BERKELEY – The euro crisis shows no signs of letting up. While 2011 was supposed to be the year when European leaders finally got a grip on events, the eurozone’s problems went from bad to worse. What had been a Greek crisis became a southern European crisis and then a pan-European crisis. Indeed, by the end of the year, banks and governments had begun making contingency plans for the collapse of the monetary union.
None of this was inevitable. Rather, it reflected European leaders’ failure to stop a pair of vicious spirals.
The first spiral ran from public debt to the banks and back to public debt. Doubts about whether governments would be able to service their debts caused borrowing costs to soar and bond prices to plummet. But, critically, these debt crises undermined confidence in Europe’s banks, which held many of the bonds in question. Unable to borrow, the banks became unable to lend. As economies then weakened, the prospects for fiscal consolidation grew dimmer. Bond prices then fell further, damaging European banks even more.
The European Central Bank has now halted this vicious spiral by providing the banks with guaranteed liquidity for three years against a wide range of collateral. Reassured that they will have access to funding, the banks again have the confidence to lend.Eichengreen
When you economy is runing rank N-1, and politicians think they are at rank N, then you get spirals as the excess debt bobbles around trying to find a sucker. So the ECB says screw this, they move up the curve to three year note and equilibrium arrives. Greeks and Italians go berzerko, but that can;t be helped.
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