The trade imbalances in Europe are enormous. There are huge trade deficits, not just huge government budget deficits. Germany’s economy floods the place with exports — something that the euro cannot adjust for because it is the currency of the importing nations too.

Germany’s bailouts are the only thing keeping peripheral governments funded at all. This kind of wealth transfer might’ve worked to reunify Germany, but the countries receiving the bailout funds aren’t exactly apologetic over their profligacy, let alone grateful for their bailouts.

People are rioting in half the capitals of Europe and Draghi thinks there is ‘social cohesion’?! What’s remarkable is that the complaints have come from those getting bailed out, not those paying for the bailouts. Just wait till those riots start.

Draghi reckons there is more social cohesion within Europe than within Japan and the US. Are you serious? Has he met a Frenchman?

‘That [social cohesion] is a very important ingredient for undertaking all the structural reforms that will actually graduate the bumblebee into a real bee.’

God, not that again. It gets even more absurd:

‘The second point, the second message I would like to send today, is that progress has been extraordinary in the last six months. If you compare today the euro area member states with six months ago, you will see that the world is entirely different today, and for the better.’

HAHAHAHAHAHAHAHAHA! Stock markets, bond yields, voter sentiment, debt levels, breaches of agreements, debt ratings… Everything is worse. Now the contradictions begin:

‘…while I was glorifying the merits of the euro, you were thinking “but that’s an average!”, and “in fact countries diverge so much within the euro area, that averages are not representative any longer, when the variance is so big”. But I would say that over the last six months, this average, well the variances tend to decrease and countries tend to converge much more than they have done in many years — both at national level, in countries like Portugal, Ireland and countries that are not in the programme, like Spain and Italy.’

Damn right the divergences have decreased — towards disaster. Bond yields of one country after another have been sucked into the ‘unsustainable’ level. Meanwhile, in the real economy, the divergence is as rapid as ever. German companies can borrow money at around half the interest rates their Spanish and Italian friends are paying. Sounds like a great result…

Far Side cartoons

Goldman Sachs reckons this breakdown of debt markets within the Eurozone is messing with the ECB’s ability to conduct proper monetary policy: ‘…sovereign tensions have segmented financial markets in the Euro area, thereby increasing the divergence of bank lending rates across countries, and hindering the uniformity and transmission of monetary policy.’

That happens to be Draghi’s excuse for his coming money printing efforts. More on that in a moment.

‘The progress in undertaking deficit control, structural reforms has been remarkable.’

Yeah right. Greece is about to announce its failure to meet either ‘deficit controls’ or ‘structural reforms’ and the IMF and Germany are threatening to withdraw aid because of it.

‘But a lot of progress has been done at supranational level. That’s why I always say that the last summit was a real success. The last summit was a real success because for the first time in many years, all the leaders of the 27 countries of Europe, including UK etc., said that the only way out of this present crisis is to have more Europe, not less Europe.’

Yes, after they’ve mismanaged on a colossal scale, let’s increase the responsibilities of these plonkers. Let’s give them more power to stuff things up even more.

‘A Europe that is founded on four building blocks: a fiscal union, a financial union, an economic union and a political union. These blocks, … mean that much more of what is national sovereignty is going to be exercised at supranational level, that common fiscal rules will bind government actions on the fiscal side.’

Have fun getting that past the citizenry. The rich nations will not want their money being sent to support the poor and the poor will not want their benefits controlled by the rich. Europe used to be splintered by nationalism. Now the nationalism will combine with class warfare.

Having the same monetary policy where needs differed caused an incredible debacle in Europe. But that was just the first of the four blocks Draghi wants. Imagine the problems the remaining three will cause if the first is this bad. And Germany is already getting dragged down after sharing just one part of its cherished sovereignty. Imagine if it opened up even more to the abuse of other nations.

‘So more Europe, but also the various firewalls have been given attention and now they are ready to work much better than in the past.’

Yes, the part of this saga which is about stopping the euro from melting down while its politicians get on with ‘more Europe’ is given a single sentence of attention by the man charged with stopping the euro from melting down. And one of the firewalls, the European Stability Mechanism, still doesn’t even exist. Its potential existence is being challenged in the European Court of Justice.

‘When people talk about the fragility of the euro and the increasing fragility of the euro, and perhaps the crisis of the euro, very often non-euro area member states or leaders, underestimate the amount of political capital that is being invested in the euro.’

Political capital? Invested? He must mean that a lot of politicians’ careers are staked on it. Let alone his own job. Last we checked, Germany was a democracy. And that means politicians who care about their jobs (have invested their political capital domestically) will eventually figure out that people don’t want a transfer union.

‘And so we view this, and I do not think we are unbiased observers, we think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible.’

No currency is irreversible. In fact, fiat currencies tend to last about forty years on average. The idea that a country can’t leave a union is downright dangerous. It gave the world America’s civil war, for example. Will Draghi build a monetary Berlin Wall around the Eurozone to keep anyone from escaping?

And now for the big statement that sent markets soaring:

‘But there is another message I want to tell you. Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.’

That sounds like a threat. If the citizens of Europe want to leave the euro, the ECB will send its army of coin shooting robots to make them comply.

A lot of people accept that central bankers have to lie to keep things stable. Nobody should accept that they know what will happen in the future. But Draghi reckons, no matter what happens, his policies will keep the euro going. Sounds like a clueless lie, based on presumed omniscience, with one heck of a disclaimer at the beginning in case he fails.

‘There are some short-term challenges, to say the least. The short-term challenges in our view relate mostly to the financial fragmentation that has taken place in the euro area. Investors retreated within their national boundaries. The interbank market is not functioning. It is only functioning very little within each country by the way, but it is certainly not functioning across countries.’

What happened to all that progress and convergence he mentioned a moment ago? Maybe the ‘social cohesion’ doesn’t extend to financial markets.

‘And I think the key strategy point here is that if we want to get out of this crisis, we have to repair this financial fragmentation. There are at least two dimensions to this. The interbank market is not functioning, because for any bank in the world the current liquidity regulations make — to lend to other banks or borrow from other banks — a money losing proposition. So the first reason is that regulation has to be recalibrated completely.’

Why is it unprofitable for banks to lend to each other? Because the interest rates the central bankers like Draghi set are so near zero!

‘The second point is in a sense a collective action problem: because national supervisors, looking at the crisis, have asked their banks, the banks under their supervision, to withdraw their activities within national boundaries. And they ring fenced liquidity positions so liquidity can’t flow, even across the same holding group because the financial sector supervisors are saying “no”.’

More examples of ‘convergence’ and ‘progress’. And from the same people Draghi believes should be combined into one single regulatory body for all of Europe. They can’t even get things right in their own countries.

‘And then there is a risk aversion factor. Risk aversion has to do with counterparty risk. Now to the extent that I think my counterparty is going to default, I am not going to lend to this counterparty. But it can be because it is short of funding. And I think we took care of that with the two big LTROs where we injected half a trillion of net liquidity into the euro area banks. We took care of that.’

Wait, a minute ago he said ‘The interbank market is not functioning.’ But he took care of that…so we’re ok then. Phew.

No, wait….

‘Then you have the counterparty recess related to the perception that my counterparty can fail because of lack of capital. We can do little about that.’

Uh oh. So the banks need saving, the ECB has already saved the banks and it can’t save the banks. It has a limited mandate on what it can do, but it will ‘do whatever it takes to preserve the euro.’ And ‘believe me, it will be enough.’ Except it clearly hasn’t been so far.

Here’s why Draghi believes ‘whatever it takes’ but ‘within the mandate’ will be enough. His interpretation of ‘within the mandate’ is rather broad:

‘To the extent that the size of these sovereign premia hampers the functioning of the monetary policy transmission channel, they come within our mandate.’

In other words, if interest rates on sovereign bonds blow out, that messes with the ECB’s ability to conduct monetary policy. And the ECB conducting monetary policy is something the world couldn’t exist without. So the ECB can intervene in any way that allows it to conduct monetary policy.

The ECB President thinks he has found a way to monetise debt. He isn’t allowed to do so directly. But if the debt markets become such a mess that the ECB can’t do its job, anything goes as far as trying to normalise those markets.

Money printing, here we come!


Nick Hubble
for Markets and Money

From the Archives…

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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.

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