Conjuring trick? Draghi's long-lasting legacy

Mario Draghi
Getty Images
Mario Draghi

For the European Central Bank (ECB), the success of the OMT bond-buying program outlined a year ago lies in the fact that, like the nuclear deterrent during the Cold War, it has not been used – and, indeed, may never be.

Nonetheless, the grandly-named Outright Monetary Transactions plan has generated a steep decline in bond yields in problem countries and snuffed out talk, for the moment at least, that the euro zone could break up.

ECB president Mario Draghi's statement in June – "It's really very hard not to state that OMT has been probably the most successful monetary policy measure undertaken in recent time[s]" – would not win him any prizes for modesty, but has so far been justified by events.

(Read Op Ed: One year on: Did Draghi's promise solve anything?)

Draghi, who became president of the ECB on November 2011, has shown himself to be a more focused and active policy-maker than his predecessor, Jean-Claude Trichet, who used to pepper speeches with historical references and took a far too forgiving line on the deep, underlying problems building up in the economic and monetary union (EMU) under his eight year stewardship.

In one area of intellectual leadership, Draghi's legacy may prove long-lasting. In a cautious way, he has opened up a new debate on the essential reasons behind EMU's difficulties that surfaced after the trans-Atlantic financial crisis of 2007-08. This is a debate that still has a long way to run and will prove to be of more than mere academic significance.

Draghi has to tread carefully. As a representative of Italy - one of the countries in the euro with the largest government debt-to-GDP (gross domestic product) ratio - Draghi has to show implacable neutrality between debtors and creditors, and must, if anything, lean in the direction of protecting creditors' interest.

This is important since, as part of efforts to shore up EMU for the future, euro countries next year will have to agree more government debt restructuring to allow countries like Greece to achieve debt sustainability.

The unsustainability of Greece's debt position, with outstanding borrowings of 160 percent of GDP, and the need for drastic write-down action after the German parliamentary elections on September 22, is one of the world's worst-kept monetary secrets. The International Monetary Fund has been warning for months that write-downs will be needed.

Because two-thirds of Greece's 300 billion euros of government debt is owed to official creditors, this time - unlike the first two debt packages in 2010 and 2012 -taxpayers' money will be involved. This is likely to cause particular concern among the biggest EMU creditors, led by Germany and the Netherlands.

(Read More: ECB's Draghi Defends Interest Rate Guidance)

Even more significantly, the ECB and its constituent central banks will also almost certainly be forced to accept write-downs – which they can finance partly through the profits they have generated on government bonds of problem countries that were acquired at large discounts in 2010-11 and were subsequently redeemed at par.

During the difficult political negotiations on debt restructuring, the question of the extent to which both creditors and debtors made fundamental mistakes in generating EMU's earlier colossal debt build-up will take on an extremely important role.

For understandable reasons – because no leading German politician wants to rock the boat by discussing the taboo subject of official debt restructuring before the German elections – the matter is on hold at the moment. However, the more it is kept under wraps now, the great will be the explosive power when it becomes a matter of public debate next year. This is certain to lead to more discussion on whether Greece should remain in the euro.

Vote to see results
Total Votes:

Not a Scientific Survey. Results may not total 100% due to rounding.

Pivotal role

In these complex and difficult issues, Draghi can be expected to play a pivotal role.

For the time being, he is still basking in a good deal of acclaim among politicians and on the financial markets. Yet the threat of EMU turbulence has not been dissipated.

The previously most-imbalanced states in the 17-member currency bloc – the peripheral countries previously running unsustainably large current account deficits – have taken action to get their finances into better balance, mainly through a sharp reduction in domestic demand and a vast and painful increase in unemployment.

Yet, as a result of continuing recession and relatively high interest rates on their borrowings, their overall debt has continued to rise. Every week brings fresh evidence of the euro club's fateful dilemmas. And, along with this, insistent questions are being raised about whether the extreme problems faced by EMU were inevitable – or whether corrective measures could have been taken in EMU's first few years after 1999 to head off the existential predicament the bloc subsequently faced.

(Read More: Three Bullets for Draghi as ECB Set to Downgrade Growth)

By pointing out that politicians who made unfulfillable promises and launched over-ambitious economic expansion after the euro's birth were mainly to blame for the imbroglio, and warning too that the ECB's powers now are not unlimited, Draghi has tried to deflect attention from the ECB's own programs and concentrate debate on the role of politics.

He has underlined, for example, that OMTs are designed to keep government bond yields just below "panic" levels, as previously defined - not to bring them down to levels that would somehow help government solvency.

Draghi has accomplished a considerable conjuring trick. How long this lasts in the tougher 12 months after the German elections cannot be answered with certainty. One thing seems reasonably clear: the atmosphere in the euro bloc may be still less forgiving next year.

David Marsh is the chairman of independent think tank the Official Monetary and Financial Institutions Forum.