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The future of euro and Mario Draghi

Chaklader Mahboob-ul Alam
IN January 2012, it looked as though the nightmare scenario about the collapse of the euro would come true. It was widely predicted even by serious financial analysts that the mounting debts, the banking crisis and the draining recession would break the euro.
Actually, last June, everything turned so bad that many feared that the end was near.
Luckily, today, on January 1,2013, things look quite different. Greece is still a member of the euro area. No one has forced it to abandon the common currency. The very high borrowing costs for Spain and Italy that were pushing them towards bankruptcy have come down in a significant manner. It is expected that after the fiscal agreement is reached between the Democrats and the Republicans in the US, they will come down even further. The stock market has also rallied.
Does this mean that the crisis is over?
No, it is not yet over. In many countries sharing the euro, the banking system is still a mess, there is no credit, and economic activity, instead of growing, is still shrinking where unemployment is reaching a socially unacceptable limit.
If that is so, why in spite of all this, is there a renewed air of optimism in certain quarters now?
Much of the credit for this optimism should go to one person, Mario Draghi, the president of the European Central Bank. The euro was born with a number of fundamental design flaws. He is trying to correct them. Leaving aside the political problem of managing a common currency for 17 independent countries with widely different levels of productivity, which guard their sovereignty with great zeal, the euro was born with a number of important technical flaws as well.
It was created without a lender of last resort, without a common banking regulator and without a common fiscal policy and no one at that time even thought of a debt mutualisation scheme. Actually, it is surprising that it lasted this long.
Last July, when it seemed that the end was near, Draghi came out with a strong statement aimed at the bond-market speculators. In order to emphasise that the euro was irreversible, he declared: "The ECB is ready to do whatever it takes to preserve the euro." Then he added, "And believe me, it will be enough."
It turned the tide of growing pessimism to one of
cautious optimism.
Although his legal mandate is somewhat limited -- the ECB is not allowed to finance the member countries directly --, in reality, as president of the ECB, Draghi can exercise enormous powers, if he chooses to do so.
ECB is an independent body, therefore, in a crisis situation it should be able to act quickly and decisively. As head of the ECB, he is
the only one in the euroarea who can create money. So merely a firm statement emphasising that he was willing to use his powers to buy unlimited amounts of bonds, issued by the troubled euro-area countries like Spain and Italy, calmed the markets and as a consequence, their borrowing costs came down significantly.
By this statement he assured the market that if necessary, the ECB will act as the lender of last resort. In order to allay the fears of the private investors that they will be at a disadvantage vis-a-vis the ECB, if it insisted on being the first in the line to be repaid, Draghi stated that "the pecking order of creditors will be maintained."
Draghi's job is not an easy one. In exercising his powers to create money or even threatening to do so, he must strike a balance between adopting emergency measures to save the euro and making the governments too reliant on the ECB money to get them out of the crisis, which after all, was created by them.
Draghi feels that the long-term solution to the prob-
lem lies in the hands of the governments who must undertake fiscal and structural reforms and at the same time work steadfastly towards achieving "greater pan-European banking, fiscal and political union." He can only push them towards that direction.
While embarking on a bond-buying project, Draghi will also have to be careful that this policy does not lead
to high inflation. His objective is to provide enough stability to the financial market so that economic growth can resume.
The banking crisis has clearly demonstrated that the national regulators have been ineffective and most probably negligent in carrying out their duties. According to an ECB report, "almost all the banks in Europe are valued by the stock market at substantially less than the book value of their loans outstanding and other assets."
This is a terrible indictment on the performance of the national regulators. To correct this situation Draghi feels that there is a need for the creation of an effective regulator under the ECB with the power to intervene before it is too late.
After much haggling, an agreement has recently been reached by the member countries to put all large banks of the euro-area under the supervision of one single pan euro-zone regulator. Unfortunately, thousands of small banks will still remain under the supervision of the national regulators.
Although it is not an entirely satisfactory measure, no doubt, it is a step in the right direction. It is hoped that eventually all euro-area banks will be supervised by this European regulator.
In order to encourage the banks to issue credit to the businesses, the ECB recently cut the interest rate to 0.75%. It has assured the banks that they can borrow unlimited sums of money.
Unfortunately, latest figures published by the ECB show that the banks are still reluctant to issue credits because many of them are still undercapitalised. It is expected that the ECB will cut the rate even further. If it happens, there is no doubt that Draghi will be accused of increasing the risk of inflation.
Germany wants collective (pan European) control over national fiscal policies before agreeing to a debt mutualisation scheme. The details of a European bailout fund, the European Stability Mechanism to provide aid directly to the troubled banks, will unfortunately not be finalised until the German national elections are over.
So, what is the conclusion?
Will the euro survive? Although things have improved considerably, the crisis is not over yet. The euro still remains a work in progress. As Floyd Norris, of The New York Times pointed out, "At the heart of the problem was Europe's unwillingness to choose either unification or separation. It wanted economic unification, with continued political independence of nation-states.''
I think that the Europeans have now come to realise that it is an impossible proposition. They are working towards achieving greater political and economic unification. The fact that Greece has not been thrown out is a positive sign. There is a greater acceptance of the idea that the euro is irreversible and that the break-up of the euro will wreak havoc not only in the so-called peripheral countries but also in Germany, France and Holland.
For now, the Europeans may consider themselves lucky to have a very competent and pragmatic — he is not insisting on the immediate implementation of the Basel III rules -- central banker like Mario Draghi who is slowly but steadily building up pan-European mechanisms to save the euro.
Let us hope that the politicians would allow him to finish the job.
The writer Is a life member (Fellow) of the Institute of Chartered Accountants In England and Wales and a Daily Star Columnist.