E is nothing markets love more than a good dose of monetary activism, especially when they detect a hidden bailout, so it is no wonder that traders and investors reacted so positively to Mario Draghi’s bond buying plan. But the extent of the enthusiasm on the other side of the Atlantic was almost touching in its naivete, for in reality Draghi’s plan is somewhat more restrained than investors seem to have realised. The Dow closed at its highest level since December 2007; the S&P was at its best since January 2008 and – most strikingly – the Nasdaq was back to November 2000 levels.
Not all of this bounce was caused by Draghi’s announcement, of course, but the soaring equity markets will have delighted Barack Obama, who desperately needs some positive economic news to bolster his reelection campaign. In the short term, of course, the market’s reaction makes sense: Draghi has probably bought the euro a little more time.
Yet generally speaking these days, the more the markets like a central bank intervention, the more I worry. This is because all too often investors are trying to get central banks – and ultimately, the taxpayer – to monetise debt to protect themselves, or because they believe that there are monetary solutions to real, structural problems.
I disagree on both counts: excessive debt needs to be written off, with the cost born by the creditors, not redistributed to the taxpayers of more prudent countries or inflated away. It is right that investors should be able to make a fortune if they make a correct bet – but it is equally right that they should lose their shirt when their investment goes sour. This habit of quietly enjoying the former but loudly refusing the latter is one of the main reasons why the City’s reputation is at such a low ebb.
Equally, there is a perfectly good reason why the yields of peripheral Eurozone nations have shot up over the past year. It is because the markets have finally started to price risk properly. Higher yields on Spanish or Greek debt reflect the reality of deeply troubled, structurally uncompetitive nations in a one-size-fits-all monetary area. Before the euro, there used to be a wide dispersion of bond yields across the continent; after years of ludicrous mispricing, we have returned to that original state of affairs. The market is sending a clear and precise signal, and warning the world that there is a major problem that needs resolution; buying vast amounts of bonds to try and distort or even entirely eliminate that signal and pretend that nothing is wrong with Europe’s weaker economies would be an absurd act of delusion.
But while there are many problems with Draghi’s plans, he is actually being relatively sensible. He will not help Portugal, Ireland and Greece until they are able to access bond markets; even more importantly, Spain and Italy will need to ask for European bailout fund support, and accept the ensuing conditionality, before ECB bond-buying starts. It will theoretically be unlimited in scale but Draghi only wants to “do whatever it takes” as long as politicians toe the line. Given that they won’t, and that many countries will soon be borrowing even more, the crisis will soon flare up again.
The simple reality is that the Eurozone in its current form is doomed. Draghi’s plan will buy some time, and his next one even more, as will the one after that. But eventually the size of the fiscal and competitiveness crisis, combined with voter anger in both Northern and Southern countries, will overwhelm all of his attempts at papering over the cracks. It’s just a matter of time.