Mario Draghi, ECB chief created flutter yesterday with his speech. He remarked ECB will do whatever to support Euro. This gave confidence. The exact words were:
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
In the beginning he refers this Euro project as bumblebee:
I asked myself what sort of message I want to give to you; I wouldn’t use the word “sell”, but actually I think the best thing I could do, is to give you a candid assessment of how we view the euro situation from Frankfurt.
And the first thing that came to mind was something that people said many years ago and then stopped saying it: The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years. And now – and I think people ask “how come?” – probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis. The bumblebee would have to graduate to a real bee. And that’s what it’s doing.
The first message I would like to send, is that the euro is much, much stronger, the euro area is much, much stronger than people acknowledge today.
I just read up on this bumblebee thing and was quite interesting:
According to 20th century folklore, the laws of aerodynamics prove that the bumblebee should be incapable of flight, as it does not have the capacity (in terms of wing size or beats per second) to achieve flight with the degree of wing loading necessary. The origin of this claim has been difficult to pin down with any certainty. John McMasters recounted an anecdote about an unnamed Swiss aerodynamicist at a dinner party who performed some rough calculations and concluded, presumably in jest, that according to the equations, bumblebees cannot fly. In later years McMasters has backed away from this origin, suggesting that there could be multiple sources, and that the earliest he has found was a reference in the 1934 French book Le vol des insectes; they had applied the equations of air resistance to insects and found that their flight was impossible, but that “One shouldn’t be surprised that the results of the calculations don’t square with reality”.
The calculations that purported to show that bumblebees cannot fly are based upon a simplified linear treatment of oscillating aerofoils. The method assumes small amplitude oscillations without flow separation. This ignores the effect of dynamic stall, an airflow separation inducing a large vortex above the wing, which briefly produces several times the lift of the aerofoil in regular flight. More sophisticated aerodynamic analysis shows that the bumblebee can fly because its wings encounter dynamic stall in every oscillation cycle.
Thanks to Draghi, got to know something more…
Overall speech is pretty powerfully worded as well. European policymakers always point that on an aggregate basis, Euro is more solid than US. However, people criticize that this is just artificial as within Europe there are wide viergences. Draghi responds:
At national level, because of course, while I was saying, while I was glorifying the merits of the euro, you were thinking “but that’s an average!”, and “in fact countries diverge so much within the euro area, that averages are not representative any longer, when the variance is so big”.
But I would say that over the last six months, this average, well the variances tend to decrease and countries tend to converge much more than they have done in many years – both at national level, in countries like Portugal, Ireland and countries that are not in the programme, like Spain and Italy.
The progress in undertaking deficit control, structural reforms has been remarkable. And they will have to continue to do so. But the pace has been set and all the signals that we get is that they don’t relent, stop reforming themselves. It’s a complex process because for many years, very little was done – I will come to this in a moment.
On the last summit:
But a lot of progress has been done at supranational level. That’s why I always say that the last summit was a real success. The last summit was a real success because for the first time in many years, all the leaders of the 27 countries of Europe, including UK etc., said that the only way out of this present crisis is to have more Europe, not less Europe.
A Europe that is founded on four building blocks: a fiscal union, a financial union, an economic union and a political union. These blocks, in two words – we can continue discussing this later – mean that much more of what is national sovereignty is going to be exercised at supranational level, that common fiscal rules will bind government actions on the fiscal side.
Then in the banking union or financial markets union, we will have one supervisor for the whole euro area. And to show that there is full determination to move ahead and these are not just empty words, the European Commission will present a proposal for the supervisor in early September. So in a month. And I think I can say that works are quite advanced in this direction.
So more Europe, but also the various firewalls have been given attention and now they are ready to work much better than in the past.
He says Euro is irreversible:
When people talk about the fragility of the euro and the increasing fragility of the euro, and perhaps the crisis of the euro, very often non-euro area member states or leaders, underestimate the amount of political capital that is being invested in the euro.
And so we view this, and I do not think we are unbiased observers, we think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible.
What is within ECB’a mandate:
And then there is a risk aversion factor. Risk aversion has to do with counterparty risk. Now to the extent that I think my counterparty is going to default, I am not going to lend to this counterparty. But it can be because it is short of funding. And I think we took care of that with the two big LTROs where we injected half a trillion of net liquidity into the euro area banks. We took care of that.
Then you have the counterparty recess related to the perception that my counterparty can fail because of lack of capital. We can do little about that.
Then there’s another dimension to this that has to do with the premia that are being charged on sovereign states borrowings. These premia have to, as I said, with default, with liquidity, but they also have to do more and more with convertibility, with the risk of convertibility. Now to the extent that these premia do not have to do with factors inherent to my counterparty – they come into our mandate. They come within our remit.
To the extent that the size of these sovereign premia hampers the functioning of the monetary policy transmission channel, they come within our mandate.
In the end:
I think I will stop here; I think my assessment was candid and frank enough.
Fairly frank but am not sure how many takers. People are quite fed up of hearing these tall and strong claims.
Here is Buiter increasing the probability of Grexit from 50-75% to 90% in 2-3 quarters.