Recent remarks by ECB President Mario Draghi have promised to tackle the near-recession level of activity plaguing the Eurozone. But while words have come often, there has been far less action from the central banking system, which seems rife with internal debate and political issues.
First ECB President Mario Draghi ended the first Euro Crisis by saying the ECB would do ‘whatever it takes’ to stabilize the union. Then came ‘whatever it takes’ part two this summer, where he announced a quantitative easing-type program designed to fight off inflation. Both times markets believed that the ECB would follow through.
Last week, the ECB statement put off large-scale asset purchases once again, instead insisting that it is prepared to – you guessed it – do whatever it takes. The problem is that the marginal returns on these declarations are decreasing quickly given that they depend on receiving the confidence of the market, which will only believe the same words so many times before demanding action. Despite his best efforts, Mr. Draghi is turning into the Boy Who Cried Wolf.
Draghi-Germany Relations Chill Even Further
Purely based on their monetary philosophy, German leaders like Bundesbank President Jens Weidmann are at odds with Mr. Draghi. Tight money, and the low inflation that comes with it, has been the cornerstone of the German export-led economy. When combined with the deleterious North-South divide in the Eurozone, Mr. Weidmann ends up diametrically opposed to Mr. Draghi, who is Italian, on nearly every policy issue.
Mr. Draghi, as outlined in his speech at the Federal Reserve Bank of Kansas City’s Jackson Hole Conference in August, believes large-scale asset purchases are necessary to fight a deflationary spiral in the Eurozone. While low prices sound nice, especially to German exporters who maintain their competitiveness through relatively low wages, an extended period of deflation could spell disaster for the broader European economy.
As if the chasm between Mrs. Weidmann and Draghi‘s policies were not a large enough obstacle for good policy-making, reports over the last few months have detailed their ice-cold personal relationship. They simply cannot stand working with each other.
Now, it is rumored (but not confirmed) that three of the ECB’s six governors refused to sign Mr. Draghi’s most recent statement. The crux of the conflict centers around just one word in the policy statement, saying that the ECB ‘intends’ to expand its balance sheet to approximately €3 trillion instead of ‘expects.’
What Would the ECB ‘Intend’ to Buy, Anyway?
It appears Mr. Draghi’s political capital on the ECB Governing Council is fully spent after changing that one word. Still, no large-scale asset purchases have been firmly announced and the European economy continues to wallow at near-recession levels.
Even if the ECB were to start purchasing assets it is unclear what the mix of assets would be. To expand its balance sheet to the €3 trillion as its statement says it ‘intends’ to, the ECB would have to purchase at least €500 billion in assets. Mr. Draghi may wish for a larger program, but diplomatic limitations rule out those ambitions.
In the US and UK, QE primarily targets residential mortgage-backed securities (RMBS) and long-term government debt, but these assets do not make as much sense for Eurozone QE. There are only € 1 trillion of outstanding securitized debt products in Europe (excluding the UK), meaning that the ECB could nearly take a majority-stake in the market with a moderately sized program. That bold of a move would likely even make Mr. Draghi uncomfortable.
As the ECB looks for other assets to fill up its allotted budget, long-term government debt becomes a problem as well. There are no Eurozone bonds, so any government debt would be from member states, like Spain, Italy, and Germany.
Unfortunately, the Creditor-Debtor power makeup already divides Europe and has caused the impasse that the ECB already has. The divided ECB Governing Council agreeing on how much of each country’s debt to buy seems an insurmountable task given its inability to agree on ‘intends’ versus ‘expects’ – and there are still intermediate steps and negotiations that are unlikely to come before then. These latest developments make any eventual QE seem less and less likely.