Draghi vs. Weidmann: Our Futures are at Stake

By Shlomo Maital  

 Jens Weidmann

  A fierce  behind-the–scenes battle is underway in Europe. The future of all of us is at stake.

  The  head of the European Central Bank, Mario Draghi, an Italian economist, and the Prime Minister of Italy, Mario Monti, both want to implement more radical policy solutions for the euro.  Their idea?  Use the bailout fund, the ESM (European Stability Mechanism).  Give the ESM a license to act as a bank. Let it borrow low-interest money from the European Central Bank (ECB). Then the ESM could directly buy sovereign bonds of Spain, Italy, Portugal and Greece, lowering their borrowing costs. It could even issue its own bonds, using the money to support distressed euro-area governments whose borrowing costs are now excessively high. 

    Basically, Draghi wants to allow the ECB to act like the Fed and the Bank of England, injecting liquidity into a deflationary system that desperately needs it, using the ESM. Had the Fed and the Bank of England not acted thus, using QE (quantitative easing), both the US and UK would be in serious trouble.  The Fed may soon engage in a third round of QE, unless Romney wins in November and replaces Bernanke, as he has promised.

   The truth?  It’s the only solution for Europe’s fiscal woes.  But here’s the problem.  The head of Germany’s central bank, Jens Weidmann, is fiercely opposed. And Weidmann, before he ran the Bundesbank, was German Chancellor Angela Merkel’s chief economic advisor for five years. 

   Where does Merkel stand?  Firmly in between.  She is very smart and realizes much more must be done than is now being done. But as a politician, she seeks re-election, sees her party’s support declining, and realizes German voters hate the idea of giving more money to the bums in Greece, Spain and Italy. 

    The 27 nations that make up the European Single Market comprise, together, the world’s largest economy. 

    A German research institute, Ifo,  conducts a regular survey of world economic conditions. They then pinpoint the global economy in 2-dimension space, with the x-axis representing “current situation” and the y-axis representing “improving or worsening”.  Here are the results for the past few years:

 

   You can see that the world economy has done a loop-the-loop, getting worse, much worse, improving, strengthening…and then, back into another downward loop, as of  2010.  The second downward loop in large part reflects the European inability to deal with its euro troubles. 

    The solution is there.  But will Angela Merkel have the wisdom and strength to rein in her Central Bankers, Jens Weidmann, and do the right thing, even though she may lose at the ballot box?   Stay tuned.    As the Luxembourg Prime Minister once said, we politicians know what we have to do. But we don’t know how to do it and get re-elected.