Any central bank head that passes through an eight-year term without once raising rates has some explaining to do. To leave monetary policy extremely loose for such an extended period comes with major consequences (can we at least agree on that?). So, what went wrong? How did policy measures not operate as expected? With the benefit of hindsight, what could have been done differently?
What will be Draghi’s legacy? How will history view his stewardship over eurozone monetary policy? The years sure pass by. I still ponder how history will judge Alan Greenspan and Ben Bernanke. At this point, with securities prices (equities and bonds) basically at all-time highs, contemporary monetary policy – and its major architects – are held in high regard. I don’t expect this to remain the case following the next crisis.
A reporter question from Draghi’s Thursday news conference: “A recent survey by the Bank of America reveals that impotence and ineffectiveness of central banks, including the ECB, are the second risk perceived by investors. My question is: do you think that these investor concerns are justified? In other words, is there a risk of financial bubbles?”
Mario Draghi: “…You asked whether the expansionary monetary policies of central banks is the second-largest risk. I can answer for the eurozone; in the eurozone, and it’s a question we ask ourselves every day, many times a day, and I’m saying this because we monitor market developments very closely. We see some segments of financial markets where valuations are overstretched. One case is real estate, for example, and especially prime commercial real estate. Now, the causes of these overstretched valuations often don’t lead directly to our monetary policies. For prime commercial real estate, it’s the action of international investors… We may have other segments to watch, but frankly, all in all we don’t see bubbles. When we see some bubbles, they are local bubbles that should be, for example, some segments of the bond market, the high-yield leveraged bond market – which by the way is not a big issue in Europe. It’s more of a big issue in another jurisdiction… Certainly the other important issue is that much of this danger, much of this risk, much of this search for yield happens in the non-banking sector and more specifically in the so-called shadow banking sector. Unfortunately there, the perimeter of macro-prudential policies does not include that sector. We have some visibility, pretty good visibility, into what happens in the banking sector… But we don’t have much visibility for the rest of the financial sector. I’m talking for the non-banks, so for the shadow banking sector.”
Reminiscent of mortgage finance Bubble era Alan Greenspan, Draghi references “local Bubbles.” Yet Draghi concludes his term staring eye-to-eye with one of history’s most spectacular Bubbles – and it’s anything but “local” and it is not in real estate or high-yield. I’ll assume when ECB officials are monitoring markets “very closely” and pondering risks “many times a day,” perhaps sovereign bond markets garner some occasional attention.
Greek yields were at 22.31% when Mario Draghi began his term on November 1, 2011. Italian yields were at 6.09%, with Portuguese yields at 11.79%, Spanish at 5.54%, French at 3.10% and German yields at 2.03%. At 2011/12 highs, Italian yields reached 7.26%, Spain 7.62%, Portugal 17.39% and Greece 31.68%.
The collapse of eurozone yields has been nothing short of miraculous. Greek 10-year yields ended this week at 1.20%, and Italian yields closed at 0.95%. Portuguese and Spanish yields are down to 0.22% and 0.27% – and those are among the high-/positive-yielding instruments. German and French yields ended the week at negative 0.36% and negative 0.06%. Other negative-yielding eurozone 10-year bonds include Netherlands (-0.24%), Austria (-0.14%), Finland (-0.14%) and Belgium (-0.08%). Latvia’s 10-year yields ended the week at zero, slightly ahead of Slovakia (0.03%), Ireland (0.04%), Slovenia (0.08%) and Cyprus (0.46%). It’s curious that one of history’s greatest bond market inflations didn’t garner so much as a mention during Draghi’s final ECB press conference.
Scant interest in the ECB’s holdings as well. The ECB balance sheet doubled in size over the course of Draghi’s eight-year term. Total ECB Assets ended October 2011 at 2.333 TN euros, having already inflated dramatically from 2005’s one TN (euro). ECB assets are now at 4.687 TN ($5.230TN). There were the Long-Term Refinancing Operations (LTRO), Outright Monetary Transactions (OMT), and Quantitative Easing (QE). ECB assets surged 2.6 TN euros during the 2015 QE program that ran through the end of 2018. After a brief hiatus, the restart of QE (20 billion euro monthly) was announced in September.
Draghi will forever be known for “whatever it takes…” (“…and believe me, it will be enough”). He is hailed as having saved the euro. The dire consequences of a collapsing monetary union certainly afforded him extraordinary leeway. When the euro stabilized, he then leaned on the ECB’s inflation mandate to basically do whatever he wanted. Similar to central bankers around the world, global disinflationary forces associated with globalization, manufacturing over-investment, technological advancement, and changes in the nature of output (i.e. digitization) were used to justify unrelenting unprecedented monetary stimulus and policy experimentation. When these inflation mandates were created, did anyone ever contemplate that they would be justification for creating Trillions of new “money” through the monetization of government bonds and other securities?
Central banking has a long history of prudence and conservatism. After all, risks associated with bold measures and experimentation are too great: inflation, Bubbles, wealth redistribution, loss of trust, wars and so on. The role of central banks should be well contained; the scope of mandates limited in nature. Allow central bankers to drift into the domain of bolstering securities markets and you’re asking for trouble. Any “buyer of last resort” crisis-period operation should be concluded at the earliest available juncture. Never promise a market backstop. Efforts to use inflating securities markets as a mechanism for system reflation – to boost spending, borrowing, investment and incomes – is fraught with great risk. To have a central bank assume the role of savior for an ill-conceived monetary union guarantees precarious runaway monetary inflation.
There were momentous unintended consequences when Dr. Bernanke in 2008 unleashed his monetary experiment. Mario Draghi was a paramount one. I doubt Draghi would have even been considered for the ECB’s top post if not for Bernanke’s radical stimulus gambit. With the guardian of the world’s reserve currency having flung open the doors to rank inflationism, traditional central bankers in Germany were blown back on their heels. All the uncertainty and confusion created an opening. Articulate, diplomatic and with deep experience (including a stint as Goldman Sachs vice chairman and managing director), the smooth Italian fatefully overcame opposition from the sound money Germans to win the job.
For posterity, I’ll include a few headlines. “Mario Draghi, Hailed as the Euro’s Savior, Leaves With the ECB Divided” (Wall Street Journal). “How Mario Draghi Brought Determination to Calm Market Turmoil” (Financial Times). “Mario Draghi Reaches the End of His Fight to Save the Euro” (Bloomberg). “Mario Draghi Leave Europe Near Recession, in a Deflation Trap – and Out of Ammunition” (UK Telegraph). And my personal favorite from Axios: “ECB Head Mario Draghi Saved by the Bell as the Eurozone’s Mess Escalates.” A more forward-looking headline: “Lagarde Will Seek to Heal ECB Policy Split with Review Plan.”
Question: “What advice are you giving to Christine Lagarde – that you can tell us about anyway?”
Draghi: “…No advice is needed. She knows perfectly well what she has to do. By the way, she has a long period of time ahead during which she will have to form her own view, together with the Governing Council, about what to do.”
Bernanke and Yellen left Chairman Powell in a difficult predicament. It was up to him to move forward with a much delayed “normalization” (brought to a screeching halt in less than a year). Draghi has essentially set a policy course that will run much beyond the end of his term. There are no expectations for any so-called “normalization.” Negative deposit rates will continue indefinitely, as will QE. No difficult decisions anywhere on the horizon. The Governing Council will surely present a unified front. Christine Lagarde will have an easy time of it – that is, until trouble strikes.
The “ammo” issue will not be going away. The entire world will deeply regret having disregarded the sordid history of inflationism. And that has been the momentous unintended consequence of Bernanke and Draghi’s grand monetary experiment: once you travel down the path of using monetary stimulus to reflate financial and economic systems, there will be no turning back.
I don’t believe Draghi saved the euro – he merely postponed monetary breakdown. In so many ways, delaying the day of reckoning only makes things (much) worse. The world over the past couple weeks has experienced riots in an expanding number of countries – including Lebanon, Egypt, Iraq, Spain, Chile, Bolivia, Ecuador and Hong Kong. Wait until the global Bubble bursts. Similarly, wait as it expands further, with wealth inequalities mounting and social and geopolitical stress festering.
It’s crazy that central bankers have expended such precious resources to sustain the unsustainable. What does the ECB have remaining in its arsenal to expend when the next crisis erupts? One thing: Trillions of QE. And markets are perfectly aware of this reality, which explains the historic speculative Bubble that has engulfed eurozone and European bonds. European yields have been a major force pulling international bond markets along for the ride – and why not? The next crisis will be global, with the ECB’s Trillions of QE joined by Trillions from the Fed, ECB, PBOC, BOE and the rest.
It’s fitting that Mario Draghi’s final meeting in charge of the ECB came with the S&P500 trading right at all-time highs, while Italy’s two-year bond issue was oversubscribed with a yield of negative 0.11%. And then there was the announcement of the U.S. fiscal deficit of almost $1 TN, despite decent growth, unemployment at a 60-year low and historically low funding costs.
There is a long list of developments that were only possible because of the superhuman feats of “Helicopter Ben” and “Super Mario.” Paul Krugman has referred to Draghi as “the greatest central banker of modern times.” I’ll assume Dr. Bernanke is a close runner-up.
I’m convinced China’s historic Credit Bubble would not have inflated to such extremes without unprecedented monetary stimulus from the Fed, ECB and BOJ. The Chinese banking system doesn’t inflate to $40 TN without China’s massive holdings of international reserves underpinning its currency. China’s currency doesn’t sustain its international value without devaluations in the world’s reserve currency, along with the euro and the yen. And it was all made possible by Team Bernanke and Draghi, with the resulting Chinese-led investment boom a major factor behind global downward pressure on technology and manufactured goods prices.
Consequences of unprecedented monetary stimulus are now used as justification for only more outrageous monetary stimulus. Sinking “real rates” – “the natural rate” – “r star” – the “neutral rate” – now apparently demand lower for longer. And markets appreciate that global central bankers are trapped – nowhere to go but ongoing aggressive stimulus. With a straight face, investment managers assert on Bloomberg and CNBC that Federal Reserve policy is “too tight.”
Even with the S&P at highs, unemployment at lows, financial conditions loose, and “money” growing crazily, the Fed apparently has no alternative but to cut rates for a third time in three months – to avoid at all cost the Scourge of Disappointing Markets. At the minimum, the Fed should signal it will now pause. Most view this as unlikely, as such a bold maneuver risks upsetting fragile markets (trading at record highs). It’s hard to believe the FOMC is comfortable having highly speculative markets dictate monetary policy, but it’s similarly difficult to see them willing to break this dynamic. Right, no appetite for rattling markets.
I’ll be really curious to see how history views this cast of characters. When asked about his future, Draghi said “ask my wife.” I’ll assume he’ll follow in Dr. Bernanke’s footsteps – rake in millions. It’s an absolutely wonderful time to be an ex head of one of the world’s major experimental central banks. Such powerful incentives to keep the game going – the Bubble inflating. “‘Never Give Up!’ Draghi Tells Lagarde as He Leaves ECB,” read a Reuters headline..”
