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The Mario Draghi Put

Updated on September 30, 2012
Mario Draghi
Mario Draghi
Old School (MIT)
Old School (MIT)

Draghi Is Old School and the School is MIT

Great attention has been paid to the internal politics and conflicts at the ECB; in relation to Mario Draghi's unlimited bond buying announcement. His announcement seems to have been tempered by the resistance of the Bundesbank. A compromise appears to have been found; by which the ECB will insist upon conditions of austerity being implemented in the recipients of this conditional support. Pundits opine that this conditionality is no different than the Carthaginian terms of an EU led bailout; that would cause even more damage to the economies of the countries receiving this support.

Actions however speak louder than words; and it is the actions of Spain and Italy that provide the most interesting signals. Having seen their Sovereign Bond yields fall out of the danger zone, it is now believed that these two countries are dragging their heels on seeking a bailout. Commentators observe that these falls in yields are actually in anticipation of the two countries requesting a bailout. Logic then dictates that, if they do not follow this course of action,their yields will rise; and they will be forced to seek a bailout ultimately. This logic ignores what Mario Draghi's words were really indicating.

Suddenly, there is an alternative to a fiscal bailout. This alternative is unlimited ECB bond buying aka Quantitative Easing. Mario Draghi has effectively made the ECB the Federal Reserve of Europe. There is therefore another policy tool to complement fiscal austerity in solving the European Debt Crisis. This policy tool is Monetization; and it is something that the ECB's mandate allegedly precludes it from doing. Draghi however has done it in practice and committed to it in words; so there is no turning back.

Why Mario Draghi would take this route is not hard to understand. He is an alumnus of MIT; as is Ben Bernanke and Mervyn King. One can therefore see that the practical "Minds and Hands" approach to central banking shares a common root for the ECB, Federal Reserve and the Bank of England. It should thus be no surprise to find out that Draghi is following the same monetary policy tools as Bernanke and King. There is therefore a Draghi Put, represented by the word "unlimited". This also implies that there is a King Put. Perhaps they all should really be called the MIT Put.

The implications of this conclusion are profound. Far from being the bastion of Monetarist orthodoxy, the ECB is now at the cutting edge of monetary policy to enable Keynesian fiscal policies. There is also a profound political implication that goes with the economic one. It has been assumed that European countries seeking a bailout from the EU would be required to surrender to fiscal and political union. It was anticipated that this loss of sovereignty would lead to political chaos and social unrest. The advent of Dragh's unlimited bond buying removes the necessity for the abandonment of sovereignty in return for a bailout.

It is unlikely that Draghi's revolution will be without further resistance from Germany. Legal challenges to the legitimacy of Draghi's policy can be expected. There is however a subtle political seduction for German politicians from Draghi. Unlimited ECB bond buying means that German and other "Core" taxpayers do not have to transfer wealth to the South. The printing of Euros by the ECB will also a be a welcome shot in the arm for German industry; and its effect in weakening the Euro will be another positive externality. Perhaps the most subtle seduction is that further political union is avoided; so that Germany remains unconstrained by the EU. A Federal Europe, rather than one centrally controlled by the EU, is not without its admirers in Germany; as it means that Germany will still have the most power and influence.

We may have to wait some time for the hyperinflation, that the Bundesbank foresees by following Draghi's strategy; but in the meantime depression and social unrest will be averted. Europe may also remain a group of nation states, much to the chagrin of the EU.

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