ecb chief The Misunderstood Mr. Draghi

Halfway through his tenure as president of the European Central Bank, leading economists are giving Mario Draghi the credit for saving the euro. Yet Germany, Europe's economic powerhouse, still does not seem to trust the ECB.
Josephine Witt showered Mario Draghi with confetti at an ECB press conference.

It happened in a flash. Mario Draghi was about to speak to journalists about credit terms for households and businesses, when a woman leapt out of the audience and onto his table.

Pictures from the European Central Bank's press conference on April 15 this year went viral. Europe's top banker looks small and lost as the activist Josephine Witt towers over him, demanding the end of the ECB dictatorship.

Mr. Draghi threw up his hands in a gesture of self-defense. Once he realized he was only being attacked with confetti, his panicked expression was replaced by a look of wonderment – did people really see him as a dictator?

Halfway through his eight-year term as president of the Frankfurt-based ECB, the guardian of monetary policy for the 19-nation euro zone, opinion is more divided than ever. To Josephine Witt, Mr. Draghi is a dictator. To the IMF's recently departed chief economist, Olivier Blanchard, Mr. Draghi is nothing less than the savior of the euro zone. He says Mr. Draghi's achievement in averting a financial catastrophe was outstanding.

He's committed to European interests, and does what needs to be done for the good of Europe. Carlos Bowles,, chief of the ECB staff council

Could it be that Mr. Draghi is doing everything right – and yet people thinks he's got it all wrong?

In an interview with the German weekly Die Zeit at the beginning of the year, Mr. Draghi said that he feels that in Germany he's the least understood public person. Even his supporters recognize that he's failed on one central point.

“The greatest weakness of the ECB is the fact that it's lost the trust of the German people,” said Marcel Fratzscher, president of the Berlin-based Economic Research Institute, the DIW.

One could also say that Mr. Draghi had to disappoint the Germans in order to save the euro.

If you want to understand just how prickly things are between Mr. Draghi and the Germans, you need to know the story about the “Pickelhaube," the spike-topped Prussian military helmet. Four years ago when Mr. Draghi replaced the Frenchman Jean-Claude Trichet as ECB chief, Germany's press was in uproar. The daily tabloid Bild despaired that an Italian was to head Europe's most important monetary policy regulator.

They printed what many Germans were thinking. To remind Mr. Draghi of Prussian frugality, they sent him a gift: An original Prussian officer's Pickelhaube from 1871 – a gesture loaded with historic symbolism.

The ECB chief accepted the gift – but he knew he had to lead a central bank responsible for all 19 eurozone countries, not a Prussian army regiment. It wasn't long before the bill came. When Mr. Draghi began toying with the idea of a massive purchase of government bonds to prevent a break-up of the euro zone, Bild screamed that there should be “no more German money for bankrupt states,” and demanded the Pickelhaube back.

Mr. Draghi knows the game by now. The right in Germany accuses him of keeping insolvent countries alive with cash injections, the left says the ECB's austerity measures are forcing poorer countries to their knees. The ECB chief won't let those criticisms stop him. Even in the face of strong resistance, Mr Draghi has a remarkable ability to prevail, says Carlos Bowles, chief of the ECB staff council.

 

Mr. Draghi is forging a new path as ECB president.

 

“He's committed to European interests, and does what needs to be done for the good of Europe,” Mr. Bowles said.

Mr. Draghi's job description makes his task sound pretty banal: To maintain price stability within the euro zone. But whether the euro zone – an agglomeration of economically and politically diverse nations, thrown together by fate – functions at all, is Europe's greatest experiment.

Mr. Draghi's interim performance after four years in office has to be looked at in perspective. Indeed, time and time again the ECB has missed its inflation target of around 2 percent. But to Mr. Draghi, it's about much more than that.

At the weekend he told the Italian newspaper Il Sole 24 Ore that it's the certainty – or at least the hope – that his decisions can avert suffering for Europeans that drives him forward.

As the Italian famously said in July 2012, much is at stake. The entire euro zone was threatening to disintegrate. First the investors fled from Greece. Then from Ireland and Portugal. Governments collapsed and panic grew out of uncertainty.

Instead of working to place the currency union on a new foundation, Europe's politicians allowed themselves to be driven by speculators. They hastily cobbled together one bailout after another. But the countries in the biggest difficulty were too large to be saved. Spain and Italy were already wobbling. And what would happen if France were next?

Mr. Draghi, addressing politicians, captains of industry, and big investors at an investment conference in London, signaled that the ECB would take on the financial markets over high Spanish and Italian borrowing costs. He told his audience that the ECB “is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

The markets responded almost instantly. With three words he'd managed to achieve what Europe's politicians had been struggling towards over two years of crisis summits. He removed the shadow of fear of an imminent failure of the euro that had been hanging over the markets.

Financiers were reassured that they needn't fear losing money they entrusted to Portugal or Italy. If necessary, the ECB later that year said it would buy the bonds of countries in trouble under a program dubbed Outright Monetary Transactions, or OMT.

As a former Goldman Sachs banker, Mr. Draghi knew what the markets wanted. Just the promise was enough. So far no one has actually made use of the OMT arrangement.

“Whatever it takes.” The three magic words that no other central banker could have said, according to the DIW president, Mr. Fratzscher.

“Draghi sees the world primarily from the viewpoint of the financial markets,” he said. “On this matter he's always been true to himself,” remarked Mr. Fratzscher, who also worked for the ECB and knows Mr. Draghi well. He said the ECB boss chose the right moment in time and had the courage to surprise the markets.

Not everyone agrees with Mr. Draghi's methods – above all in Germany. When the OMT program was launched in September 2012, it was Jens Weidmann, the president of Germany's central bank, the Bundesbank, who was the lone dissenting voice on the ECB's governing council, the panel that meets once every six weeks to discuss and vote on monetary policy.

Mr. Weidmann told the news magazine Der Spiegel that the OMT program was basically “government financing through the printing press.” He argued that, in a democracy, such a comprehensive pooling of risks should be decided by the parliament and not the central banks.

Josephine Witt's criticism of the ECB dictatorship can't be dismissed out of hand. Under Mr. Draghi's stewardship, the guardian of the euro has gathered more power – ostensibly not because they want to, but simply because no one else can. The cracks in the currency union spread faster than politicians can repair them. With the ECB, Mr. Draghi has been able to act quickly when cracks appear.

Bank supervision is a good example. Because the euro zone's debt crisis showed that Europe's banks are sitting on shaky foundations, European state leaders were quick to nominate the ECB to the role of the most senior banking overseer. That puts them on the horns of a dilemma.

As banking supervisors, they're expected to mercilessly illuminate the darkest corners of the balance sheets of financial institutions; but as a central bank they're expected to shore-up the stability of the financial system. The problems of combining these potentially contradictory roles became clear earlier this year in Greece. There, Alexis Tsipras's government surprised everyone by declaring a referendum on whether to accept austerity measures in return for a bailout package – and the ECB froze emergency funds for Greek banks.

The result was a run on the banks, financial institutions closed down, and with each passing day, the pressure on Athens increased. And once more, Mr. Draghi was showered with criticism from both sides for playing politics. The right were outraged that he was still giving credit to bankrupt financial institutions and criticism came from the left that he wasn't opening the money-tap further. Ultimately Mr. Tsipras accepted the austerity measures that his people had rejected in the referendum. The Greek tragedy goes on.

Uncertainty also reigns over the outcome of what is probably the biggest ever monetary policy venture in Europe with Mr. Draghi's stamp on it. Because the ECB can't bring falling prices under control, it has been buying securities to the tune of €60 million a month since March.

 

Through so-called quantitative easing, or QE, Mr. Draghi will add about €1.1 trillion to the ECB's balance sheet. He expects total assets will grow to around €3 billion by September next year. That money should support growth in the euro zone, and also raise inflation from its current low of around zero percent.

The purpose of the exercise is difficult to explain to the Germans, who have been historically wary of any uptick in prices. The German economy weathered the global financial crisis relatively well and rising inflation remains a bogeyman after the country's experiences with hyper-inflation back in the early 20th century.

No wonder that the bond purchases didn't go down well in Germany. Three entrepreneurs even challenged it in Germany's top constitutional (and lost).

“The ECB has entered into this QE program for political reasons,” said constitutional lawyer Christoph Degenhart, who represents the plaintiffs. “How are they ever going to come out of this without stifling the economy?”

For Mr. Draghi's critics, the large sums of money from the QE program are working like a drug. Fittingly, many market players already want to increase the dose – and Mr. Draghi obliged by promising last month that more is likely on the way.

The outgoing French central bank president, Christian Noyer, is warning against a hasty expansion of bond purchases – even though he was one of the QE scheme's original proponents. He says one can't expect to see the full effects of the program after just six months.

“One has to give it time,” he says, “to bear its full fruit.”

But what happens when it's time to pull out?

“The most difficult challenge for the ECB is not the current monetary policy,” warned Mr. Fratzscher of DIW, “but having a well-prepared exit strategy to come out of the low-interest period.”

How Mr. Draghi aims to carry that off, he hasn't yet explained. On the contrary. The more responsibility that lands at the ECB's feet, the more they seem to go on the defensive.

The clearest demonstration of that is in the new ECB headquarters. Once they were in full view in the heart of Frankfurt. Now they've decamped to the outer suburbs and are hunkering behind razor wire in a €1.3-billion glass bunker. The Prussian Pickelhaube hangs on the wall of Draghi's office, on the 40th floor.

Perhaps it's worth noting that the German army quickly did away with the shiny spike in the First World War – it made soldiers in the trenches an easy target for enemy snipers.

 

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Michael Brächer is a financial editor in Handelsblatt's investment team in Frankfurt. Jan Mallien covers monetary policy. To contact the authors: [email protected], [email protected]