Can Draghi persuade financial markets that sovereign spreads are unreasonable?

In: Blog

23 Jul 2012

Not yet (if ever)!

In an interview with Le Monde, also available from the ECB, Mario Draghi stated that “the euro is irrevocable!”

One might think that “irrevocable” means that the euro is not simply a fixed exchange rate arrangement, but it is indeed a permanent currency union, i.e., a region where holders of deposits in euros know their money is worth the same as ECB currency, irrespectively of where their deposit is in the euro zone. After all, this is the sense in which the U.S. monetary union is irrevocable: Dollar deposit protection is the same across the nation.

Earlier in the same interview, he had been asked:

Is a Greek exit from the euro area still a leading concern?

To which Draghi had responded:

Our unequivocal preference is for Greece to remain in the euro area. But that is a matter for the Greek government. It has stated its commitment, now it must deliver results. Regarding the renegotiation of the memorandum [to ease the austerity measures and reforms imposed on the country], I will not take any stance before seeing the Troika’s report.

The notion that Greece’s permanence in the euro zone is up to Greece suggests that the above interpretation of “irrevocable” may not be what Draghi had in mind.

In fact, following his statement on Greece, Draghi’s interviewers then asked this question

So is the euro still in danger?

To which Draghi responded:

No, absolutely not. From the outside, analysts are seen to be imagining scenarios in which there is an explosion of the euro area. That underestimates the political capital that our leaders have invested in this union, as well as the support of European citizens. The euro is irrevocable!

There’s a potential conflict between the two statements. If Greece can leave, in what sense is the euro irrevocable? What does Draghi mean by “irrevocable”?

Two interpretations are possible:

Draghi may have meant “irrevocable” in a much weaker sense, i.e., that the euro will stay around, with or without Greece. If Draghi really believes this, and if this is the message, it is a call for explosive sovereign spreads!

Or, Draghi may have meant that while in principle countries may be forced to leave (if they are unable to adjust to the common rules), in practice the ECB will do, literally, and with no ‘taboos’ (a word Draghi used in the interview), anything necessary to prevent that they are being forced to leave. This allows more muddling through, between crises and last-minute rescues.

Yet, a scarier scenario is that EU leaders may consider a plan like the one implied here.

1 Wait that the German court gives green light to ESM.

2 Make ESM operational.

3 Prepare the rescue of all 17 minus one countries.

4 Let Greece go.

This way, holders of deposits in Greece (if there are any left) will find that the euro is not irrevocable!

Do EU leaders really believe that they can re-start a cleaner euro a-fresh, without Greece, and then fund everyone else?

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