Of Bazookas, Bailouts, and Bubbles

They can’t say he didn’t warn them.

In July European Central Bank Chairman Mario Draghi said that he would do “whatever it takes” to save the Euro. He was backed up—and not slapped down—by German Chancellor Angela Merkel and French President François Hollande. Since then the European debt markets have been largely constructive: the yield on Spanish 10-year government bonds declined from a high of 7.6% to 6.3% in late August.

But in the run-up to the ECB meeting this month, the markets were nervous. Yields rose, and there was concern that Draghi might back away from his commitment. But yesterday put those fears to rest. In spite of objections from the German central bank Draghi outlined a plan to purchase unlimited amounts of government debt out to three years from ECB members who formally apply for aid, establish a framework for structural reform of their labor markets and business conditions, and submit to budget oversight by the IMF.

This combination of financial support in exchange for internal reform is what Draghi has been hinting at all summer, most recently in an op-ed piece published in the Financial Times on August 29th. In that piece he lays out the rationale for gradual centralization of economic policies and stronger institutional support for the Euro. The ECB is now the primary Federal institution in Europe, and it has a mandate to act as both the financial backstop and the fiscal and regulatory cop of the monetary beat.

Will Draghi’s big bazooka lead to over-accumulation of risky assets and a bubble economy? They could. But one rally does not a bubble make, and European stocks aren’t widely held or expensive. For now, there’s still a lot of skepticism. But with Europe currently in a recession, their markets need all the monetary help they can get. It looks like they just got some.

Douglas R. Tengdin, CFA
Chief Investment Officer
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