The European Central Bank spent most of yesterday rejecting any hope of an imminent intervention in the European bond markets, to put a cap on the spread between the yields of the cheapest and most expensive sovereign bonds. But Ambrose Evans-Pritchard of the Telegraph (UK) not only confirmed the existence of the program, but said Germany would get behind it.
“A currency can only be stable if its future existence is not in doubt,” said Jörg Asmussen, the powerful German member of the ECB’s executive board.
He signalled full backing for the bond rescue plan of ECB chief Mario Draghi, brushing aside warnings from the German Bundesbank that large-scale purchases would amount to debt monetisation and a back-door fiscal rescue of insolvent states in breach of EU treaty law.
Mr Asmussen told the Frankfurter Rundschau that the surge in Club Med bond yields over recent months “reflects fears about the reversibility of the euro, and thus a currency exchange risk” rather than bad economic policies in struggling states.
The choice of wording is crucial. If it can be shown that the ECB is acting to avert EMU break-up – known as “convertibility risk” – bond purchases would no longer be deemed a bail-out for Italy and Spain.
Mr Asmussen confirmed that purchases may be “unlimited” in scale, a far cry from the half-hearted intervention of the past two years, which failed to stem capital flight.
This has really raised expectations for the next ECB meeting. Because it would represent one endgame, on sovereign debt, in Europe. If the ECB vows to hold debt yields to a reasonable level, then Spain and Italy don’t have to worry about losing access to financing, ending the crisis in that particular area. It doesn’t mean the European crisis is over; the economic crisis looks to be continuing. But the panic about debt would end for now.
It’s true that a spread cap like the one envisioned here could get costly. But the intention to enact one will keep the spread down by itself. Under one theory, you just have to credibly threaten to use the bazooka; you shouldn’t ever have to use it at that level.
The only outstanding question is whether the ECB would withhold the employment of a spread cap until Spain and Italy formally ask for help and submit to some “overhaul” of their labor market or other concessions. This is the holy grail that Mario Draghi has always sought, and it doesn’t make sense that he would give up the leverage, even in the name of market stability.
However, there is a sense that the Europeans finally recognize that running government like a game of chicken doesn’t work for anyone. Heck, German leaders are even starting to give a bit on Greece. Stringing along the crisis has caused massive suffering and harmed most of the economies in the Eurozone. Maybe fixing the problems one by one is a better strategy.