by Nomi Prins
In Southern Europe, things went from bad to worse. On October 31, Greek prime minister Papandreou called for a national referendum on the second bailout agreement. He called it off after the center-right opposition agreed to back a revamped EU-IMF deal. He was forced to step down by Western European leadership, in particular, the heads of state of France and Germany. Merkel said: “We would rather achieve a stabilization of the euro with Greece than without Greece, but this goal of stabilizing the euro is more important.” Sarkozy hammered home the same message, saying in a joint news conference with Merkel, “Our Greek friends must decide whether they want to continue the journey with us.”119
Even the IMF’s Lagarde levied significant pressure. Without the IMF, Germany, or France, the Greek economy would never survive in such a state on its own, unless its debts could be forgiven, which core European elites were unwilling to contemplate.
“At the IMF’s annual meeting in Washington the first thing Lagarde emphasized in talks with Venizelos was the need for consensus,” confided a top aide to the minister. “She asked him bluntly, ‘What Greece am I talking to, the one who endorses reforms, who accepts austerity or the one who doesn’t?’ She was very concerned by the stance of the political opposition, especially the [main opposition] conservative party which has repeatedly refused to endorse the [EU-IMF] fiscal adjustment programmes.”120 She was seemingly concerned about whether what was occurring with Greece could be repeated throughout the weaker economies of Europe, which would threaten the strength of the EU more generally as a result.
For instance, in Italy, two days before the IMF meeting, Silvio Berlusconi proclaimed that he alone could save Italy and “there is no chance for me to step aside.”121 It was fortuitous timing—but not for Berlusconi. He knew the economy and financial system were shaky.
Draghi wasn’t going down with that ship. He had been announced as the replacement for Trichet on June 24, 2011. Before taking office, he had favored the German policy of inflation fighting with higher rates and a stronger euro over the Fed’s cheap-money policy. But power and a higher seat at the table of central banker elites were a potent elixir. Draghi would be exposed to wide skepticism regardless of his actions if the Italian economy truly tanked. He knew he had to act as a part of the establishment, while also setting himself apart enough to show strength.122
On November 1, 2011, Draghi assumed Trichet’s role as head of the ECB.123 Draghi, with a fondness for expensive, well-tailored black suits, was sixty-three when he was appointed.124 Once at the helm of the ECB, he followed the Fed’s prescription of cheap money without hesitation. His opening gambit was to reverse Trichet’s policies. Draghi cut rates twice before year-end, including by 0.25 percent within two days of his arrival.125 He also expanded the existing covered bond purchase program.126
Draghi, in contrast to Trichet, was brief when questioned about anything. With a PhD in economics from the Massachusetts Institute of Technology, the ascending central banker believed he understood what banks needed: access to cheap capital. He had been a former managing director and vice chairman at Goldman Sachs, where he worked from 2002 to 2005. That post combined with his political experience truly established him in the elite networks of international and European finance. And he would deliver cheap money to big finance in return.
Early in his career, Super Mario, as he was known in Italy, helped draft legislation to govern the Italian financial markets (the so-called Draghi Law). He went on to become governor of the Bank of Italy, where he served from 2006 to 2011 before becoming the ECB president.127
On November 10, 2011, Lucas Papademos, former ECB vice president and governor of Greece’s central bank, was named interim prime minister of Greece to work on guaranteeing the country’s permanence in the Eurozone. Papademos had never held an elected office.128 The desperate measures confirmed the strong relationship between power and money in turbulent times.
Since the beginning of 2011, foreign bank deposits at the Fed had doubled from $350 billion to $715 billion, ensuring the dollar’s status as the world’s reserve currency.129 Even after Standard & Poor’s had cut the United States’ AAA credit rating on August 5, the dollar went on to appreciate 7.2 percent and was the second-best-performing currency after the yen during the period. This move was counterintuitive, considering the US budget deficit had reached more than $1 trillion and unemployment hovered around 9 percent.
This behavior struck at the core of the problem of international currencies. The market, investors, and most economists couldn’t conceive of a change in the international monetary system structure. Instead, they clung to the same unreliable system.
On November 30, the key central banks (of Canada, England, Japan, the European Union, the United States, and Switzerland) searched for proof that their methods were effective. But they still didn’t think there was enough liquidity to keep the international financial system humming. Leaders collectively agreed to lower the pricing on existing US dollar liquidity swap arrangements by 50 points.130 They established temporary bilateral liquidity swap arrangements so they could inject funds into each other’s central banks if necessary for use by their respective banking systems.
With that sorted, at the European parliament in Brussels, Draghi moved beyond the scope of a central banker, like his predecessor had, and called for more fiscal policy: “What I believe our economic and monetary union needs is a new fiscal compact—a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.”131 What he meant was—more austerity.
By the end of November 2011, Tim Geithner, after five trips alone to Europe to meet with bankers and various figureheads, said that European leaders were “moving ahead, but we just need them to move ahead more quickly and with more force behind it.”132 During the first week of December, Geithner arrived in Germany on the first leg of another trip to meet with European leaders, including a one-and-a-half-hour meeting with Draghi.133
Geithner declined to comment on the visit, but his goal was to urge European officials to do something to prevent a full-blown debt crisis.134 He and Obama worried that a European crisis could affect the fragile US economic recovery. It was important that Europe find a collaborative solution. US officials saw Europe as a critical part of the economic-political system. Geithner went to Europe to “emphasize how important it is to the US and global economy to succeed in building a stronger Europe.”135 The move had a political motive as well—upcoming elections. However, the United States was unwilling to augment the IMF’s resources to provide liquidity to Europe.136
That meant more money conjuring was on the docket.
Two days after Draghi met with Geithner, the ECB announced it would cut rates by 0.25 percent. The rate on main refinancing operations was reduced to 1 percent, the rate on marginal lending facility to 1.75 percent, and the rate on the deposit facility to 0.25 percent.137
On December 16, 2011, at a House Oversight and Government Reform subcommittee hearing in Washington, New York Fed president William Dudley classified the European sovereign debt crisis as “their problem to solve,” affirming that the United States would not continue buying European debt. He noted, “The bar to doing that would be extraordinarily high.”138
Nevertheless, he defended currency swap agreements to provide access to US dollar funding, which for him was “in the US national interest,” by ensuring credit flow to US households and business.139 To him, Europe had the “fiscal capacity needed” to deal with the sovereign debt crisis, it just needed the political will.
Steven Kamin, the Fed’s director of international finance, declared, “It is incumbent upon European authorities to address all these issues.” The Fed and other regulatory agencies were “very alert” to the risks of short-term European bank debt held by US money market funds, which have “been substantially reducing their exposure” to the most vulnerable European economies. The Fed swap lines could work as a safeguard against market liquidity problem
s, helping European financial institutions get the dollar funding they needed, he said.
Super Mario leapt to the rescue. He steered the ECB to inject €1 trillion into the European financial system in three installments from December 2011 to January 2012 to maintain liquidity and reduce borrowing costs in Spain and Italy.140 It worked for a short time, as most temporary Band-Aids do. By May 2012, borrowing costs were rising again.141
Another problem was plaguing Europe: the south’s swing toward austerity-touting political parties was on the rise, even though austerity seemed to go against their populations’ best interests. On December 21, 2011, Mariano Rajoy of Spain’s conservative People’s Party was elected prime minister. It was the Right’s biggest win in Spain since the end of the Franco dictatorship in 1975.142 Rajoy’s first austerity measures were public spending cuts set to start in July 2012.143
By year’s end, the euro had fallen to its lowest level since June 2001 versus the yen.144 It also sat at a fifty-two-week low against the dollar.145 Even after two years of summits to discuss the depressed situation, and the bailouts of Greece, Ireland, and Portugal, the European debt crisis was not contained. The opposite. Contagion now threatened Italy and Spain.
WHAT RECOVERY?
Tensions mounted globally over the absence of a solid economic recovery anywhere, especially in the developed markets. In Europe, concern about the sovereign debt crisis and Italy and Spain rose. Draghi showed his commitment to expansionary policy. Under his guidance, the ECB announced it would cut the deposit rate to zero for the first time on July 5, 2012, and flirted with the idea of expanding its asset purchase program.146
Although most of the governments in Europe approved of Draghi’s expansionary policy, criticism was in no short supply, especially from conservative parties in Germany, which elevated tensions. Most of the mainstream media accused the ECB of hijacking authority over economic policies in Europe rather than monetary ones.147
On January 13, 2012, S&P downgraded France, Italy, Spain, Portugal, and five other Eurozone countries, blaming Eurozone leaders for failing to deal with the debt crisis. Three days later, it downgraded the EU bailout fund and the European Financial Stability Facility. German federal minister of finance Wolfgang Schäuble downplayed the news, saying, “In the past months, we’ve come to agree that the ratings agencies’ judgments should not be overvalued.”148
Whether their judgments were appropriate or not, Southern European countries had been held hostage to the agencies’ ratings since the onset of government bond purchase programs that favored Germany (only investment-grade bonds could be purchased).
On January 24, a new IMF report concluded the world economy, particularly emerging markets, faced risks due to the situation in the Eurozone.149 Yet to confront deteriorating growth and uncertainty, the IMF embraced the same conjured-money policy that hadn’t moved the needle. “There are three requirements for a more resilient recovery: sustained but gradual adjustment, ample liquidity and easy monetary policy, mainly in advanced economies, and restored confidence in policymakers’ ability to act.”
About a week later, Bernanke explained to the US House Committee on the Budget that the US economic recovery remained “frustratingly slow” and that the European debt crisis represented an extra challenge on the path to restoring growth.150 He warned that new difficulties coming from Europe or elsewhere could “worsen economic prospects here at home.” It was his habit to draw up the facade of action. He was a fan of DC’s hometown baseball team the Washington Nationals and harbored a sense of nationalism merged with his ability to dream up a playbook when he told members of Congress that “we will take every available step to protect the US financial system and the economy.”151
On February 21, 2012, the second EU-IMF bailout for Greece of €130 billion (US$172 billion) was passed. It included a 53.5 percent debt write-down—or “haircut”—for private Greek bondholders.152 In exchange, Greece had to reduce its debt-to-GDP ratio from 160 percent to 120.5 percent by 2020. Greece and its private creditors completed the debt restructuring on March 9, the largest in history.153
It was the fourth year since the onset of the financial crisis and the mentality of central bankers hadn’t changed—it had metastasized; like frenzied gamblers they played long after the house had won. Only they played with fake money. Central banks had bloated their books, swapped lines with one another, and sent cheap money throughout the waning financial industry.
In the United States, Bernanke faced opposition from Republicans in Congress. Rising Wisconsin Republican chairman of the House Committee on the Budget Paul Ryan feared expansionary monetary policy. “This policy,” he said, “runs the great risk of fueling asset bubbles, destabilizing prices and eventually eroding the value of the dollar.”154
Meanwhile, Draghi contended with Josef Ackermann, chief executive of German mega-bank Deutsche Bank, who declared that bankers now feared a stigma from accepting long-term ECB loans. Draghi depicted these bankers as posturing, saying, “Some of these virility statements, manhood statements, often are not correct.… The very same banks that make these statements access funds of different kinds but [they are] still ‘government facilities’—the euro-dollar credit swap facility, for example.”155
According to the Financial Times, in December 2011 more than five hundred banks had borrowed €489 billion in three-year loans from the ECB. Ackermann had praised the ECB for extending the loans, as “a very important and very intelligent move.”156 Then, he flipped to say Deutsche Bank preferred to be seen as independent of government support.
On February 28, 2012, the ECB announced a new easing strategy.157 Draghi’s fresh gambit would provide three-year loans to banks at a 1 percent interest rate, a ploy that one senior European banker likened to “methadone for junkies.”158 Criticism of his policies, considered to represent more interventionism, was solid. The ECB tried to sidestep the notion that this was direct QE because the funds would be borrowed in exchange for collateral, not injected into the market directly in return for bonds. However, in practice, it was the same, letting banks access easy money in return for assets they didn’t want, or that were less liquid, or less desirable.
In Germany, many said that liquidity provisions were a risk to financial health and might encourage banks to make bad decisions. Jens Weidmann, president of Germany’s Bundesbank, warned that “too generous a provision of liquidity will open up business possibilities for banks that could lead to greater risks for the banks” and thus jeopardize financial and price stability.159 German leaders were prudent to worry that banks might make bad investment decisions. However, divergence with the ECB was a political issue. Germany was not used to seeing the ECB make decisions that might go against its interests (or willing to acknowledge that possibility).
A month later, the euro hit a three-week peak against the dollar as concerns about the European economic slowdown shrank.160 Eurozone finance ministers solidified an agreement on a rescue fund of €700 billion, to be discussed at an upcoming meeting in Copenhagen.
In May 2012, the success of left-wing and protest parties in local elections was a measure of public discontent with austerity measures, with the center-right People of Freedom Party and its Lega Nord ally performing badly in Italy.161 In France’s presidential election, François Hollande and his anti-austerity platform won against Sarkozy, making Hollande the first Socialist president in seventeen years (Marine Le Pen also increased her influence, deepening the polarity among voters).
In the general election of Greece, the leftist Syriza party achieved strong growth, capturing 16.8 percent of the votes and fifty-two seats.162 But the swing to the left would ultimately not prevail as euro economic anemia persisted. It was seen as an inflection point.
Meanwhile, debt was rising everywhere. Italian public debt rose above a record €2.2 trillion.163 Those figures from Draghi’s old stomping ground came at a time when the Greek debt crisis was dominating headlines as was the ballooning public debt within the
currency union.
On May 31, Draghi declared that the Eurozone could become unsustainable if policymakers didn’t take action.164 He told the European parliament that EU leaders must “clarify the vision” for the future of the common currency area. Draghi defended ECB actions, saying they were working but that they were not a substitute for decisive action by governments. “Can the ECB fill the vacuum left by the lack of euro area governance?” he asked and then responded, “The answer is no.” He was a man in the spotlight.
He envisioned the best way of exiting the crisis was to eliminate uncertainty in the financial markets. Draghi supported a banking union in Europe, which was proposed by the European Commission. It would be integrated along three pillars: a Europe-wide deposit guarantee mechanism, resolution fund, and centralized banking supervision and continuous adjustment. It would also increase the power base of the ECB.
Up to that point, the Eurozone had integrated monetary policy, but not fiscal policy. This created economic and power imbalances. The idea Draghi supported was a step toward a fiscal consolidation, but it could only occur if a real political union existed. Difficulties stemming from a lack of unity in the Eurozone would blossom.
In early June, Draghi announced the ECB would keep rates unchanged.165 This decision wasn’t unanimous; some members wanted a cut. Draghi reemphasized the need for Eurozone leaders to collaborate. When asked about a fiscal union, Draghi said this was not under his purview: “These processes have their own independent legislative roots and they cannot be subject to the monetary policy-makers.”166 He nonetheless provided opinions on fiscal matters, rendering the idea that the ECB operated independently of policy ludicrous.