Governments Blink

By Dr. Lynn Reaser

Last week we witnessed panic sweep financial markets over fears that Greece would default on its debt, triggering losses in a number of European banks.  Solvency concerns over Portugal, Spain, and Ireland amplified the selling pressure on equities and other assets bearing any risk.

Policymakers blinked.  Following a weekend of frantic political negotiations involving both U.S. and European leaders, a three-part “fix” was proffered.  First, European governments and the International Monetary Fund (IMF) would lend up to $955 billion to nations in need of funds.  Second, the European Central Bank (ECB) would purchase bonds of beleaguered European states.  Third, the U.S. Federal Reserve would reopen its swap lines to the ECB, allowing the Eurozone’s monetary authority to lend dollars to various banks seeking that form of cash.

While these steps provided some relief to financial markets, questions and uncertainties persist.  Will the Greek government have the ability and public support to implement and carry through with fiscal austerity and structural reform?  Will taxpayers in other countries support “bailouts” of nations encountering the consequences of fiscal largesse?  Will European banks increase their capital sufficiently to cushion themselves against any sovereign debt restructuring down the road?  Will financial markets believe that the short-term “fix” announced at this week’s start will prove to be a sufficient stop gap to the more difficult steps? 

More fundamental philosophical and practical issues are also now on the table.  Will central banks act soon enough to ward off possible inflationary consequences of some of their actions?  Has government intervention now supplanted the discipline of the marketplace?  Are all institutions and nations now too big to fail?

We could be starting to walk or run down a very dangerous path.  It will be critical for governments to have their eyes fully open between blinks.


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