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Toward a soft rescue

The intervention of the ECB in the debt market will cost Spain and Italy more cutbacks

Mario Draghi, the president of the European Central Bank (ECB), made it clear on Thursday that the lender will not buy up sovereign debt, nor will it apply “other non-conventional measures,” if countries that have solvency problems haven’t previously applied for assistance via the European rescue funds — in other words, they must accept macroeconomic conditions in exchange for the intervention of the ECB.

It was not surprising to see that Draghi’s words caused great waves in the markets on the day (the Ibex 35 gave up 5.14 percent, and Spain’s risk premium was around the 600-point mark once more), given that he was saying that in the future, there will be no purchasing of debt by the ECB if there is no request for a bailout. But in this case, it would not be a rescue like those of Greece, Portugal and Ireland, but rather there would be the imposition of strict macroeconomic conditions that, according to what is negotiated with each country, could involve the loss of autonomy in terms of domestic economic policy.

The board of the ECB announced what amounted to a painful correction for those who assumed that the institution was prepared to immediately intervene on a huge scale in the debt market in order to reduce the stifling differentials in terms of Spanish and Italian borrowing costs compared to those of Germany. Pressure from the Bundesbank, the zealous guardian of the anti-inflationary essence of the ECB, has imposed its one-dimensional model: reduction of the deficit and conditioned purchases in the debt market. Draghi did, however, introduce a small glimmer of flexibility (no doubt frowned upon in Germany), when he announced that he “will reconsider” the preference of the debt that countries have with the ECB. As such, he was letting investors know that he will not allow for declarations of default, given that in such a case the bank would assume losses with the same conditions as if it were private debt.

To summarize, the ECB announced that relations with the countries that have solvency problems will have to deal with new rules of the game that will be in force at least while the powers of the European Stability Mechanism are finalized. In the case of Spain, the consequences are clear. The government will have to think about whether it will resort to the rescue fund to ask for assistance, and when would be the right time to do so, once the door has been shut in terms of the ECB’s direct intervention in the secondary debt market. The attitude of the Spanish prime minister to the direct question as to whether Spain will ask for help from the rescue fund was disappointing. He ignored the crux of the question while the Italian prime minister, Mario Monti, who was stood beside Rajoy at the time, responded correctly and prudently, saying that he would carefully consider his decision.

After the rescue of the Spanish banks, the government insisted that the Spanish economy was not going to need a second bailout. But the refinancing decisions for Spanish debt suggest that the government will have no other option but to request the intervention of the ECB, and that once more the Rajoy administration will have to break its promises. Thursday’s auction saw the Treasury sell 10-year bonds with yields of 6.7 percent and four-year bonds at 6.05 percent. An economy that is in recession cannot bear financial costs of six percent for very long. In fact, the markets are assuming that Spain will make use of the path sketched out on Thursday by Draghi, given that the yield curve of two-year debt, on which the ECB would act in the case of intervention, was relaxing late this week, while 10-year bonds were demanding a much higher return.

The euro is not going to break up, Draghi emphatically promised. The means of intervention announced on Thursday seem to guarantee that. But it is hard to avoid the perception that the single currency will be maintained at the cost of more draconian cutbacks in Spain and Italy, the social consequences of which are still unknown.

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