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Europe acts to rein in its debt crisis

Central bank promises to buy the bonds of troubled countries, says there's no going back on the euro.

September 06, 2012|By Don Lee and Henry Chu, Los Angeles Times
  • Mario Draghi, president of the European Central Bank, at a news conference in Frankfurt, Germany. “It is pointless to bet against the euro,” he said.
Mario Draghi, president of the European Central Bank, at a news conference… (Hannelore Foerster, Bloomberg )

The European Central Bank unveiled an aggressive plan to buy the bonds of financially flailing countries such as Spain and Italy, its boldest step yet to stanch the continent's 3-year-old debt crisis and one that could lift the U.S. and the global economies.

The bond-buying plan unveiled Thursday is intended to stimulate economic growth by reducing the borrowing costs for cooperating Eurozone governments. But its ultimate purpose is to set up a financially adequate and politically acceptable way of containing the crisis and maintaining the survival of the euro currency.

Not all analysts were convinced that the new program was a big leap forward.

Greece's situation remains volatile, fundamental flaws exist in the 17-nation Eurozone's political institutions, and Germany's high court could throw a wrench into the ECB's effort when it rules next week on whether certain aspects of the financing plan are compatible with German law.

Still, many experts and investors regarded the announcement as a significant step in the right direction. And they expected that it would be approved by Germany, despite that nation's long reluctance to allow the central banker to act as a lender of last resort.

U.S. stocks surged Thursday as investors got an additional boost from positive signals on the American job market before Friday's important employment report.

All three major stock indexes closed at their highest levels in years, stretching back to the beginning of the Great Recession for the Standard & Poor's 500 and the Dow Jones industrial average.

"There is enough here [for the ECB] to assure investors in Europe and around the globe that the Eurozone is here to stay and there's no reason to flee the region," said Bernard Baumohl, chief global economist at the Economic Outlook Group. "I think it's going to work."

In announcing the plan, ECB President Mario Draghi was making good on a pledge in July that the central bank would do whatever it takes to preserve the euro.

He said Thursday that bold intervention was necessary to relieve undue pressure on governments facing high borrowing rates that weren't warranted and that raised the risks of default and a messy debt-induced death for the euro.

"Let me repeat … the euro is irreversible," Draghi declared in Frankfurt, Germany, the city where the ECB's headquarters is located. "There is no going back to the lira or the drachma or to any other currency. It is pointless to bet against the euro."

Spanish 10-year government bond yields fell sharply after the announcement, to below 6% for the first time since May. Italian yields also edged lower, as did Greek, Portuguese and Irish yields.

The ECB's bond-buying program doesn't directly address the financial strains in Greece, which is receiving emergency funds even as Athens is struggling to meet certain economic and fiscal conditions of the bailout.

But the biggest fear among investors hasn't been so much what happens in Greece, but whether its problems would spread to the much larger Spain and Italy, economies that are too big to bail out and substantially more risky for the Eurozone's sustainability.

Now, with the ECB saying it would buy an unlimited amount of bonds of such countries, it could not only create a market of lower-priced bonds for the countries, but also assure investors that if something were to go wrong, they could sell the bonds to the ECB.

"This [plan] significantly reduces, if not eliminates, the risk of an uncontrolled scenario in the Eurozone," such as a default by Spain, said Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington.

"What we have today is not a guarantee against volatility in the euro area, but a financially adequate and politically sustainable firewall for the euro. And this is a very new and important development," he said.

The debt crisis in Europe has been a persistent head wind for the U.S. and the global economies, damping investor confidence and threatening financial instability. Europe is a major market for U.S. exports, and many American corporations have significant investments and sales in the continent.

The Eurozone economy is expected to contract this year but return to growth in 2013, with the ECB's plan boosting activity.

The central bank's action adds to the likelihood that the debt crisis "will evolve in a controlled way," said Martin Schwerdtfeger, who analyzes the global economy for TD Bank in Toronto. And that would benefit the U.S. economy.

Under the plan, the ECB would not buy bonds directly from governments at auction. The purchases would be made in the secondary market and focus on debt maturing in one to three years, but that doesn't mean the ECB couldn't buy longer-term bonds.

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