The proverbial circle can be squared if Draghi steps down as ECB President and takes the high profile post of Italy's president.  Germany's Weidmann is the obvious choice as his successor.  After Trichet, it was supposed to go to the Bundesbank's Weber, who resigned over the ECB's SMP scheme in which sovereign bonds were purchased (and turned out to be quite a profitable investment). 

Some observers have stressed the poor economic performance as a reason for more aggressive ECB action.  We disagree. While we recognize the weakness of the region's economy, we do not think European central banks generally see monetary policy as the instrument to address it.  At Jackson Hole, Draghi called for fiscal flexibility.  This apparently, according to some press accounts, raised the ire of senior German officials.  The German concern is not only over the well-worn moral hazard arguments,  it is about debt in the first place and the rejection of Keynesian demand management.  We have suggested it is very revealing that in German, the word for debt and guilt is the same. 

Structural reforms and the promotion of risk-taking and profit-seeking behavior over the traditional rent-seeking is  necessary.  This does not necessarily mean embracing neo-liberalism.   Germany instituted key reforms several years after the Berlin Wall fell, for example.  Spain appears to be engaging in a similar effort now.

In fairness, the EU has shown willingness to explore the fiscal flexibility that is embedded in the Stability and Growth Pact.  Has not France, Italy, Spain and others been given more time to reach the 3% deficit target?  Perhaps Draghi's comments were not so much about the debtor countries, but the surplus countries, like Germany.  With the German economy slowing, is there really a compelling reason for it to strive for a budget surplus?

We also take exception with arguments that contend that the problem in Europe is the lack of private investment.  We think the problem is one of aggregate demand.    The large trade surplus shows that the EMU is producing more goods than it consumes.  Moreover, capacity is under-utilized.    I cannot think of a major country that has had an economic recovery that was led by investment for at least several decades.  Public investment in a different story.  Here it does not appear that all of the funds, including EU funds, that are for infra-structure spending have been used.  European countries are their own worse enemies in this context.

European officials pride themselves on the rule-based approaches, but the rules are respected often only in the breach.  One area of public investment that euro area countries consistently miss is their pledge to spend 2% of GDP on defense.  Greece is one of the only EMU members that does, and it is probably among the least able to do so (though it buys its weapons primarily from Germany and France, which participate in lending it funds).  In light of the events in Ukraine, and on the eve of the NATO meeting, an increase in defense spending may turn out to be a more viable path.  To be sure, this is not to advocate military Keynesianism, just merely to recognize that it is an area that may be explored on political, economic and ideological grounds.

The euro has fallen for seven consecutive weeks coming into this week.  The gross speculative short euro position in the futures market is within a stone's throw of the record set just before Draghi uttered his famous pledge in July 2012.  While we expected the interest rate and growth trajectory to sustain the downtrend in the euro, we are concerned about the risks of either disappointment with the ECB or "sell the rumor, buy the fact" type of activity.  Medium term investors should be prepared for the a counter-trend move, which should seen as a better opportunity to get with the trend by reducing euro exposure directly or through hedges.

Marc Chandler​
Associate Professor at 
New York University Center for Global Affairs
​Marc to Market