The European sovereign debt crisis, touched off in 2010 amid worries about impending defaults on Greek government bonds, has been rattling global investment markets ever since. Finally, though, the situation is improving, and investors seem increasingly confident that the worst may be over. It now appears Europe will avoid a deep recession, says independent economist Fritz Meyer, who points to a recent policy move by the European Central Bank (ECB) as a turning point.
On February 29, the ECB reopened its Long Term Repo Operation (LTRO), a program that enables banks to take loans from the ECB on favorable terms. Since then, 800 European banks have borrowed a total of €529.5 billion at an interest rate of 1% that the banks can repay over a three-year term. That follows an earlier round, in December 2011, in which 523 banks took loans totaling €489 billion. Yet while the two rounds have resulted in more than €1 trillion in total borrowing, fewer banks than expected have had to take loans, according to Meyer, and that suggests the health of the European banking system may be better than most observers have believed. Global investors have been heartened, and many now seem to think the recession that may already have begun in Europe could be relatively short and mild.
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The European Central Bank is Europe’s counterpart to the U.S. Federal Reserve, and like the Fed as it relates to U.S. markets, the ECB is charged with making sure European capital markets have sufficient money to operate smoothly. Also much like the Fed, which is funded by 12 Federal Reserve Banks, the ECB is funded by the central banks of the eurozone—the 17 countries of the European Union (out of a total of 27) that have adopted the euro as their common currency.
Using the two rounds of the LTRO, the ECB has added much needed liquidity to the coffers of Europe’s banks, enabling them to lend money and boost economic activity, according to Meyer. For eurozone countries such as Portugal, Spain, Italy, and others that have been struggling to avoid defaults on their sovereign debt, this action comes as a long-awaited salve that may help minimize further distress.
Since the second LTRO funding began on February 29, the euro has been gaining strength against other currencies, and global stock markets have made significant advances. By helping alleviate concerns that Europe would experience a deep recession, the second LTRO has been a catalyst for a rise in U.S. stock markets, which have recently surged to levels last seen before the global economic crisis that began in 2008. Markets in China and Brazil have also been buoyed by indications that Europe’s downturn may not be severe.
To explain the recent gains, Meyer uses the analogy of trying to drive a car while keeping a foot on the brake. Now, he says, it’s as if the brake has been released. “This is not a permanent fix,” says Meyer, “but it has allowed global markets to seek higher levels based on fundamentals.”
European economists have not changed their calls for a recession, and recent data suggest that the economy in Europe may indeed have begun to contract in late 2011. But Meyer notes that economists’ projections since the LTRO fundings call for a stronger global economic expansion this year than had been predicted before the ECB’s latest moves.
The European sovereign debt crisis has been fueled by disparities between rich and poor nations of the eurozone. Greece, Italy, and other debtor countries have borrowed from Germany and other nations that have stronger economies and relatively little debt. But when it appeared that Greece and other nations might default on their obligations, it led to far-reaching questions about the long-term viability of the eurozone and its common currency. The wealthier nations didn’t want to continue subsidizing the poorer countries while the people of Greece, Ireland, and other nations chafed under the draconian austerity measures their governments were forced to put in place.
A particular flashpoint was the bailout of Greece by the European Union and the International Monetary Fund. Through those two organizations, eurozone members financed €68 billion of Greek debt—and risked losing €51 billion in a Greek default. Now, a restructuring of Greek debt has been delayed for one year, while the LTRO fundings have eased the burdens of European banks, according to Meyer. For now, at least, Europe appears to have avoided a downward economic spiral, leading to hopes that the continent can participate in and even help fuel a global recovery.