LAST Friday was a momentous day for the European Central Bank (ECB). Traders across Europe rejoiced as the floodgates were finally opened and ECB President Mario Draghi announced the long-awaited decision to undertake quantitative easing, a policy of purchasing government bonds, which is aimed at stimulating inflation in the eurozone. The decision is undoubtedly excellent news for investors, who are likely to see asset prices rising across the board off the back of this huge cash injection. However, politicians across the Continent will consider the development somewhat more ruefully; for hidden within the announcement was evidence of Germany’s weakening commitment to the European project.
From a purely economic perspective, Draghi delivered almost everything the markets could have asked for. At 1.1 trillion euros ($1.13 trillion), the quantitative easing program was more than twice the size expected and included all the peripheral sovereign bonds that had already been bought by traders in anticipation, raising prices to record highs. Best of all, he suggested that the central bank’s commitment to hitting its 2 percent inflation target was unlimited and that it would continue buying bonds until it succeeded. The man famous for saving the eurozone in 2012 will now do his famous promise of “masterful work with whatever it takes,” for as long as it takes.
Considering the economic heft of this decision, why did the ECB wait until the eurozone had actually entered deflation (-0.2 percent in December) before using it? Within the answer lies the flaw in Draghi’s plan, and the sacrifice he had to make in order to hit the inflation target, his primary responsibility as president of the ECB. For Friday morning’s announcement also revealed that 80 percent of the bonds would be bought not by the ECB but by the national central banks, which would each buy their own country’s bonds and hold the default risks separately.
While this unusual formulation should have little impact on the effectiveness of quantitative easing, the political message it sends is starkly negative: If things go badly, everyone is on their own. This message is a change of direction for the eurozone. Ever since the inception of its forerunner in 1951, the European Union’s credo has been “an ever closer union,” constantly tightening the links that connect the nations until one day a United States of Europe existed. Draghi’s decision to separate the risks of the European states is a seminal moment, since it is a reversal of this momentum.
In 2005, European voters rejected a treaty that would have established a constitution for the future union. It was a setback and a pause in progress, but the constitution idea could still have been floated again at a later date. The move to separate the risks of eurozone states, by contrast, is a step backward. It is a negation of the precedents established in the 2011-2012 crisis, in which countries raised funds to aid their fellow members, and in which the “whatever it takes” promise implied that the ECB backstopped all eurozone bonds. Now, Europeans are taking a step further apart.
But how did this happen? What forced Draghi to adopt a structure that undermines the European project in this way? The answer to that question is Germany. For at least the past 12 months, German Chancellor Angela Merkel and Bundesbank head Jens Weidmann have been united in the belief that quantitative easing would be bad for Germany because it would involve spending ECB money (of which Germany provides 17 percent) on the countries in the European periphery — and would leave Germans carrying a large part of the bill in the case of a default.
When it became clear that deflation was imminent as the global oil price plummeted, the Germans realized that a compromise would be necessary. In fact, it was Weidmann who in December first began talking publicly about a solution similar to the one announced Friday morning. On Jan. 14, Draghi held a private meeting with Merkel, presumably to gain her blessing on the plan, and it seems certain that she gave it. Merkel signed off on a plan that would loosen the ties that bind the eurozone, preferring it to a standard risk-sharing model that, though unpalatable to her countrymen, would have brought Europe’s countries closer together.
The weakness in Europe’s construction has always stemmed from the fact that ultimately, every individual nation puts its own interests first and Europe’s second. In 2009, Greece revealed that it had been falsifying its official figures for several years, allowing its citizens a more comfortable life while saving problems for later. This revelation was the start of an economic crisis, culminating in the sovereign bond crisis of 2012. In 2014, France and Italy both failed to comply with the Growth and Stability Pact, struggling to accede to the budgetary demands of the European Commission because of domestic political constraints. The commission’s unwillingness to discipline the offenders has resulted in an undermining of its credibility.
It is not new for a country to put its own well-being before that of the collective, or for the European Union’s institutions to be undermined by its own members. What is new this time around is that the problems came from Germany, Europe’s largest economy and historically its staunchest defender. Germany has proved that, just like its fellow eurozone members, it is willing to forgo the good of the union to protect its own interests. But in doing so, it has reversed the momentum of the eurozone — a slow-moving beast, which will be hard to turn around again.
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