07/31/2012 09:38 am ET Updated Sep 30, 2012

The Euro Gets a New "Transmission" From Super Mario

Mario Draghi has signaled to the market that there is yet a path for action by his European Central Bank (ECB) that could halt the relentless slide of the euro currency into complete dysfunction. A currency divided against itself, one might say, cannot stand -- or "sell" for that matter. And that division has grown exceedingly painful as represented by the interest rate spread between those charged on German bonds and those charged on Spain, France and even Italy. To continue for much longer to say that a common currency applies to nations whose bond spreads are over 500 basis points (95 percent) apart is a fiction that will be harder and harder to sustain.

Yet, the ECB is charged with managing the "transmission" of its interest rate policy -- intended to bring inflation down to about the 2 percent level euro-wide -- to all the member countries. Of course, countries that have actually defaulted on their debts but remain in the euro, like Greece, might be considered outside the pale of euro-rate policy for the time being. But where no default has been seen, like the case of Spain, it becomes transparent reality that the ECB's interest rate policy is not being effectively transmitted in the Spanish economy. Same for Italy and France.

Why does this matter? Well, the German financial representatives on the ECB Board from the Bundesbank as well as the German political figures including Chancellor Merkel and Schäuble, her Finance Minister, have been outspoken opposed to the purchase of Spanish or Italian government bonds in order to keep their interest rates down to levels that their economies can afford. In their view, the ECB has no treaty-based mandate to print money or undertake "quantitative easing" in this way.

If that is the case, however, then the euro is a suicide pact, powerless to defend itself against its own demise. So a way around must be found if we are to believe the statement of Draghi and the political leadership of the eurozone, including Merkel, that they will do whatever it takes to sustain the euro currency.

The way around would seem to involve interpreting the mandate that everyone agrees that the ECB has -- namely, to assure an effective "transmission mechanism" for its interest rate policy throughout the eurozone. Thus it could undertake more Spanish and Italian (and if necessary Portuguese and even French) government bond buying, either directly or indirectly through putting even more long-term money into eurozone banks to effectively force them to do so.

Most if not all commentators on the euro crisis have come to agree that the ECB has the central role to play in any rescue of the troubled eurozone government finances and the euro currency itself. But there has been tremendous disagreement on whether or not they have the legal power, or the political leverage, to do so in a manner similar to the U.S. Federal Reserve or even the Bank of England. We will learn this Thursday whether Super Mario has aligned the stars (or at least the Germans) in a way that permits the "transmission mechanism" ploy. Stay tuned!