--Mario Draghi, July 26, 2012
So, is the eurozone crisis over? Do Draghi’s remarks today mean that the ECB has capitulated to the South, and will now buy Spanish and Italian bonds without limit until their yields come down? Is it time to sell bonds and jump back into the equity market with both feet?
In a word, no. We need to learn to stuff cotton into our ears whenever a non-German eurozone official is speaking. Unless you hear this kind of talk from Jens Weidmann, head of the Bundesbank, it is meaningless.
So far, we have had heard, in addition to Draghi, officials from Austria, France, Italy, Spain and Belgium, statements endorsing an ECB rescue of the eurozone. We have heard no such statements from Finland, Holland or Germany.
Draghi may be one of the smartest people in Europe, but he is stuck in a no-win situation. If he does not act, the eurozone will blow up and he will lose his job. If he acts (with a working majority), Germany will go ballistic. He knows this, which is why his remarks* were so carefully crafted.
Draghi began with the bald statement above (“whatever it takes”) and then, later on, he walked back by saying “whatever it takes within our price stability mandate”. “Whatever it takes within the price stability mandate” is dramatically less than “whatever it takes”. He then goes on to list all the things that the ECB can’t do, such as lending to insolvent banks or buying bonds of non-compliant governments.
Basically, Draghi believes that he can lend to compliant governments and solvent banks in order to preserve the transmission mechanisms of monetary policy.
The fact that the North is doing well and the South is in a depression suggests that those transmission mechanisms no longer exist. Right now, Europe has two different eurozones, one where everything is working and one where nothing is working.
I will believe Draghi if and when (1) Weidmann says something similar; and (2) the ECB moves into the Spain/Italy bond market with overwhelming force and absolutely destroys the shorts (say, yields dropping below 4%). I do not expect either of these to occur, or at least not until we are closer to the edge of gotterdammerung.
And furthermore, not only will the ECB not do whatever it takes, it will not even do whatever it takes within its mandate unless Germany agrees. Weidmann is very close to Merkel, so I believe that when he speaks, he is speaking for Germany.
The ECB governing council meets in one week. Between now and then, Weidmann or Schauble will say something relevant. Those remarks will be much more telling than anything Draghi says. Then, the ECB will have to craft its press release next Thursday. That will be the dispositive event. If it mentions yield-targeting for Spain and Italy, Draghi has won. If it doesn’t, Weidmann has won.
I am personally light equities and long Treasuries (TLT) and gold (GLD). If Weidmann wins, it’s bad for the world, but I will make some money. If Draghi wins, I am badly positioned. But I think I’m OK, at least for now.