The Draghi Dilemma

Mr. Draghi “solved” the euro problem – the doubts the international investors harbored about the single currency’s future due to the perspective of several southern governments defaulting on their debts – by promising that he would do “whatever it takes to save the euro”, i.e. buy unlimited amounts of these debts in order to guarantee their market value. In other terms, do whatever it takes to save the value of the capital that international investors put in European government bonds.

Indeed such a policy so reassured the international capital investors that, lacking an equally central-bank-guaranteed investment opportunity elsewhere in the world (the “Draghi put”), they flocked to the Eurozone, determining a rise in the euro/dollar exchange rate in the process.

Mr. Draghi thus added a supplementary deflationary influence to the budgetary austerity policies that northern governments are currently forcing on the southern European governments, as a condition for continued northern lending that the “south” badly needs to avoid government default and Euro exit. This is an unfortunate timing for monetary and exchange rate policy at the beginning of a recession, the present condition of the EU economies. What was needed, on the contrary, was a progressive but major depreciation of the euro in order first to stimulate the economy and second to allow the governments that absolutely need a competitive currency to revive their economies to exit the euro system altogether. 

Hence the Draghi dilemma: guarantee the investors’ stake in bankrupt government bonds and boost the euro in the exchange markets, and thus further depress the economy and deteriorate even more the public finance equilibrium while trying to improve it (by decreasing the risk premium in interest rates), or create more money in order to let the euro depreciate and alleviate the external debts of European governments but violate the ECB charter and enter in a conflict with the German government that just enters an electoral campaign, and risk determining a capital flight and government bankruptcies in the south.

Did they say that the euro problem was “solved”?