The Man who Broke theThermometer

Published on 2014/08/05

Mario Draghi has been fêted by the media lately. As they have it, he is the man who solved the Eurozone crisis, and who did so with just a few words: “But there is another message I want to tell you. Within our man-date, the ECB is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough.”

With this statement, Draghi put an end to speculations against the Euro on 26 July 2012. He made it clear that the ECB is prepared to buy up government bonds from member states of the eurozone in unlimited quantity.

In the time since, prices of government bonds from crisis-ridden states such as Spain, Italy, and Greece have plummeted, in some cases to historic lows not seen for 200 years.

So is everything ship-shape? Has the Eurozone crisis been resolved? Quite the opposite! The sovereign debt of these countries has gone up by an average of 10% since. The seeming paradox: While the yield on gilt-edged securities is as low as its ever been, sovereign debt levels have never been higher. Many of the aforesaid countries have been reluctant to implement reforms.

The bond yields have precisely not gone down because these countries rolled back their debts or did their homework in terms of labour market reforms, but only because Draghi guaranteed he would buy up the bonds if push came to shove.

The situation resembles that of a patient running a high temperature: Not checking the thermometer for a day or two may be a sensible thing to do in order to calm your nerves. But to simply smash the thermometer and then to declare the patient well is definitely not a good way to cure anybody.

On the contrary: If the patient feels chipper because he erroneously believes to be well again, he will start doing more than he should be doing. He will stop taking his medicine, even though it is essential for his recovery, and may lapse back into the very patterns that may have brought on the symptoms in the first place.

Just like the thermometer indicates the state of the patient, bond interest rates reflect the financial and economic condition of a country. This makes interest rates the market economy indicators par excellence. Draghi’s move has entirely stripped them of this function. Interest

rates in countries like Italy are barely higher than those in Germany – and much lower than they would be without the “Draghi guarantee.”

The crisis countries make themselves believe that the Eurozone crisis has been more or less resolved, and that the danger has been contained. They keep running up debt, delay reforms, and thereby prepare the ground for the onset of the next crisis.

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