The untalented Mario Draghi and precious metals

One week before the rate setting August ECB council meeting, Mr. Draghi made the following statement at a pre-Olympic investment conference in London: “Within our mandate the ECB is ready to do whatever it takes to preserve the Euro. Believe me, it will be enough!" In financial markets, these strong words from the president of the mighty ECB had been understood that the central bank of the eurozone would resume its security markets program again, which was dormant since March.

The chief-editor of a German business daily, the Handelsblatt, criticized Mr. Draghi for working some years with the investment bank Goldman Sachs. But obviously, he did not learn enough about financial markets as he demonstrated during the ECB press conference last Thursday. Or maybe, he just believed that financial markets were information efficient and form rational expectations, and thus, would interpret his statement in London correctly.

At investment banks, it is quite normal that at the annual review, underperformer would not only get no bonus but in addition have to leave the company. The performance, which the ECB president showed at the recent press conference, makes Mr. Draghi a top candidate as underperformer of the millennium. The week before, we had the impression that Mr. Draghi realized that the ECB would have to take measures for keeping his job. Now, we have doubts whether he deserved to get his current job. From our point of view, Mr. Draghi has damaged the credibility of the ECB seriously.

In the introductory statement, Mr. Draghi admitted a severe malfunctioning in the price formation process in the bond markets of eurozone countries. He continued: “Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy. Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.”

The analysis of the ECB is right. But if the effective working of monetary policy is hindered, then the ECB would have to employ the available tools in its arsenal to restore it again. One tool available is the security markets program introduced under Mr. Draghi’s predecessor, Jean Claude Trichet. But instead of announcing the resumption of buying government bonds of Spain and Italy, the ECB under the leadership of Mr. Draghi failed miserably.

The ECB blamed again fiscal policy for its inability to restore a proper working of monetary policy. Pushing ahead with fiscal consolidation, structural reform and European institution-building with great determination were needed for such risk premia to disappear. Furthermore, governments would have to stand ready to activate the EFSF/ESM in the bond markets. And of course, this would have to be with strict and effective conditionality in line with the established guidelines.

It is the mantra of the ECB and German politicians that austerity measures have to be implemented. One argument for the rating downgrades of various government bonds in the eurozone had been that austerity measures lead to recessions, which undermine the ability to redeem outstanding debt. It has been observed again and again over time - also in history of Germany during the Great Depression - that austerity measures during a recession lead to a downward spiral. Therefore, investors in government markets demand higher risk premia for bonds from countries, which would have to implement further austerity measures, another vicious circle. Thus, the insistence of the ECB on strict and effective conditionality is counter-productive.

However, prime ministers are not only hesitant to apply for financial assistance for economic, but also for political reasons. As the developments in Greece demonstrated, at the start there is support for measures to curb the budget deficit. However, as more and more spending cuts and tax hikes are required without improving the economic outlook, the support declines and turns into resistance. This has also been the case lately in Spain. Furthermore, radical parties at the right and left wing of the political spectrum become stronger. Instead of intensifying the economic and political integration in the eurozone, the remedy prescribed from Berlin and the ECB could lead to more separation and a collapse of the euro could not be ruled out, too.

Mr. Draghi declared that the ECB may undertake outright open market operations of a size adequate to reach its objective. However, “the adherence of governments to their commitments and the fulfillment by the EFSF/ESM of their role are necessary conditions.” Thus, instead of acting decisively, as Mr. Draghi created the impression at the conference in London, the ECB just takes a wait and see attitude. The council did not even give a firm commitment for open market operations. It is just an option the ECB might exercise. The ECB has the big bazooka in its armory, but Mr. Draghi only wants to use a popgun, and this is the big disappointment and underperformance.

The malfunctioning of bond markets in the eurozone will continue for the time being. This has, of course, also a negative impact on the euro exchange rate versus major currencies. A stronger US dollar is usually negative for precious metal prices. In addition, as we expected, the Fed was not ready yet to implement further measures of quantitative easing, which is another negative factor for precious metals.

The US labor market report for July came in far better than the consensus of Wall Street economists predicted. The number of new jobs created was 60% higher than the consensus forecast of 100,000 new jobs. This reduces the likelihood that the FOMC would decide to embark on QE3 at the September meeting. However, the positive surprise of the US labor market report triggered a rally in stock markets. Increasing risk appetite is currently positive for precious metals. Thus, it will depend on further economic data whether the risk appetite will advance further and will lead to further gains in precious metals prices. But buyers should not count any longer on the ECB to be supportive for precious metals.