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What’s Going on in Europe?

Paul Solman: A departure from the usual Q-and-A format this morning to address an issue on the minds of many: what’s going on in Greece…and Europe?

Conservative economist Ed Yardeni, whom we’ve consulted from time to time over the years, has a pertinent paragraph in his newsletter this morning, referring to the European Union’s guarantee of Greek debt as a “shock-and-awe financial rescue program”:

The idea behind shock-and-awe policies is to convince markets that the government is ready to do ‘whatever it takes’ to stop a financial contagion. So far, this approach seems to be working in the EU’s bond markets [Greek 10-year bonds, which had to pay 13 percent interest to attract buyers, now pay only 8 percent]…Nevertheless, the ultimate test of the success of shock and awe is whether a financial meltdown is averted with far less resources required than were committed by the government. So far, this seems to be the case. The ECB’s assets rose only euro 7.0bn during the week of May 21, after increasing euro 106.0bn during the prior two weeks.

In other words, the EU GUARANTEE was enough to calm markets by reassuring the so-called “bond vigilantes” — the institutional buyers of bonds who, practically speaking, keep vigil over the finances of those to whom they lend. The European Central Bank’s [ECB’s] “assets” are the bonds it actually has to BUY on the open market to keep their value up. Bottom line: Greek bond yields dropped from 13 percent to 8 percent NOT because Europe’s Fed was buying them, but because the EU’s guarantees were deemed credible (credit/credere/credibility).

This is what the U.S. government under Bush and Paulson tried to do with Fannie Mae and Freddic Mac, skeptics might point out. It didn’t work and the Treasury essentially had to take over the “GSE’s” (“government-SPONSORED enterprises”).

But for the moment, the European guarantee seems to be working. For the moment.

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