Is the Euro Saved?

August 1, 2013

The Book of Proverbs teaches that pride goes before the fall. Mario Draghi, the president of the European Central Bank (ECB), should take heed of that lesson. For at the very same time that he is trumpeting the great success of his "whatever it takes to preserve the euro" statement made last year, the European economic periphery is again showing the clearest signs of economic and political distress, says Desmond Lachman, a resident fellow at the American Enterprise Institute.

Sadly, aside from declaring that the European crisis is over, Draghi is doing little to respond to these distress signals.

  • This makes it likely that Europe will again experience a full blown economic crisis before the year is out.
  • It also makes it all too probable that Draghi's declaration of victory in the euro crisis will prove premature and that his credibility will end up greatly diminished.

Draghi does have some justification for feeling satisfied with the ECB's performance over the past year.

  • In July 2012, Europe was quite literally peering over the abyss and the very survival of the euro was in serious question.
  • Underlining the gravity of the crisis was the fact that Italian and Spanish government borrowing rates had soared to over 7 percent, levels that were clearly not sustainable over the long run.
  • Just one year later, in response to the ECB's bold policy initiatives, those borrowing costs have been reduced to affordable levels and the tail risk of a euro break-up appears to have passed.

The rabbit that Draghi managed to pull out of his hat to save the euro was the ECB's introduction in September 2012 of an Outright Monetary Transaction (OMT) program. Under that program, the ECB committed itself to buying unlimited quantities of European peripheral government bonds with maturities of up to three years in order to keep government borrowing costs for those countries at affordable levels.

Perhaps Draghi will become more proactive after the German elections scheduled for September 22, when he might again be politically less constrained to act. If he waits much longer, however, he could very well find himself being forced to deal with a major intensification of a European crisis that he has never tired of assuring us has long since been resolved.

Source: Desmond Lachman "The European Central Bank's Clay Feet," The American, July 23, 2013.

 

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