What a roller coaster ride Europe has embarked upon. A week ago Mario Draghi, the president of the European Central Bank, made his now-famous “whatever it takes” remark in defense of the euro, and the markets bounded upward. Since then they have shot through the floor again—once more on Draghi’s comments—and then finished the week with another upward bounce. There is more of this coming, surely. So what is going on?
It is now clear that the ECB is the lynchpin of Europe’s effort to get beyond its three-year-old economic and financial crisis. But how much like a central bank can it act in the European context? The issues are what its role will be—and, more acutely, what the limits of its role will be. When can it intervene in bond markets by buying sovereign paper to drive down interest rates on, say, Spanish or Italian debt? These are the questions Draghi is working overtime to resolve and the questions he is addressing in his market-moving speeches.
It is going to require time to resolve these questions. In the meantime, should investors be parsing every syllable Draghi utters in the course of this project? If they do they are bound to get it wrong. To wit: After pushing bond yields down, last week investors handed Spain the worst day on record in trading on its 10-year bond. The yield rose above 7.5 percent, well beyond the level at which borrowing is simply not sustainable. The next day it was down again.
This kind of market activity is emerging as the measure of a perverse mismatch. Crisis-ridden Europe has begun a fundamental transformation of its institutions. This is a dramatic and difficult passage in a 60–year story. Investors appear to have no understanding—and perhaps do not care—about the magnitude of the undertaking. So they stand to the side wreaking havoc and screeching that it all has to happen now—as in yesterday.
Draghi, when he spoke late last week in Frankfurt, did not step away from his sweeping “whatever it takes” reassurance of the week before. In fact, he reaffirmed that the ECB would enter the bond markets to keep sovereign borrowing rates down. And he put this every which way he could. The central bank would “undertake outright open-market operations of a size adequate to reach its objective.” Interest rates, he said later, “that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner.”
What changed? Nothing of consequence. Draghi spoke a little more technocratically, offering details and leaving behind the billboard headlines. He implicitly acknowledged a target yield on European sovereign debt. That amounts to another commitment to whatever it takes.
In the meantime, Germany’s central bank president, Jens Weidmann, repeated that Germany was against the ECB’s latest thinking about bond buying. But we already knew this. As of last week it leaves Germany in a 22–to–1 position on the issue within the European Union, and that is untenable.
There was, in short, no reason for the markets to swoon southward on Draghi’s latest remarks.
As things now stand, Draghi has cautioned that a sovereign debtor would have to ask for help before the ECB would buy anything, and the central bank would follow the European Stability Mechanism, the EU’s rescue fund, into the market. ESM aid comes with conditions. It was in this context that the markets took their most recent bounce upward. This was in response to the announcement at week’s end by Mariano Rajoy, the Spanish prime minister, that Spain was thinking about approaching the ECB for bailout assistance — implicitly suggesting that the conditions would considered.
There are a couple of large ironies in all this. For one thing, investors are beginning to add risk to their own investments when they jangle the markets every other day. For another, bond investors are supposed to be the true blue ones in favor of unfettered markets. Yet of all the participants in the European mess, they are the ones most eager to see the involvement of official EU institutions in any resolution.
The core questions being played out in Europe are of vital importance. The EU and its sovereign debtors are at bottom social and political formations: They represent societies, each in its own way. Facing them are investors, who represent markets. The emerging truth is that we have not yet evolved institutions to contain our own inventions—in this case computerized, hyper-fast market operations.
Just as a footnote, the U.S. won’t have any trouble grasping this last point. While Europe was ramping up and down last week, the New York share market went haywire when a rogue algorithm, caused a computerized trading glitch that cost the firm in question, Knight Capital Group, $440 million in losses.
Once again, the advanced economies have reached a point when their own technologies have no political, economic, or social framework to contain them. This is Europe’s reality, but it is also ours.