Super Mario May Need a Bazooka to Save the Euro

The Super Mario of video game fame fights off Goombas and Koopa Troopas to save Princess Peach Toadstool. The suave, 64-year-old Italian economist nicknamed Super Mario by the Italian press looks nothing like Nintendo’s mustachioed plumber, but the mission he faces is even harder. As the new president of the European Central Bank starting Tuesday, Nov. 1, Mario Draghi faces the challenge of a lifetime: to save Europe’s damsel in distress, the 12-year-old single currency known as the euro.

This is not a time for cautious incrementalism. If Draghi thinks it is, he is destined to fail. Only by taking personal risks and confronting powerful entrenched interests does Draghi have a chance to preserve the shaky 17-nation bloc that lives under the single currency. It is no exaggeration to say that the fate of the euro rests in large part on decisions he will make in the coming months.

The risks to the grand euro experiment rose yet higher on Nov. 1 as Greek Prime Minister George Papandreou’s grip on power weakened and Italian 10-year bond yields spiked again, reaching 6.2 percent, vs. 4.9 percent as recently as mid-August.

Draghi is being urged to act by economists and policymakers both inside and outside Europe. Take a minute to consider the arguments of one of them, Paul De Grauwe, an expert on the European Central Bank. De Grauwe is a Dutch-speaking economist at the Catholic University of Leuven in Belgium who has researched and taught in more than a dozen cities, from Washington to Tokyo to Milan to Berlin. Right now he’s wrestling with what to say about the euro in the ninth edition of his textbook, Economics of Monetary Union.

“What I’ve learned since the last edition is that the currency union is more fragile than I thought, once you have confidence evaporating,” De Grauwe said in an interview on Oct. 31, the day before Draghi’s ascension to the ECB presidency.

Dire Peril of Italian Default

The existential threat to the euro zone is a speculative attack on the government bonds of Italy that could, in a worst-case scenario, drive the nation into default. An Italian default would seriously damage French banks that own Rome’s debt and probably destroy the euro currency forever—in the process, causing a deep and lasting European recession.

De Grauwe wants Super Mario to get himself a bazooka—a weapon so powerful that he might never need to pull its trigger. The bazooka would be a firm commitment from the European Central Bank that it will buy as many Italian bonds as necessary to keep interest rates from spiraling out of control. With default risk off the table, Italian bond yields would fall to levels that the government could more readily afford to pay. Crisis averted.

If this were easy, it would have happened already. Deadlocked Europeans have stuck with worthy but insufficient measures, such as adding to the firepower of the European Financial Stability Facility. Standing in the way of an ECB bond-buying promise is German Chancellor Angela Merkel, who says an open-ended commitment would give Italians a carta bianca to continue their profligate ways.

Merkel is right to worry. The answer is to couple the backstop with tough supervision and enforcement of Italy’s deficit-reduction goals. A good start would be to force out Italian Prime Minister Silvio Berlusconi, says Paolo Manasse, an economist at the University of Bologna. It’s also helpful that Italy will be subject to Europe’s new “six pack” of enforcement measures, which include a requirement that national budgets be submitted for tough scrutiny by the European Union, even before they go up for passage by national parliaments.

Keeping Italy dangling is counterproductive for Germany as well as for Italy, De Grauwe says. “You have to set aside moral hazard concerns because there is a bigger evil to fight.” He offers the analogy of a fire department that shows up at a blazing house whose flames threaten other buildings and then hesitates to put out the flames because that might induce the guilty homeowner to keep smoking in bed.

Pleasing Germany Isn’t Enough

What’s required now, says De Grauwe, is courage. Draghi needs to stop trying to curry favor in Berlin by acting more German than the Germans, as his predecessor, Frenchman Jean-Claude Trichet, was wont to do.

True, an ECB chief has less power than a Federal Reserve chairman. Trichet was pressured by the resignations of two key Germans, Executive Board member Juergen Stark and former Bundesbank President Axel Weber. De Grauwe believes (”I may be mistaken,” he allows) that Draghi could assemble a majority on the ECB Governing Council to outvote the Germans and other hard-money stalwarts in favor of an open-ended promise to buy Italian bonds. Another obvious step would be to cut Europe’s official short-term interest rate, which stands at 1.5 percent, vs. just 0 percent to 0.25 percent in the U.S.

“Sometimes one has to take a risk,” De Grauwe concludes. “If Mario Draghi can then show that it works, the criticism will disappear. Then he will be the hero.”

Mark Cliffe, chief economist in London for the Netherlands’ ING Group, favors a slightly more diplomatic approach. If he were Draghi, he says, “I would probably be camping out in Berlin and trying to persuade the German government to give the ECB a bit more leeway.”

Even some Germans understand the urgency of action. Holger Schmieding is chief economist in London for Berenberg Bank, Germany’s oldest private bank (founded in 1590). “I’m worried about a market panic in Italian bonds that spins out of control,” Schmieding says. “If we get into a deeper crisis, the ECB is the only reliable backstop.”

What Does Draghi Think?

Schmieding admits that most of his friends back home in Germany disagree with him. “They think I’ve gone soft and I think they don’t see the danger.”

For Draghi, the right question is not whether to backstop the euro, but how. Daniel Gros, director of the Center for European Policy Studies, says that direct purchases of sovereign debt by the ECB run afoul of Article 123 of the European Union’s founding treaty. The way to get around that, the German-born Gros argues, is for the European Financial Stability Facility to make the purchases, drawing on loans from the ECB. That arrangement should be both constitutional and democratic, Gros argues.

Can Draghi take dramatic action? Does he even want to? So far he has kept ECB watchers guessing about his intentions. “It may be an advantage, so he’s not battling a preconception—but there may also be a degree of confusion,” says Klaus Baader, co-chief European economist at Societe Generale in London. Michael Schubert, an economist at Commerzbank in Frankfurt, says Draghi’s influence “is rather limited.”

On the other hand, Draghi is no pushover. Working for Italy’s finance ministry in the 1990s, he helped the country narrowly avert default. As Francesco Giavazzi, who worked alongside him, told the New York Times: “the lesson is that rather than waiting for help, you need to regain the confidence of the markets through your own actions.” Draghi showed a flash of steel at Trichet’s farewell gala on Oct. 19 when he said, “friends tell me that I rarely shy away from impossible tasks.”

There is a scene in Shakespeare’s Twelfth Night in which a buffoonish character named Malvolio reads from a letter: “Some are born great. Some achieve greatness. And some have greatness thrust upon them.” Yes, they do. Mario Draghi is no buffoon. Nor is he a video-game protagonist. What he might yet be, if he chooses, is the savior of the euro.