The ECB’s Rescue Speeding Through – Could it Be too Late?

on Sep 14, 2012
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A looming threat for the European Central Bank (ECB) and Mario Draghi’s rescue plan of the euro has been neutralised with today’s German court ruling on the European Stability Mechanism (ESM). The court in Karlsruhe and its eight justices rejected a petition attempting to block the creation of the Eurozone’s €500 billion (£400 billion) rescue fund, a decision met with great relieve from members of the German parliament. Even the “but” conditions, which were expected to be harsh, appear less austere as the court simply decided that the €190 billion (£151.89 billion) in German financial guarantees can only be increased with the lawmakers’ approval.

Just hours after the court ruling, Jean-Claude Juncker, chair of the Eurogroup finance ministers, assured that from now on it is full steam ahead for the bailout fund: “Taking full account of all elements of the ruling, I look forward to the completion of the outstanding procedures allowing for the Treaty Establishing the European Stability Mechanism to enter into force. I plan to convene the inaugural meeting of the ESM-Board of Governors in the margins of the Eurogroup meeting of 8 October in Luxembourg.”

!m[](/uploads/story/363/thumbs/pic1_inline.png)As long as the outcome of the Dutch elections is pro-EU, there will be nothing to offset Mario Draghi’s bond buying plan and its implicit promise of bringing unlimited firepower against the sovereign debt crisis. Whether the programme of Outright Monetary Transactions actually succeeds in convincing people that the Eurozone will last is a completely different matter.

According to the ECB, the new rescue plan does not aim to finance governments in difficulty but rather to fix the “bad equilibrium” created by panicky markets pushing solvent countries into self-fulfilling default. This phenomenon is compounded in the Eurozone by investor’s fear of convertibility risk – the loss they would suffer if Spain and Italy leave the euro and subsequently redenominated their sovereign debt in a new currency.

According to Mr Draghi:

“We aim to preserve the singleness of our monetary policy and to ensure the proper transmission of our policy stance to the real economy throughout the area. OMTs will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro.”

The main shortcoming of Draghi’s plan rests on the fact that no one can be sure whether Italy and Spain are indeed solvent, even after recent reductions in their cost of borrowing. For the past ten years Italy has been plagued by an inflexible labour market and zero growth rate numbers, while its net public sector debt is more than 100 percent of GDP. Spain’s economy fell back into recession in the first quarter of the year, contracted 1.3 percent in the second quarter on an annual basis and reached astronomic unemployment rate of 24.6 percent.
What the ECB achieved with its last week announcement was to buy Italy and Spain more time for much needed reforms, without actually directly bailing them out. The ball is now in these two countries’ governments to exploit the breathing space they are given and take care of the intractable problems in their economies.