Throwing money at the problem

David Brancaccio Nov 30, 2011

Investors woke this morning to news that six central banks, led by the U.S. Federal Reserve, acted jointly to inject dollars into the life support system keeping European banks alive. The move was meant to restore confidence in the global financial system and show that the central banks will take action to prevent a repeat of the financial crisis of 2008.

It’s a liquidity problem: European banks want to borrow dollars, but there’s fewer and fewer entities willing to lend them to the banks. And that’s a big problem because the U.S. dollar is still the currency of choice when it comes to doing global business. So the central banks have stepped in and said, “We’ll lend you dollars, and at low interest rates.” Investors liked what they saw and global stock markets soared. The Dow rose more than 400 points and U.S. markets marked their first three straight days of gains since August.

We spoke with Tony Crescenzi, an executive vice president at PIMCO and the author of “Beyond the Keynesian Endpoint.” Crescenzi says the European contagion has become so dire, and politicians have become so frozen in the headlights, that the central banks were forced to act to prevent a run on the banks.

But it’s not a George Bailey “It’s a Wonderful Life”-kind of run, with citizens yelling at the doors and waving deposit slips. As far as bank runs go, this one happened in slow motion. Investors have been exceptionally wary of European banks for the past two years, as each new plan to save the euro has fallen apart. So investors have been slowly, deliberately, pulling their money out of European banks. They’ve also been turning away from European bonds. Because of that, Europe’s financial nest egg gradually shrank. That made it harder for banks and governments to have the cash on hand; in some cases, as in Greece, they literally need enough to keep the lights on.

Crescenzi says the injection today doesn’t solve the underlying problems of Europe’s debt crisis. For that, you’d have to turn to the Merkels and Sarkozys and Monti’s of the world, but investors were happy to see any response from the central banks. That’s especially true considering that politicians seem rather sanguine about taking bold action.

The stock market is, of course, rallying. But that could be dampened soon by Friday’s monthly unemployment numbers, which are expected to be disappointing. But stay on the edge of your seats: the next move in Europe’s crisis is likely to come sometime before or during the European Summit next Friday, Dec. 9.

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