Can Draghi do 'whatever it takes' to save euro?

Mario Draghi speaks to Spanish Finance Minister Luis De Guindos in June 2012 What evasive action will Mario Draghi take? (Left, with Spanish finance minister Luis De Guindos)

As we wait to see whether Mario Draghi and the European Central Bank will tomorrow announce "whatever it takes" to save the euro (to use his resonant phrase of last week), it is worth reminding ourselves of the eurozone's unhealthy lifestyle (forgive my anthropomorphising please).

Since 2009, its history has been of fiscal and banking crises that force eurozone leaders to make modest reforms, which provide calm for just a few weeks and months, till there is another crisis and more modest reforms.

So if you were the eurozone's physician, here is why you would be concerned.

The crises have become progressively more serious: the €500bn or so that Spain may need in a bailout is more than four times Greece's initial rescue needs in 2010.

But there has been limited progress towards the kind of political union - or central control of budget-making, borrowing and supervision of banks - that many would see as necessary to the eurozone's long-term survival.

So have the crises now reached such a magnitude that some time soon the eurozone's leaders will be jolted into taking the kind of serious evasive action which would see future shocks diminishing in their severity?

Or are the forces of financial and economic contraction now so powerful that they are incapable of being solved by any of the tools likely to be at the disposal of the European Central Bank and government leaders in the foreseeable future?

One strand of these negative financial trends has been elucidated by Morgan Stanley, in what it calls the balkanisation of the eurozone banking system.

Its banking and money team have highlighted how the weaker eurozone economies - Spain, Italy, Portugal, Cyprus, Greece and Ireland - have been progressively starved of credit as banks in the bigger, stronger economies of Germany and France have stopped lending to them.

Here are a couple of striking and disturbing statistics.

According to data published by the German central bank, the Bundesbank, net lending by German banks to Spain, Italy, Portugal, Greece and Ireland rose from €67.4bn when the euro was launched in 1999 to a peak of €510bn in November 2008. In other words, banks behaved as though the eurozone was a seamless unified banking market.

But since then, total net credit provided to these economies by German banks has more than halved, to €241bn in May - and there has been a net contraction of credit of more than €60bn in just the last six months. Or to put it another way, banks are increasingly seeing themselves as national institutions again, rather than euro institutions.

As for France's banks, they have also been retreating back to their home market. According to Morgan Stanley, their net lending to the rest of the eurozone reached a peak of €742bn as late as April 2010, but has since plunged to €489bn. Morgan Stanley expects this repatriation of lending by French banks to continue - and warns this could be particularly deleterious for credit availability in fragile Italy.

Or to put it another way, the unbreakable link between credit provision and economic activity means that recessionary conditions in Spain, Italy and the weaker eurozone economies will intensify, as French and German banks take their money back.

Now there is only so much the European Central Bank and national central banks can do about this. It can flood domestic Spanish and Italian banks with liquidity or cheap loans. That stops them from falling over, at least until they run out of acceptable collateral (and see this previous post).

But it can't compel those southern European banks, many of which are chronically lacking in confidence, to provide additional loans into the real economy to compensate for the sucking out of credit by banks from northern Europe.

That said, there is an expectation that the European Central Bank will start to penalise banks for holding money on deposit with it, rather than using that cash to make loans, by charging negative interest rates for deposits. This could happen tomorrow or in coming months.

However for Morgan Stanley, the risk aversion of German, French and other northern European banks is now so entrenched that it does not expect them to cease their withdrawal of credit from Spain, Italy and the other weaker economies, even in the circumstances where the ECB penalises them for sitting on cash.

And for Italian and Spanish banks, in today's febrile climate there is a strong temptation to put any spare cash on deposit with central banks, even for a guaranteed loss on that money, because they don't want to double up on lending to households and businesses struggling to repay what they owe, and they don't want to be short of cash if capital flight intensifies.

It would mean contractionary conditions in those weaker economies would be sustained and could intensify.

That in turn would cause tax revenues for their governments to continue to shrink, such that reducing public-sector deficits would become a never-ending labour of cutting expenditure and raising taxes.

In those circumstances, austerity programmes would become a prison with impossibly high walls, not a route back to rehabilitation and credibility in the eyes of commercial investors.

In other words the solution is the same as it ever was, and may be as politically impossible as ever it was: the Germany government would need to provide official underwriting for the funds borrowed by the Italian, Spanish and other eurozone governments, what is known as mutualisation of borrowing, to reduce their borrowing costs and provide assurance of credit supply.

If that potential solution remains some way off, how concerned should we be?

Well the boss of a big global bank yesterday told me he is convinced that that the eurozone will continue to lurch from crisis to crisis but will muddle through - and that eventually the political reforms will be adequate. For him, the crises are the just-about-acceptable price of spurring eurozone leaders to do the right thing.

Maybe he is right. But I feel obliged to point out that this banker - like pretty much all his peers - has for three years consistently under-estimated the magnitude of what has gone wrong in Europe's currency union.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 26.

    the cajas of spain were effectively nationalised as politicans were directing where the loans were going but bearing none of the consequences of there actions.
    See where that got spain.
    Someone else is holding the baby.

    these is no more credit to spend spend spend anymore get real and learn to live within your means.

    break up the euro and quick is the only answer

  • rate this

    Comment number 25.

    1. Mario Draghi & ECB will do "whatever it takes". This was said & this will be done - in little steps or big. Good thing too because our super-power friends across the ocean are broke, desperately needing another war to boost production;
    2. eurozone's "unhealthy lifestyle" is mistimed; the poorer countries are truly suffering. As for "anthropomorphising", all I can ask is: "Et, tu, Robert?"

  • rate this

    Comment number 24.

    We should be careful as Europe owns much of us. Our dairy farmers are being paid less than the production cost for their milk. The majority of dairy processors are run from mainland Europe, are sourcing milk at the same price as it was before in the eurozone, and expect us to sell at that price too. But because the euro has fallen by 10% against the pound, we get 10% less pounds (3p a litre).

  • rate this

    Comment number 23.

    Banks - lend you an umbrella (at a penal rate) when it is sunny and ask for it back when it is raining.

    "(banks) seeing themselves as national institutions"... well certainly in the UK, eh Robert? All that taxpayer cash propping them up, if only they were nationalised and weren't just leeching the money out and into the hands of the few... what would happen if they just rolled over?

  • rate this

    Comment number 22.

    Maybe if he dresses up as a draghi queen it would help?

    Those banister types need to lighten up anyway.

  • rate this

    Comment number 21.

    NO11 Che-Che,
    Yes , a wonderful opportunity to clear out the ' socially useless', incompetent , reckless and greedy individuals running the world's financial system in their OWN interest, and their associates, the Ponzi operators, insider traders along with a phalanx of associated crooks and thieves.
    Capitalism without crisis? It is like 'Christianity without the devil'.

  • rate this

    Comment number 20.

    This is becoming a critical battle beween the Bundesbank
    and the ECB.
    "President of Germany's Bundesbank says BUBA is more "important"
    than (all?) other eurozone central banks as tension grows over how
    Mario Draghi will make good his pledge to protect the euro".
    Who will win ? What will happen if Draghi loses ?

  • Comment number 19.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 18.

    I have said it before and I will say it again , who ever is lending the money to the Greeks / Spanish etc will NEVER SEE THEIR MONEY AGAIN . The Germans are taking advantage of a low euro for their exports , but it is going to cost them a fortune in the long run .

  • rate this

    Comment number 17.

    10 cont.
    ECB creation of a new Euro 'B' currency to run alongside the existing Euro (A) to be used & replace existing Euro (A's) in Sunmed & PIIGS is only workable outcome without massive upheaval of existing arrangements. Would still be painful but once exchange rate equilibrium found, EU would move on very quickly with those using Euro B being very competitive & as effecting much needed adjsmt.

  • rate this

    Comment number 16.

    The Euro is an ill-conceived project that cannot and should not be saved; the price is too high economically and too high in the loss of democracy in Europe.

    A managed break-up is the sane, humane and courageous solution (and as such, highly unlikely).

    And I should add that I was a supporter of the Euro when it was first created.

  • Comment number 15.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 14.

    Its going to take a lot....
    I hope Germany has big, very big, pockets and the German people the stomach, for some big 'propping up' that has to be done.
    Time will tell

  • rate this

    Comment number 13.

    Germany will do what is best for Germany, the euro meant cheap exports for it (the DM would surely have floated up).
    Also Germany has not the cash to bail out the EZ without suffering.
    Also politically Ms. Merkel could not do it even if she wanted to. Therefore if the EZ is to survive, real cash must come in from outside. Most likely sources are the US (after the election) or China.

  • rate this

    Comment number 12.

    Germany, the manufacturing powerhouse of Europe is doing fine. It's got the euro down, so it's exports are helped and imports are less competitive. And it's using the ECB rather than its own banks to fund help to PIIGS. Why would it change its strategy?

  • rate this

    Comment number 11.

    The solutions don't lie in the past - those economists weren't dealing with these problems, so old solutions don't work

    FT's Gillian Tett's Fools Gold descibes it in detail, David Malone too

    You have to isolate a cancer before it spreads everywhere. Too late now the whole western banking system is riddled with insolvency

    New banks, sovereign debt write offs etc

    Radical change the only way

  • rate this

    Comment number 10.

    Can he fix it? - Yes he Cannot
    Well not unless eg
    Germany, France & northern neighbours either
    1) Leave Euro or start using their own currencies again, or

    2) Reconstitute Euro to have two Euro currencies for Haves and Have Nots

    Rest of EZ pool resources and devalue currency to sustainable competitive level & all of EZ and possibly EU required to form Eurobonds to save weak Euro 'B'

  • rate this

    Comment number 9.

    "Can Draghi do 'whatever it takes' to save euro?"

    Not while the German Constitutional Court has anything to say about it.

    Then again, the Germans did have experience of just how save-the-lenders-at-all-costs central bank policies lead to money printing which leads to hyperinflation, societal collapse and war.

    But hey, "This Time Is Different" (there's a book with that name, read it).

  • Comment number 8.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 7.

    Robert: to answer your headline - no, he can't do 'whatever it takes'. That clever little phase has been dreamed up by the Spin Doctors. Think about it ... it's very hard to argue against. Clever eh? Almost as good as the other stock phrase: Let's hold an inquiry about (whatever). Means two things - 1: we can't say anything more about it now; 2: we can come back to it in a year or two or three..


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