Mario Draghi's QE blitz may save southern Europe, but at the risk of losing Germany
The ECB has put German political consent for the euro project at risk
By Ambrose Evans-Pritchard, in Davos
5:18PM GMT 22 Jan 2015
Mario Draghi has achieved a spectacular triumph. His headline offering of €60bn (£45bn) a month in quantitative easing comes in the face of scorched-earth resistance from the German Bundesbank and the EMU creditor core. It is finally big enough to make an economic difference.
Yet today's shock-and-awe action by the European Central Bank (ECB) comes three years late, after the eurozone has already been allowed to drift into deflation, and very nearly into a triple-dip recession.
The fact that the ECB is having to act on this scale a full six years into the world's post-Lehman recovery is in itself an admission that policy has been horribly behind the curve. Mr Draghi told us year ago in Davos that warnings of deflation were jejune and that QE was out of the question.
His hands were tied, of course, whatever he really thought at the time. He could not move too far beyond the ECB's centre of gravity. He had to demonstrate that all else had failed, and all else did then fail.
It comes after six years of mass unemployment that has ravaged southern Europe, eroded the job skills of a rising generation, left hysteresis scars, and lowered the growth trajectory and productivity speed limit of these countries for a quarter century hence. It comes as the eurozone's GDP is still languishing well below its pre-Lehman peak, with Italian industrial output down 24pc, back to levels first achieved in 1980.
The bond purchases will not begin until March. They are cribbed about with conditions that may ultimately prove damaging and possibly fatal.
Adam Posen, a former UK rate-setter and now head of Washington's Peterson Institute, said the QE blitz is large, but not as overwhelming as some think. "It will make some difference. It's not going to be enough to fully offset deflationary forces, let alone restore growth, but to the degree that Draghi was able to make it sound open ended is a good thing," he said.
"Ultimately, €1.1 trillion over 18 months versus euro area GDP is roughly a third of what the Bank of England or Federal Reserve did under similar circumstances, and it's likely to take more money to get the same effect in Europe right now," he said.
The limits of delayed action are by now well known. Bond yields are already down to 14th Century lows. The ECB cannot force them much lower, though Mr Draghi did say cheerfully that it would buy debt with negative rates, prompting audible murmurs of alarm from German journalists.
The decision amounts to an act of political defiance by a majority bloc in the Governing Council - unmistakably a debtors' cartel of Latin states and like-minded states - and therefore opens an entirely new chapter of the EMU story.
This Latin revolt is to violate the sacred contract of EMU: that Germany gave up the D-Mark and bequeathed the Bundesbank's legacy to the ECB on the one condition that Germany would never be out-voted on monetary issues of critical importance.
Nor is the irritation confined to Germany. The Tweede Kamer of the Dutch parliament was up in arms today, the scene of fulminating protests from across the party spectrum. "Dutch taxpayers should not be made liable for the debts of the Italian state," said the liberal VVD party.
Mr Draghi said there was a "large majority on the need to trigger (QE) now, so large we didn't need to vote". That is an elegant way to describe a pitched battle. No doubt we will learn over coming days just how many hawks voiced their protest, and with what vehemence.
He also said that the decision to pool 20pc of the risk through collective purchases was pushed through by "consensus", the ECB's euphemistic term for disagreement. This is an uncomfortable fudge.
It is enough to irritate those in the creditor states who oppose any "fiscal transfers" through debt mutualisation. Yet at the same time, it means that 80pc of the bonds will be bought by national central banks at their own sovereign risk, entrenching the sort of "negative feedback loop" that EU leaders vowed to end in 2012. It is a step back towards fragmentation.
Chancellor Angela Merkel said in Davos that the ECB's independence must be respected. Yet she also warned that its actions must be within "reasonable bounds" and in accordance with EU law.
Mr Draghi was quick to tell us that the entire ECB Council had signed off on the principle that QE is a "true monetary policy tool in the legal sense". This gives him some defence against the coming lawsuit by eurosceptic professors in Germany's top court. Serial litigator Peter Gauweiler has already vowed to file a case.
Yet this is a thin shield. Prior rulings of the court have made it clear that scale matters. The bigger it is, the more clearly it leaks into fiscal policy and violates the budgetary prerogatives of the German parliament. This is a sensitive matter. The court has ruled that no supranational body may usurp the budgetary powers of the Bundestag, for to do so would be to rip the heart out of Germany's post-War democracy. This legal battle will drag on.
Let me be clear: I have argued for at least three years that the Latin bloc should seize control of the ECB's machinery and call the German bluff, and this is exactly what has just happened.
They have perfect right to do so. The ECB's policy has been far too tight even for Euroland as a whole. For them it has been disastrous. The slide towards deflation - and contracting nominal GDP - has caused their debt trajectories to spiral upwards even faster.
Yet nobody should have any illusions about the implications of such defiance. What is at stake is German political consent for the euro project. Bernd Lucke, the leader of the AfD anti-euro party, called today's decision an "act of desperation and the introduction of eurobonds by the back door" by the ECB.
The Bavarian Social Christians (CSU) are also furious. "With this decision, the ECB has crossed the Rubicon," said Angelika Niebler, the party's parliamentary leader. The Bavarian finance minister, Markus Soder, said: "unlimited purchases of sovereign bonds threaten to bring down the whole system."
On the Left, Die Linke lashed out at the decision, calling it a gift for insiders. It plunders the savings of the poor to make the "super-rich even richer" by driving up asset prices.
Mr Draghi may have saved Italy from a debt-deflation trap in the nick of time. He may have gained another year or two for Southern Europe to recover before radical populist parties sweep the stale elites from the political scene. But in doing so he risks losing Germany.
The bond purchases will not begin until March. They are cribbed about with conditions that may ultimately prove damaging and possibly fatal.
Adam Posen, a former UK rate-setter and now head of Washington's Peterson Institute, said the QE blitz is large, but not as overwhelming as some think. "It will make some difference. It's not going to be enough to fully offset deflationary forces, let alone restore growth, but to the degree that Draghi was able to make it sound open ended is a good thing," he said.
"Ultimately, €1.1 trillion over 18 months versus euro area GDP is roughly a third of what the Bank of England or Federal Reserve did under similar circumstances, and it's likely to take more money to get the same effect in Europe right now," he said.
The limits of delayed action are by now well known. Bond yields are already down to 14th Century lows. The ECB cannot force them much lower, though Mr Draghi did say cheerfully that it would buy debt with negative rates, prompting audible murmurs of alarm from German journalists.
The decision amounts to an act of political defiance by a majority bloc in the Governing Council - unmistakably a debtors' cartel of Latin states and like-minded states - and therefore opens an entirely new chapter of the EMU story.
This Latin revolt is to violate the sacred contract of EMU: that Germany gave up the D-Mark and bequeathed the Bundesbank's legacy to the ECB on the one condition that Germany would never be out-voted on monetary issues of critical importance.
Nor is the irritation confined to Germany. The Tweede Kamer of the Dutch parliament was up in arms today, the scene of fulminating protests from across the party spectrum. "Dutch taxpayers should not be made liable for the debts of the Italian state," said the liberal VVD party.
Mr Draghi said there was a "large majority on the need to trigger (QE) now, so large we didn't need to vote". That is an elegant way to describe a pitched battle. No doubt we will learn over coming days just how many hawks voiced their protest, and with what vehemence.
He also said that the decision to pool 20pc of the risk through collective purchases was pushed through by "consensus", the ECB's euphemistic term for disagreement. This is an uncomfortable fudge.
It is enough to irritate those in the creditor states who oppose any "fiscal transfers" through debt mutualisation. Yet at the same time, it means that 80pc of the bonds will be bought by national central banks at their own sovereign risk, entrenching the sort of "negative feedback loop" that EU leaders vowed to end in 2012. It is a step back towards fragmentation.
Chancellor Angela Merkel said in Davos that the ECB's independence must be respected. Yet she also warned that its actions must be within "reasonable bounds" and in accordance with EU law.
Mr Draghi was quick to tell us that the entire ECB Council had signed off on the principle that QE is a "true monetary policy tool in the legal sense". This gives him some defence against the coming lawsuit by eurosceptic professors in Germany's top court. Serial litigator Peter Gauweiler has already vowed to file a case.
Yet this is a thin shield. Prior rulings of the court have made it clear that scale matters. The bigger it is, the more clearly it leaks into fiscal policy and violates the budgetary prerogatives of the German parliament. This is a sensitive matter. The court has ruled that no supranational body may usurp the budgetary powers of the Bundestag, for to do so would be to rip the heart out of Germany's post-War democracy. This legal battle will drag on.
Let me be clear: I have argued for at least three years that the Latin bloc should seize control of the ECB's machinery and call the German bluff, and this is exactly what has just happened.
They have perfect right to do so. The ECB's policy has been far too tight even for Euroland as a whole. For them it has been disastrous. The slide towards deflation - and contracting nominal GDP - has caused their debt trajectories to spiral upwards even faster.
Yet nobody should have any illusions about the implications of such defiance. What is at stake is German political consent for the euro project. Bernd Lucke, the leader of the AfD anti-euro party, called today's decision an "act of desperation and the introduction of eurobonds by the back door" by the ECB.
The Bavarian Social Christians (CSU) are also furious. "With this decision, the ECB has crossed the Rubicon," said Angelika Niebler, the party's parliamentary leader. The Bavarian finance minister, Markus Soder, said: "unlimited purchases of sovereign bonds threaten to bring down the whole system."
On the Left, Die Linke lashed out at the decision, calling it a gift for insiders. It plunders the savings of the poor to make the "super-rich even richer" by driving up asset prices.
Mr Draghi may have saved Italy from a debt-deflation trap in the nick of time. He may have gained another year or two for Southern Europe to recover before radical populist parties sweep the stale elites from the political scene. But in doing so he risks losing Germany.
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