When Jean-Claude Trichet retires on Oct. 31, the euro area may lose more than just a European Central Bank president.
Trichet has emerged as Europe’s key policy maker during the sovereign debt crisis, holding the 12-year-old monetary union together as heads of state squabble over their response. While ECB officials have sometimes split over the direction, under Trichet the central bank shown itself more willing and able to act than the bloc’s 17 finance ministers and government leaders.
“Trichet has become the de facto president of Europe,” said Marco Valli, chief European economist at UniCredit Global Research in Milan. “He is the only one who’s delivered the leadership necessary during this crisis.”
As German Chancellor Angela Merkel and French President Nicolas Sarkozy struggle to restore investors’ faith in euro-area bond markets, Trichet has taken the ECB further and further into uncharted territory to protect the euro. In his latest attempt to stop the debt crisis from spreading, Trichet convinced a majority of the ECB’s 23-member Governing Council to start purchasing Italian and Spanish government debt, overcoming opposition from Germany’s Bundesbank in a move that economists estimate could cost as much as $1.2 trillion.
While fraught with risks, the decision highlighted that “the ECB is the only institution in a position to contain the crisis,” said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt.
For now, the gamble is paying off. The yields on Italian and Spanish 10-year bonds, which rose to euro-era records last week, have plunged about 100 basis points since the ECB started buying the nations’ debt yesterday. They were at 5.08 percent and 4.96 percent, respectively, as of 11:16 a.m. in Frankfurt.
A lack of political cohesion in Europe has forced Trichet to take the lead role in tackling a crisis that began with Greece’s fiscal meltdown more than 18 months ago.
As heads of state disagreed first over whether to bail out Athens, then over the establishment of a rescue fund for the region, then over private-sector involvement in a second bailout for Greece, they increasingly turned to Trichet for guidance, and to win them time.
While leaders have agreed to allow the European Financial Stability Facility to buy bonds on the secondary market, as requested by the ECB, individual parliaments must still ratify the change, leaving the central bank to deal with the situation in the interim. Sarkozy and Merkel want this done by October.
“Trichet has found himself between a rock and a hard place,” said Julian Callow, chief European economist at Barclays Capital in London. “By nature conservative yet pragmatic, he’s often had to step up because he saw the politicians were not capable of acting.”
In the process, Trichet has torn up the ECB’s German-inspired rulebook.
He loosened collateral rules to accommodate the deteriorating creditworthiness of Greece, Ireland and Portugal, and three times reversed the ECB’s exit from emergency liquidity measures for banks. Now he is buying the bonds of the region’s third and fourth-largest economies, potentially putting the ECB on the hook for hundreds of billions of euros and opening it to criticism that it is financing profligate nations.
Royal Bank of Scotland Group Plc estimates it could cost the ECB and the EFSF 850 billion euros ($1.2 trillion) to get on top of the Italian and Spanish debt markets. “This huge risk-pooling exercise will not come easily and the risk of political fallout will be large,” RBS economist Jacques Cailloux said.
Trichet, 68, helped design the 1992 Maastricht Treaty that established the foundations for the euro, launched in 1999. In contrast to politicians concerned about their re-election prospects, Trichet, a Frenchman, has said his life motivation is to achieve a “deepening of European unity.”
On Nov. 1, the ECB baton will pass to Italian Mario Draghi, 63, who has echoed Trichet’s criticism of politicians for failing to deal decisively with the debt crisis. Draghi said last month that politicians must “define with clarity the political objectives, the scope of the instruments and the amount of resources available” to stop the crisis.
Trichet’s drive to do what it takes has provoked the most public splits in the ECB’s history as the Bundesbank, once Europe’s most powerful central bank, objected to the scale of his interventions.
When the ECB started its bond-buying program in May 2010, then-Bundesbank President Axel Weber openly dissented, saying the move posed stability risks. Little more than a year later, Weber’s successor Jens Weidmann warned that the Eurosystem must not take any further risks onto its balance sheet. In his effort to calm investors, Trichet overruled them both.
By embarking on purchases of Italian and Spanish bonds, Trichet may be setting the ECB on a collision course with its primary mandate -- ensuring price stability. He has raised borrowing costs twice this year to curb price pressures.
“If Italy doesn’t find enough buyers for its bonds at the next auction, the ECB would be forced to step into the market massively,” said Commerzbank’s Kraemer. “In such a scenario, the bank wouldn’t raise rates anymore. Monetary policy is under the diktat of the debt crisis.”
The longer the ECB has to wait for governments to approve the EFSF as a bond-buying entity, the more assets it may have to accumulate. That may hamper the ECB’s ability to “sterilize” the purchases by taking the same amount of money from the system in the form of deposits from banks. If it fails to do so, the purchases could swell the money supply and fuel inflation.
“We always withdraw the liquidity we injected so that we don’t embark on any concept of quantitative easing,” Trichet said on Aug. 4.
Trichet is nevertheless likely to leave office with inflation in breach of the ECB’s 2 percent limit. The rate is currently 2.5 percent.
The strains the debt crisis have placed on the ECB’s inflation-fighting mandate have prompted Trichet to call for greater budget coordination in the euro area.
Trichet, one of last architects of the euro still in public office, has suggested that one day the region should have a common finance ministry to bolster the single currency through more fiscal cohesion.
“That day may be a long time coming,” said Christian Schulz, a former ECB economist now working for Joh. Berenberg Gossler & Co. in London. “And until it does, Trichet and the ECB will be the ones fighting for the euro’s survival.”