This May Really Be The Beginning Of The End Of The Eurozone Crisis

Published in Investing on 10 September 2012

Has Mario Draghi, finally, saved the world?

It's been like an old friend to me. Its dramas, its machinations, its technicalities. Its politics, its economics, its laugh-out-loud craziness. We have had the obstinacy of the Germans, the arrogance of the British and the downright despair of the Greeks. For me, it has been endlessly fascinating.

Fiddling while Europe burned

But maybe, just maybe, we are seeing a light at the end of the tunnel, and an end to all this madness. I should be glad, I know, yet I feel a sense of melancholy. Yes, eurozone crisis, I will miss you when you're gone.

In October of last year, I asked whether Mario Draghi was the man who could save Europe. At the time, Europe was mired in the depths of crisis. Bond yields in Italy and Spain were reaching unaffordable levels, Greece was on the brink of financial and social collapse, and yet it looked like Europe's leaders were fiddling while the continent was burning.

A sheep in wolf's clothing

Enter, stage left, an unassuming banker, smartly turned out in navy blue suit and black tie, with gold-rimmed spectacles and a slight glint in his eye: his name was Mario Draghi.

An alumnus of the World Bank and Goldman Sachs (NYSE: GS.US), he had the credentials of a monetary policy hawk -- so much so that commentators dubbed him, with more than a hint of seriousness, 'Herr Draghi'. Yes, this was an Italian who was, irony of ironies, more German than the Germans.

Many assumed that Draghi would be at the beck and call of the Bundesbank, and that Europe's doves, who were pleading for quantitative easing and a relaxation of the European Central Bank's monetary policy, would be disappointed again.

But, I think Draghi's initial hawkishness was no more than an opening gambit in the long game that he has been playing. Really, he was no more than a sheep in wolf's clothing. And what was the name of that game? 'Draghi vs the Germans'.

Draghi vs the Germans

Finding a solution to the eurozone crisis might seem fiendishly complicated, but it is really quite simple. Imbalances in competitiveness between the eurozone's countries have led to severe imbalances in the sovereign bond market. The result is that Greek, Spanish and Italian bonds have sky-high yields, while German bonds yield close to zero.

How do we solve this problem? Easy! Just print lots and lots of money, and use that money to buy the bonds of countries such as Spain and Italy. And keep on doing it -- relentlessly.

The law of supply and demand means that this tactic will rapidly lower bond yields. This is the key reason why the US, which is actually more indebted than Europe, can easily service its debts. In one fell swoop, the crisis is ended.

So why hasn't Europe done this before? Because the Bundesbank has blocked it. Quite simply, the Germans have made themselves prisoners of the past -- a past where unbridalled money printing has led to rampant inflation, economic collapse and, ultimately, the horrors of war.

Controlling inflation at all costs has been the watchword of post-war Germany and, many would argue, the key to its economic success. But things are different now: inflation is no longer the great danger it once was, but the Bundesbank remains wedded to the past.

Crossing the Rubicon

Until now. Mario Draghi has finally been able to persuade Angela Merkel to allow bond buying by the European Central Bank, though admittedly with conditions. The Rubicon has been crossed.

Let's hope that this works. If it does, the Germans may relax, and allow the programme of bond-buying to be extended. The eurozone crisis might finally be near its end. Of course, this does not change the fact that Europe's economies are severely damaged. But it would at least give them time to heal. And this might just be a once-in-a-lifetime opportunity to buy up shares in European companies such as BMW, France Telecom (NYSE: FTE.US), Siemens AG (NYSE: SI.US) and Total SA (NYSE: TOT.US).

Of course, I could be wrong. Germany's senior court may still rule that the eurozone rescue is unconstitutional. The Bundesbank might still throw its toys out of the pram. The agony might be prolonged. But, for the sake of the world's economy, as well as your portfolio and my portfolio, let's hope not.

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> Prabhat owns none of the shares mentioned in the article.

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Comments

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BigJC1 10 Sep 2012 , 11:28am

"But things are different now: inflation is no longer the great danger it once was" - sounds an awful lot like that guy who said "no more boom or bust".

Turned out he was wrong, I fancy you could be as well. Inflation has already massively eroded the real spending power of UK consumers as the Supermarkets are discovering. I can dimly remember my pocket money not keeping up with the 25%+ inflation of the mid 1970's and even in the 80's I studied hard to understand the intricacies of proposed Inflation Accounting standards.

The Germans do well to stand their ground. As Reagan put it " Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man"

dejw 10 Sep 2012 , 11:39am

I'm not an economist (see def below), but I keep on getting the message that inflation is ok in the short term but bad in the long term. There is an obvious logic problem here. I believe serial rapists and drug addicts use the same argument?

Def 1 of an economist "lock 10 economists in a room and you will have 11 different opinions"

Def 2 of an economist - someone who takes something that works in practice and proves it is impossible to work in theory.

Dejw

goodlifer 10 Sep 2012 , 4:06pm

"Inflation is no longer the great danger it once was."

You've got to be joking.

The toxic cocktail of stagnant GDP, rising food, energy and commodity prices, absurdly low bank rate, quantitative easing (aka printing money), yet more quantitative easing and massive govenment debt makes runaway inflation look dangerously likely.

As for the long term - about which Sir Merv is generally silent - over the last seventy years, and in almost any decade therein, it's averaged around 5%.
Can you honestly see it getting any less?

Even poor little Sir Merv has at last got around to admitting that neither he nor anybody else can make accurate forecasts about the economy.

NK104 10 Sep 2012 , 4:13pm

'But things are different now'

Whenever I hear anyone say 'it's different this time' or any version therein, my hand instantly reaches for my wallet to check that it is safe. 'It's different this time' is the rallying cry of hope over expectation. The Motley Fool taught me that in the old days - it stopped me getting murdered in the TMT boom.

If Mr Market is going to get optimistic for a bit, that will give me the opportunity to sell out of some 'pro-risk' shares and prepare for the downside. If anyone thinks the problems of southern Europe can be resolved with unlimited borrowing then good luck to them - I suggest the issues of dreck sitting on Spanish bank balance sheets and the basic insolvency of Greece aren't going away soon.

trmeer 10 Sep 2012 , 5:46pm

What the ECB has done by manipulating interest rates is make it easier for bankrupt countries that can not pay their debts to borrow more. They are making the problem far worse. Propping up people who are bankrupt and should be allowed to go bankrupt, makes things far worse in the long run. Think Japan.

GoldenSoldier 11 Sep 2012 , 1:36pm

I still don’t understand how anybody can write an article like this and expect it to be taken seriously. It is a joke, surely.

A single currency shared by several different sovereign states is inherently unsustainable, and whatever Draghi does, cannot change this.

It seems a pity that so much more suffering will occur within Eurozone states before it is finally recognised that each separate sovereign European country needs its own currency with a flexible exchange rate with the Euro. The proponents of the single currency must have known this and were motivated to force federation on us. We must not let those dictators get away with this.

ANuvver 11 Sep 2012 , 5:21pm

dejw:

Another one for your collection:

"If all the economists in the world were laid end to end, they still wouldn't reach a conclusion."

GB Shaw, I think.

goodlifer 11 Sep 2012 , 10:00pm

Another misquote coming up:

Economics is about finding bad reasons for what we know by instinct.

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