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Is the Euro Recovering?

March 23, 2012

The President of the European Central Bank, Mario Draghi, yesterday argued that the worse was over with the European Debt Crisis with the situation stabilizing.  In many ways, this may be true, as the spread between the interest rates of 10 year bonds of the PIIGS countries and those of Germany have declined in recent weeks (see chart below).  In addition, the ECB has also recently finished its second round of its “Long Term Refinancing Operation,” injecting cash into the European banking system.  Another bright note is that Greece’s structured default has been proceeding relatively smoothly.

However, this does not necessarily mean that the euro is completely out of the woods yet.  In the short term, as The New York Times reported yesterday, there is still now a worry that a bubble developing in the German 10 year bond (commonly known as a bund) market, as the crisis had depressed the bund’s interest rate and it is now rising again.

In addition, the structural causes of the Euro Crisis have not yet been completely fixed.  As Draghi stated, “The ball is in the governments’ court. They must make the euro zone crisis-proof for the long-term.”  As this blog has previously argued, the underlying cause of the financial crisis was twofold: 1) record low interest rates for government debt in many European countries 2) declining competitiveness in many Eurozone members after they surrendered control of their monetary policy by adopting the euro (see The Competitiveness of European Countries).  Many investors have now probably realized that the all Eurozone economies are not the same and the risk on their debt is not the same either.  In many Eurozone members, many reforms are still necessary if these countries want to be as competitive as Germany.

Thus, Mr. Draghi may be correct that the worse of the Eurocrisis is over, but the EU still has a long way to go in designing a system that will prevent a future debt crisis.  To learn more about the creation of the euro and the current crisis, the European Union Center at Indiana University is offering two free webinars on the topic:

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