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Europe did not enter Dante's seventh circle of hell – violence – in 2012. In spite of the predictions for terrorist attacks from bond and currency speculators, no bombs went off. The 17-country euro zone ended the year intact. The common currency is up, even if the region's Mediterranean frontier remains in dire economic shape.

Who to credit for this miracle?

Judging from the headlines and the accolades from editors, economists and investors, it is not German Chancellor Angela Merkel, the holder of Europe's biggest bailout account, or Mario Monti, the Italian Prime Minister who spared the euro zone's third-largest economy from all of Dante's circles of hell, its sure destiny under his predecessor Silvio Berlusconi. It is another Mario – Mario Draghi, president of the European Central Bank.

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Mr. Draghi, who was the Financial Times's Person of the Year and lauded pretty much everywhere else (eclipsing Canada's Mark Carney, the next Bank of England governor, if you can believe that) made two bold moves that removed the crisis's rough edges.

The first was pumping €1-trillion ($1.3-trillion) of liquidity into the banks through the long-term refinancing operations (LTRO). The cheap, three-year loans prevented the banking crisis from worsening, allowing hard-hit lenders to keep their doors open. Rolling bank failures would have triggered a European catastrophe.

The second move took the form of another inelegantly named program – outright monetary transactions (OMT). This committed the ECB to buy unlimited amounts of sovereign bonds in financially distressed countries, though ones that still had access to the debt markets. Any purchases would be done in conjunction with the European Stability Mechanism (ESM), the permanent €500-billion rescue fund. The ECB would buy short-term bonds; the ESM long-term ones. The purchases would be conditional on an austerity and economic reform package negotiated with the victim country.

The OMT has yet to be used, but its mere presence has worked a treat. The borrowing costs of the two countries most likely to beg for assistance – Spain and Italy – have plummeted from their crisis highs, though are still well above comfort levels. Spanish ministers have said repeatedly that they have not ruled out asking the ECB and the ESM to get in the bond-buying game.

So crisis fixed, Mr. Draghi? Not so fast. The Italian may have created a game that he cannot win. That's because the OMT could act as a cement life jacket.

Let's use Spain as an example. Spain is in rough shape. Its economy is in deep recession and its debt to gross domestic product ratio, once low by European standards, is soaring. Its jobless rate is the highest in the Western world. Its banks require capital injections. Spain also has a monster political problem in the form of Catalonia, the wealthy region that is hurtling toward a referendum on sovereignty.

All of which means that Spain would be a ripe candidate for the ECB-ESM treatment if investor confidence wanes, sending yields up. That could happen any day (Spain's 10-year yields are still well above 5 per cent).

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Ideally, for the good of the ECB and of Europe, Spain will get is fiscal and economic reform acts together and avoid tapping into the ECB-ESM program. That would be Mr. Draghi's, and Spain's, preferred scenario.

But suppose Spain gets into deeper trouble and asks Mr. Draghi to hit the bond-purchase switch. In exchange for the purchases, the troika – the ECB, the European Commission and the International Monetary Fund – would demand more austerity and reform commitments on top of all the previous commitments, which have taken a good part of the blame for pushing the country to the edge of the cliff.

The extra commitments could easily deepen the Spanish recession, blowing Spain's budget deficit targets (which it has a habit of blowing already). The country could be gripped by anti-austerity strikes and protests, as it was earlier this year. Spain's borrowing costs would rise, forcing the ECB and the ESM to buy more and more bonds.

At this point, Mr. Draghi would get into a damned-if-you, do-damned-if-you-don't scenario. With Spain missing its negotiated fiscal targets, the ECB by rights should cut Spain off – remember, the OMT program is conditional. But imagine what would happen if he were to do that. Spanish yields would go through the roof and suddenly you would have Greece multiplied by five. Spain's financial collapse could easily wreck the euro zone.

But keeping the bond purchases intact would not necessarily save Spain because they would, perversely, act as a disincentive to further austerity and reform. The government would be tempted to take the lid off the social and economic pressure cooker by lightening up on austerity. Buying Spanish bonds forever, however, is not an option politically or economically. Starting a never-ending rescue program would destroy the ECB's credibility.

In other words, the OMT works best only if it is not used. Mr. Draghi's life will get very complicated once it is. The ECB's man has taken the edge off the crisis; he has not fixed it. His biggest test may be yet to come.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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