They were probably the three most successful words in central-banking history. Two years ago, on 26 July 2012, the European Central Bank’s (ECB) president, Mario Draghi, pledged to do ‘whatever it takes’ to save the euro.
Back then, the situation in the eurozone could hardly have been worse. For two years the euro had been battered by the markets. Greece had gone bust and had to be bailed out by its neighbours. It was swiftly followed by Portugal and Ireland. Bond yields were rising alarmingly in Italy and Spain, at several points breaching the 6% level at which their debts would become unsustainable. European leaders were convening at crisis summits on an almost weekly basis, coming up with fresh plans to save the currency, few of which survived until the next morning. It was chaos, and to many it looked as if the euro might not survive the year.
“The ECB is ready to do whatever it takes to preserve the euro,” said Draghi that day. “And believe me, it will be enough.” It was an obvious enough promise, and was greeted with a certain amount of cynicism at the time. Yet it did the trick. The nub of the problem was that the markets did not believe the ECB was a real central bank – one that, in the last resort, would print the money needed to prevent a government going bust.
What Draghi made clear was that, on his watch, the ECB would be precisely that. Any hedge fund shorting Italian or Spanish bonds suddenly knew that it would be facing the firepower of the ECB. Unsurprisingly, they backed off. The trade was suddenly too dangerous.
It took a while, but looking back, the impact has been dramatic. At the peak of the crisis, the Spanish ten-year bond yield hit 7.5%. Now it’s 2.6%. Italy’s borrowing costs peaked above 7% – now it can raise money for less than 3%. In the bankrupt nations, bond yields have tumbled even more. The yield on Greek bonds hit 35% at one point. It’s now less than 6.5%. The days when every government bond auction was a nail-biting event have been consigned to the past. Now all the eurozone nations can access capital markets when they want to.
On that measure at least, Draghi’s speech was a stunning success, and he deserves credit for it. Whether he would ever have been able to make good on the pledge, probably no one will ever know. He never needed to. The threat alone was enough to bring the capital markets to heel.
The trouble is, it did not fix any of the underlying issues. What two years ago was essentially a financial crisis has turned into an economic one. The eurozone has locked itself into a depression. The Italian economy is still shrinking, and is no bigger than it was when it joined the single currency 14 years ago. France looks weaker with every quarter of zero growth, and may soon be back in recession. Even the supposed might of Germany is largely an illusion. It racks up big trade surpluses, but on measures such as retail sales it is almost as weak as its neighbours.
Indeed, what started as a southern European crisis is increasingly a northern one, as countries such as Finland and the Netherlands run into trouble. Unemployment is at critical levels – while America and the UK are generating jobs at a rapid rate, in the eurozone joblessness is growing quickly.
While a financial crisis is relatively easy to fix – as long as the central bank is not squeamish about bailing lots of people out – an economic crisis is far harder to solve. To take just one example, Spain has had a crucifying level of youth unemployment for so long that a whole generation may never get jobs. That does incredible long-term damage to competitiveness, from which the economy may take decades to recover.
Next, what was a liquidity crisis has turned into a solvency crisis. Two years ago countries could not borrow fresh money – they had liquidity issues. Now it looks as if they may not be able to repay all their outstanding debt – they have a solvency problem. Italy has a debt to GDP ratio of 146%. Greece’s is at 175%. Servicing those debts was already a tough task. But it just got a lot harder.
Greece is in outright deflation, with prices falling by 1.5% a year. So is Portugal. Spain and Italy are close to zero inflation and may witness falling prices very soon. Once prices start to fall, debt ratios climb every year, even if the government doesn’t borrow any more. Sooner or later, all those countries will have to restructure their debts. The only question is when, by how much, and who will take the hit.
The speech two years ago ended a chapter in the eurozone crisis, and the people who took Draghi at his word made a lot of money. But the best way for Draghi to mark the anniversary would be to come up with another formula – one that solves the problems Europe faces now.