"Draghi disappointed," was the pronouncement from Bill Gross of Pimco bond fame. "Draghi delivers" rejoined the Daily Telegraph's veteran econ observer, Ambrose Evans-Pritchard. The catch for market participants is that they both may be right.
The markets have obviously taken the side of Mr. Gross for now. No bond purchases, no refinancing operation, not even the rate cut that many considered to be the absolute minimum necessity. European equities plunged, Spanish and Italian bond yields soared, US equities logged a third straight day of losses. What was European Central Bank (ECB) president Mario Draghi thinking?
One possibility is that in reality, Mr. Draghi has successfully nudged his agenda along. His comments focused on issues of monetary transmission, which several commentators (including Mr. Evans-Pritchard) took as signaling grounds for expanded bank intervention, in particular bond purchases in the secondary market for the purpose of capping sovereign yields and heading off further crises.
In such a scenario, the conversation last weekend between Draghi and Jens Weidmann, president of the notoriously reactionary German central bank (Bundesbank) that is still fighting the ever-dangerous rebirth of the hyperinflation aftermath of World War I some 90 years ago, rather than the continent's current slide into recession, would have consisted of an agreement of broader action on the grounds of correcting faulty transmission of monetary policy.
In exchange for maneuvering room that stays within the rules, Draghi would thus agree to not lower rates, hold off on injecting more money into the system and bide his time on bond purchases until the formalities were observed. To wit, wait until yields spiral to acceptably high levels (acceptable to the Bundesbank, that is, as constituting an emergency), make Spain and Italy take off their respective hats and beg for mercy, and above all, ignore the equity markets entirely. It can be difficult for Americans to understand the level of disdain Germans have for the markets and how strongly they feel about not being dictated to by those stock market swindlers, but it is stronger than how Red Sox fans feel about the Yankees or Liverpool about Chelsea.
In sum, when bond markets are clearly failing and all have followed the proper procedure, Draghi may now have consent from Bonn to act as needed to preserve monetary order and the euro.
August might then be a particularly tumultuous month, one that first sees equities swoon as data continues to disappoint and bond buyers shun paper from the southern rim of Europe, only to be followed by a surprise cavalry charge from the ECB that re-ignites equities and suitably punishes (in German eyes) reckless speculators.
There is a hurdle in this line of thinking. The Bundesbank and the Germans are sticklers for strict protocol, leaving open the question of how narrow the opening will be for countries such as Spain and Italy. Domestic political considerations in Germany forbid any notion of its money being used to subsidize overpaid and underproductive civil servants, or indeed any worker, particularly those in industries that compete with German unions.
It may take formidably dire circumstances to extract concessions from either side - in which case, the damage to the economy and/or financial system could end up being up greater than anticipated by the optimists or the European elites still insistent upon procedural considerations being followed to the letter.
A less optimistic view is that Mr. Draghi and the Europeans are still playing the same game of grand promises and minimalist action that has characterized the last two years. The central bank president talked a lot of game about the futility of doubting the euro on Thursday, but did not go into detail about which countries might still be using it a year from now. It's possible that the current thinking from Germany is that the euro should be allowed to evolve, with some making the cut and others not, with the result being a better, more stable and above all more suitable eurozone.
It would be rash to overlook the degree of German complacency about the budding storm. There is still considerable opposition to bond-buying within Germany, and even those not in outright opposition often hold fast to imposing conditions difficult for any current EU government to accept, especially if perceived as being at the hands of the Germans. The recent European phenomenon of collapsing governments is quite likely to repeat itself if certain elements of German thinking manage to prevail in a crisis.
Despite the continual declines in recent German economic data, the country is still enjoying a time of low unemployment and recently increased salaries. It would hardly be the first country to believe that the fires burning on the horizon were a spectacle for the curious to watch at night, yet certainly not any threat to its own comfortable, well-deserved existence.
Nor is the irony lost on this writer that while much of Germany continues to obsess over the hyperinflation of the 1920s, the phenomenon was given birth by the draconian conditions of the Treaty of Versailles that wrecked the German economy and dug the first holes of the Great Depression. Now many within Germany want to take a similarly punitive approach with its supposed economic allies.
Two things were still holding US markets together at Thursday's close. The first was hopes for the jobs report on Friday, either strong enough to beat the estimate, or weak enough to provoke the Fed. The second was the rapidly growing belief that Wednesday's FOMC statement laid the groundwork for near-certain accommodation at the September meeting.
The worrisome part in all of the foregoing scenarios is the seeming requirement that equities sell off first. There is admittedly a lot of worry already priced into the stock market, but there was a year ago at this time as well. It might not take much in the way of a surprise to trigger a revisit to the year's lows.
While we wait for damage great enough to permit a rescue attempt, the European economy continues to weaken and the Germans inhabit a land quite familiar to German philosophy: cloudcuckooland. It would be a bit more reassuring to see less complacency about the potential damage of taking too long to act - the same kind of complacency that convinced our own principals that the world would be better off in the end without trying to rescue an undeserving, troubled investment bank with insufficient moral grounds for assistance.
The veterans of that crisis continue to remind their colleagues across the pond of the need for urgency, but they don't seem to heed us any more than we heeded them. Pass the dice and cross your fingers might be the best advice we can give to all but the hardiest.