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Analysis
The secret lies in the sequencing

The secret lies in the sequencing

Madrid and Rome in no hurry to apply for assistance
Shifting blame to the governments

by David Marsh, OMFIF Chairman

Mon 6 Aug 2012

‘Sequencing’ is a favourite word of Mario Draghi, the European Central Bank president. Not surprisingly, doing things in the right order was a feature of his statements at the ECB’s press conference on 2 August. In this case, this means that, before the ECB can wade in and restart buying troubled euro countries’ bonds, governments (principally Italy and Spain) must apply for appropriate financing from the EFSF and (not yet ratified) ESM European rescue funds, and accept the attached economic conditions.

The problem is that neither Madrid nor Rome is in any hurry to go down such a path. So, after all the thrills, spills and speculation of the past few days, we are really back to square one.

Whichever way you look at this, the ECB’s contingency planning unveiled last week falls a long way short of the expectations aroused in Draghi’s rather curious speech at a so-called ‘investment conference’ in London on 26 July. The occasion was itself a little incongruous: an event (where Draghi was introduced with due decorum by Sir Mervyn King, governor of the Bank of England) organised by the UK government to promote the UK ahead of the London Olympics.

The ECB’s lauded readiness to ‘do what it takes to preserve the euro’ has now been hedged in with complex talk of ‘guidance’ rather than ‘decisions’. There is much attention to the myriad ECB sub-groups who will discuss all this (subject to holidays of course) in coming weeks. As Draghi put it on 2 August: ‘The Monetary Policy Committee, the Market Operations Committee and the Risk Management Committee will all work together and produce the details necessary for us to take an explicit formal decision.’ Hmmm… hardly Churchillian stuff.

If Draghi had said in London that the prerequisite for the ECB doing ‘what it takes’ (i.e. outright open market operations) was that ‘governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the established guidelines’ (the words of his opening statement last week), then market reaction 10 days ago would have been a lot less significant.

Draghi was at pains to protest that it was not his fault that the markets had got carried away.

‘Read the speech,’ he advised. ‘The speech does not say anything about timing, bond buying programmes, shorter term – there is none of that.’

The saga of Draghi’s statements reveals an occasional inconsistency between what Draghi tells different audiences. Given that his communications strategy on the whole has improved compared with that of his predecessor Jean-Claude Trichet (notably because Draghi says less and concentrates on the main points), this is something to which he should pay attention. Another example was his interview with Germany’s Bild-Zeitung on 21 March (when he wanted to convey an upbeat mood to presumably gloom-ridden Germans) that the worst of the crisis was over. He revised his line on 2 August when said last month had brought ‘a sense of worsening of the crisis and of the worsening consequences of the financial market fragmentation in the euro area’.

With regard to Italy and Spain, we witness now a re-run (although in reverse) of the episodes between the two countries before they joined the euro in 1999. Shortly after José María Aznar was elected Spanish prime minister in 1996, Romano Prodi, then Italian prime minister, tried to persuade Spain, for all sorts of reasons (some sensible, others less so), that the two should make a joint demarche to postpone the EMU start date. Aznar turned down the idea, saying that if Italy wished to stay out, it would have to do so by itself. We see echoes of this in the weekend statement to the Corriere della Sera newspaper by Antonio Catricalà, cabinet secretary in Mario Monti’s Rome government, that Italy would be ‘mad’ to apply to the EFSF/ESM funds before Spain. Spanish prime minister Mariano Rajoy, although flirting last week with the idea of an approach to the rescue funds, seems to regard the general idea of a formal state bail-out with extreme distaste.

Which brings us to the German Bundesbank and the clearly-discernible handwriting of its president Jens Weidmann in last week’s ECB statement. Draghi at his press conference gave Weidmann a valuable public relations boost by making a lot of the Bundesbank’s objections, even though there can’t have been much in the carefully-worded statement with which the Bundesbank would disagree.

Draghi is one of a dwindling band of still-operating senior officials and ministers who were caught up in the European currency crises of 1992-93 which played a seminal role in the build-up to monetary union. He knows how risky it is to brook full-frontal confrontation with the Bundesbank.

As director of the Italian Treasury two decades ago, Draghi was particularly affected by the Bundesbank’s decision in September 1992 to invoke the shadowy ‘Emminger letter’ (named after a former Bundesbank president). This allowed the German central bank to make use of a secret agreement in 1978 to withdraw from intervening to support the lira in the ERM, forcing the Italians to leave the ERM.

Who resurrected the Emmiger letter in 1992? Step forward then Bundesbank chief Helmut Schlesinger, now a sprightly and affable 87, who retired 19 years ago. Right on cue, at the time of Weidmann’s challenge to Draghi’s ‘whatever it takes’ London pledge, Schlesinger last week re-emerged in news briefings and websites. The occasion was the 55th anniversary of the Bundesbank’s foundation, for which the central bank staged an intriguing joint interview with Weidmann and Schlesinger upholding the bank’s ‘stability-first’ principles.

Schlesinger is nearly twice the age of 44-year-old Weidmann, who could be his grandson. The two clearly get along very well. Weidmann bears a strong resemblance to a younger Schlesinger. The joint message appeared in the Bundesbank’s normally obscure staff magazine. Uniquely, the publication has now become a centrepiece of the Bundesbank’s website, including in a fully-fledged English-language version.

Softly-spoken Weidmann’s uncompromising stance on the Bundesbank’s anti-inflation independence, backed up by Schlesinger as the bank’s monetary overlord, is of more than mere symbolic importance. Weidmann is putting to one side his nominal extreme minority position on the ECB Governing Council. Significantly, contrary to indications by Draghi himself, the ECB Council took no actual vote on the bond-buying ‘guidance’ at the 2 August meeting. Draghi and Weidmann, each anxious that neither should be blamed for any euro breakdown, are trying not to enter into real confrontation.

So, in the coming weeks of euro vulnerability, we shall see further signs of both central bankers shifting responsibility for resolving the crisis to the place they believe it belongs – European governments. The secret, after all, lies in the sequencing. Governments, not the ECB, should take the lead. We shall soon find out if they agree.

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