Draghi Makes His Case

A few unorganized thoughts on yesterday’s press conference. Video is here. Transcript is … do they even publish transcripts of these things?

Draghi’s introductory remarks didn’t mention Greece but of course that’s what all the questions were about. The big question were about liquidity assistance (ELA) to Greek banks and under what conditions Greek debt would be included in quantitative easing, a big expansion of which was just announced.

There’s no way to hide the hypocrisy of the simultaneous expansion of QE and continued limits on ELA. You can say, the markets don’t want to hold this debt so we need to reduce our holdings too, to avoid excessive risk — then you are acting like a private bank. Or you can say, the markets don’t want to hold this debt so we need to increase our holdings, to keep its yield down — then you are acting like a central bank. But there’s no basis for applying one of these logics to Greece and the other to the rest of the euro area.

There was also no explanation for the decision to raise the ELA cap by 900 million. Draghi kept repeating the formula “solvent banks with adequate collateral” but obviously this implies a bank by bank assessment, not a hard cap for the country as a whole. Anyway, the logic of a lender of last resort is that, if you are going to support the banks, you need to be prepared to lend as much as it takes. A limited program only makes the problem worse, by encouraging depositors and other holders of short-term liabilities to get out before its exhausted. Paul de Grauwe has the right analysis here:

The correct announcement of the ECB should be that it will provide all the necessary liquidity to the Greek banks. Such an announcement will pacify depositors. Knowing that the banks have sufficient cash to pay them out they will stop running to the bank. Like the OMT, such an announcement will stop the banking crisis without the ECB actually having to provide much liquidity to the Greek banks.

These are first principles of how a central bank should deal with a banking crisis. I would be very surprised if the very intelligent men (and one woman) in Frankfurt did not know these first principles. This leads me to conclude that the ECB has other objectives than stabilizing the Greek banking system. These objectives are political. The ECB continues to put pressure on the Greek government to behave well. The price of this behavior by the ECB is paid by millions of Greeks.

Logically, ELA should either be ended or else provided on the a sufficient scale to restore confidence and end the run. Draghi suggested that there was something moderate and “proportional” about choosing a course in between, but this is incoherent. I was also very struck that he felt the need to reject the accusation that “there was bank run deliberately caused by the ECB,” which no one there had made. Remember that old line, attributed to Claud Cockburn: Never believe something until it’s been officially denied.

Another thing I found interesting was how much he treated the Bank of Greece as an independent actor, frequently referring to decisions “taken by the ECB and the Bank of Greece” and even trying to pass the buck to them on questions like whether the additional ELA was sufficient (“we have fully accommodated the Bank of Greece’s request”) and when the Greek banks would be able to reopen. Establishing that the national central banks have independent authority will be important if they become a terrain of struggle in future conflicts between popular governments and the euro authorities.

On the question of when the Greek banks would reopen, after deferring to the BoG, he then said that they hold all this government paper (which isn’t actually true — the ECB’s own numbers show that Greek banks have the lowest proportion of government loans on their books of any major euro-area country) and their solvency and the adequacy of their collateral therefore depend on what’s going on with the government. “The quality of the collateral depends on the quality of the discussions” with the creditors was one way he put it, a more or less explicit acknowledgement that this decision is being made on political criteria.

Someone asked him point-blank how the Greek banks could be ineligible for assistance when the ECB’s own analysis had concluded they were solvent; someone else asked why a hard cap was being announced when this was never done for individual banks, precisely because of concerns wit would intensify a panic. At this point (around 40:00 in the video) he changed tack again. Now he said that this was a special case because it wasn’t about conditions at individual banks but about a “systemic” problem of a whole banking system, so the old rules didn’t apply. Which of course made nonsense of the “solvency and adequate collateral” formula, without doing anything to justify the ECB’s actions.

On the question of whether or when Greek bonds would be included in QE, Draghi’s initial non-answer was “when they become eligible for monetary policy.” Pressed by the reporter (around 56:00), he turned to vice-president Constâncio, who explained that if a country’s bonds were rated below investment-grade, they could only be purchased by the ECB if (1) there was an IMF program in place and (2) the ECB’s Governing Council determines that there is “credible compliance” with the program. [1] Here again we see how monetary policy is used to advance a particular policy agenda, and more broadly, a nice illustration of how market and state power articulate. The supposed judgement of the markets is actually enforced by public agencies.

One of the few departures from Greece was when Draghi got going — I can’t remember in response to what — about the need for deeper “capital market integration.” Which seems nuts. Who, looking at the situation in Europe today, would say, You know what we really need? More uncontrolled international lending. It’s just like Dani Rodrik’s parable:

Imagine landing on a planet that runs on widgets. You are told that international trade in widgets is highly unpredictable and volatile on this planet, for reasons that are poorly understood. A small number of nations have access to imported widgets, while many others are completely shut out even when they impose no apparent obstacles to trade. With some regularity, those countries that have access to widgets get too much of a good thing, and their markets are flooded with imported widgets. This allows them to go on a widget binge, which makes everyone pretty happy for a while. However, such binges are often interrupted by a sudden cutoff in supply, unrelated to any change in circumstances. The turnaround causes the affected economies to experience painful economic adjustments. For reasons equally poorly understood, when one country is hit by a supply cutback in this fashion, many other countries experience similar shocks in quick succession. Some years thereafter, a widget boom starts anew.

Your hosts beg you for guidance: how should they deal with their widget problem? Ponder this question for a while and then ponder under what circumstances your central recommendation would be that all extant controls on international trade in widgets be eliminated.


[1] I’m not sure but I believe these standards were established by the ECB itself, and not by any of its governing legislation. So the answer is evasive in another way. In general, watching these things makes clear how helpful it is in resisting popular pressure to have multiple, shifting, overlapping authorities. Any decision can be presented as an objective constraint imposed from somewhere else.


UPDATE: Nathan Tankus has some very sharp observations on the press conference.


9 thoughts on “Draghi Makes His Case”

  1. Via John Cassidy, here’s a report that says Draghi echoed the IMF that debt relief was necessary and uncontroversial.


    I am wondering what this means (obviously the devil is in the details and specific amount). Was debt relief talked about before Syriza. Schauble says debt relief isn’t allowed by the Eurozone rules and so it may never happen.

    Sure they may get debt relief after another 5-10 years or more of their economy being destroyed.

    Cassidy ends his thoughts with some Marx and Lenin:

    “In the Marxist intellectual tradition, from which many senior members of Syriza hail, progress comes about gradually. To overthrow the existing order, you have to first mobilize the masses by stripping back the democratic veil and showing the real workings of the system: only then will the “objective conditions” be ripe for revolutionary change. Tsipras and Syriza didn’t create the conditions for change. But in bringing Greece to the brink, and demonstrating that its creditors were willing to see it collapse if it didn’t buckle to their demands, they did, arguably, succeed in showing up the eurozone as a deflationary straightjacket dominated by creditors. And they did this with all of the world watching. “One must know who the enemy is, in order to fight the enemy,” Alex Andreou, a Greek blogger who is sympathetic to Tsipras, wrote last week. “Syriza has achieved that. Now, it is over to you, Spain. Take what we’ve learned and apply it wisely.”

    Under this analysis, Syriza’s surrender wasn’t necessarily an ignominious one. As Lenin commented of the failed 1905 revolution in Russia, it was a retreat for a new attack, which ultimately proved successful. “I’m not going to sugarcoat this and pass it off as a success story,” Tsipras said to parliament on Wednesday, prior to the vote, acknowledging that the spending cuts and tax increases contained in the agreement would deal another blow to the Greek economy. However, that wasn’t the full story, Tsipras insisted. “We have left a heritage of dignity and democracy to Europe,” he said. “This fight will bear fruit.”

    Only time will tell if that was wishful thinking.”

  2. The way Greece is being ganged up on, it wouldn’t surprise me if a border dispute breaks out at the worst moment. I’m thinking Gaza, in Europe. Doesn’t Greece have problems with a neighbor over the word Macedonia?

  3. I like to draw a circle around Greece and a circle around the remaining euro nations. There should be a balance in both money and product exchange between these two circled economies.

    If there is NOT a balance in both money and product exchange between these two circled economies, how is the situation stabilized?

    I think the present bailout is not the end of the unbalance. It is more a continuation of the unbalance and delay of a lasting solution.

    1. You may like to do that, lots of other people like to do it too. But it’s important to recognize that a requirement for balanced trade between geographic areas is absolutely incompatible with free financial flows, let alone a common currency.

      Free financial flows (aka capital mobility) means that any liquid unit can generate a crossborder financial flow at any time, by selling or purchasing a foreign asset or incurring or extinguishing a foreign liability. A single currency area means that these transactions cannot be limited by the monetary system. i.e. a bank deposit in one geographic area must be freely convertible, at par, to a deposit in another area. So what mechanism is supposed to maintain the balance you like to see?

      Relatedly, what do you suppose the balance of payments is between New York and New Jersey? I don’t think existing statistics give us any way to even estimate this number.

      In any case, if the purpose of free flows of portfolio capital is not to finance trade imbalances, I can’t see what their purpose is.

      1. Thanks for the carefully considered reply to my comment.

        I think I should better explain the reasoning behind my comment.

        Money itself is always ‘property’. If an entity does not have money, it can not create it (unless the entity is a money creating entity). Greece, as an individual nation in the euro zone, is denied the right of creating money.

        This denial opens the door to the possibility that Greece as a nation can commit ALL of it’s money to non-Greek nations. This would leave Greece with no money. Greece would still have other property and the potential to earn money but would have no money at all.

        At this point, only the Greek Government is without any money at all. The Greek people still have some money, both in Greek internal banks and in banks outside of Greece.

        Against this background, you correctly ask what mechanism will maintain a monetary balance?

        Well, we can see that the Greek government can further tax and confiscate money (euros) held by the Greek people. This would reduce the amount of money held by the Greek people further. This could be done until the last euro was confiscated. This would be the limit on monetary imbalance (if we exclude debt).

        I think the ability to confiscate denies the existence of any mechanism to maintain balanced money flows. Instead, if balanced money flows across borders is a goal, the Greek government must allow balance to be achieved. The alternative to balance is imbalance with a limit of zero holdings .

        Yes, we can extend this logic to examine the balance between New York and New Jersey. Like you, I am not aware of any statistics that could assess the balance or imbalance. Yet, there has never been a complete absence of money in either state so we can safely assume that the balance is pretty good.

        I think the ongoing Greek tragedy is a live experiment in economics. We should be able to drawn a number of lessons from this event.

        1. Greece, as an individual nation in the euro zone, is denied the right of creating money.

          Many people believe this but it is not correct. There is not a central “euro printing press,” whatever may be implied by the models preferred by Krugman and friends. Money in the euro system is created by the banking system, just as it is in any modern economy. The commitment to the singe currency means a commitment to accept the money created by Greek banks in France, Germany, etc. Having a single currency means having a mechanism — in this case the TARGET2 clearing system — that ensures this happens. To create the effect of a single money stock in fact takes an active intervention in bank regulation by the authorities.

          there has never been a complete absence of money in either state so we can safely assume that the balance is pretty good.

          Not at all. It simply means that liabilities issued on one side of the line are freely accepted on the other. That Domesday, when accounts are settled, never comes.

  4. I don’t think this example works.

    Suppose that there are 2 guys, A and B, and there are 100GP (gold coins). In A owns 70GP, B can own no more than 30GP. This means that the maximum wealth attainable by A is 100GP (all the GPs in the world).

    But this is true only in a non-credit economy: in a credit economy, A might own 150 of the 100GP existing in the world, while B would be in debt of 50GP to A. Or A could own 1000 of the 100GP of the world, while B would be indebted of 900GP.
    Note that this would be true even in a “gold coin” economy (way stricter than a “gold standard”), as long that credit is possible.

    In the 2nd example, 100GP would be coin money while the other 900GP would be credit money.
    AFAIK, if we see banknotes and coins as “coin money”, in the real world no more than 10% of the wealth existing would be made of “coin money”, whereas 90% of existing money wealth is “credit money”, which is credit for someone, but debt for someone else.

    This is important because we tend to speak of positive or negative savings as they were an accumulation of stuff, but in reality “saving” of A is the accumulation of debt of B and the reverse. Thus there is not something like “aggregate savings”, but rather a credit expansion (when both total savings and total debt increase) or a credit contraction (when both total savings and total debt fall).

    If A wants to save, either B gets more in debt (hence we have a credit expansion) or, if B doesn’t, there is a crisis of underconsumption (as some of the products of A will be unsold). As long as A (the creditor) is trying to save, there will never be a credit contraction.

    A credit contraction can only happen (IMHO) in these three ways:
    – A (the creditor) chooses to overspend, while B (the debtor) chooses to “save” by paying back his own debts;
    – There is a surge of inflation so that, even if nominally the credit stays the same, the relative value of the debt falls;
    – B goes bankrupt and disavows his debt to A (or A cancels B debts).

    BTW, I suppose that both New Jersey and New York have a negative quantity of wealth (on the assumption that the USA is a net importer), and certainly Greece has a very negative quanty of money.

    1. After going through your example, I think it is OK. However, IMHO, there may be an oversight that should be included.

      Each new loan of money increases the wealth of the economy by the amount of the debt instrument signed. While the amount of money does not change (100 GP in your example), the amount of deposits does change (to 100 GP plus 50 loan created deposits in your example) (to 100 GP plus 900 loan created deposits in your second example).

      Using your second example, as you say, A could hold all the GP so it is better to describe the money expansion as a credit expansion. On the other hand, the expanded money could be held by A plus C plus D plus …… In this new case, it makes more sense to use a term like “aggregate savings” to describe the savings of people who have worked hard to acquire the deposits that were created by the credit expansion (money spent by the borrower).

      Turning to money contraction, I would readily agree with the first and last methods of money contraction. I question the second one. Inflation clearly affects the value of money but I don’t see that it effects the amount of outstanding money. Not until the debt is repaid or disavowed.

      I think Greece is so far in debt that if you gathered all the euros (both currency and deposits) remaining in Greece, it would not be enough to repay the debt of the Greek government, not to mention the debt of the Greek private sector. I have not verified this, just a suspicion.

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