February 20th, 2012
03:19 PM ET

Zakaria: How the eurozone was saved

By Fareed Zakaria, CNN

Imagine a region of the world where stocks have had their best January in nearly 15 years; bank shares are up 20%; the rates at which governments borrow money has fallen sharply; investor sentiment is at its best in months.

You'd think I'm talking about Asia; maybe the BRIC nations. Nope.

The region is actually sclerotic, struggling Europe.

What in the world?

The story is actually quite simple - and was pointed out to me by Sebastian Mallaby of the Council on Foreign Relations. After months of endless hand-wringing, innumerable talks, and considerable pain, it seems the eurozone has actually been saved - quietly but effectively.

The savior is Mario Draghi, the new head of the European Central Bank (ECB), an institution that had been seen as powerless and obscure until now. For much of the last couple years, it had taken a backseat amid the crisis around it. Its original mandate was almost solely to keep inflation low and stable. But now, under Draghi, it has become Europe's deus ex machina.

Last December, the ECB did the equivalent of printing nearly 500 billion euros worth of cash. Essentially, the central bank lent money to more than 500 European banks at just 1% interest.

What was the effect?

Look at the chart below. It shows what we call "bond yields" - the rate of interest governments pay to raise money from bonds.

Both Italy and Spain's rates have fallen sharply in the last three months - so they pay less to borrow money. That means they can get their financial houses in order without as much pain.

At a more micro level, Barclays estimates that the cheap source of cash from the ECB will boost the earnings of eurozone banks by 4% this year. That's going to trickle into the rest of the economy, but most importantly it means that a run on Europe's banks - the great fear – is now highly unlikely.

Remember the moment in "It's a Wonderful Life" when everyone runs to the bank to get their money out and Bailey Savings and Loan just doesn't have enough cash during the Great Depression. Well, thanks to the ECB, banks will now have access to plenty of cash.

The ECB is now said to be preparing another auction worth a trillion dollars this month. You can expect that to further de-clog the financial systems.

To put this into perspective, over the last two years Europe's governments have painstakingly put together a "stability fund" to convince markets that they are serious. Well, the ECB just conjured up three times the money - almost out of thin air.

The magic of its work is in the perception of what it does. It doesn't want to directly bail out any one country - that sets a dangerous precedent. And yet by demonstrating its ability to inject liquidity into the system, it has convinced investors that it is the ultimate lender of last resort.

Now this does not fix Europe's longer term problems. Greece is likely to default. But there is unlikely to be a Lehman-like crisis.

It's also bought crucial time for Europe's leaders to make structural changes to their economies and move towards growth. (And, no, I don't think inflation is a likely consequence - with unemployment at record highs in Europe, how can wages go up in that circumstance?) The irony is that the ECB's activism is not a new theory of what a central bank can do.

Here in America, the Federal Reserve did exactly that four years ago. The story goes that at the height of the financial crisis in 2008, Congressman Barney Frank asked the Fed Chairman Ben Bernanke if he had $80 billion to help bail out AIG. Bernanke replied, "We have 800 billion."

For all the criticism heaped on our central bank here in America - by the Tea Party and others - its instructive to look back and see how the Fed's prompt and massive action prevented our crisis from turning into a Great Depression. And it's happening once again in Europe in an even trickier situation.

The moral of the story? Don't bet against a central bank.

For more of my thoughts throughout the week, I invite you to follow me on Facebook and Twitter and to visit the Global Public Square every day. Also, for more What in the World? pieces, click here.

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Topics: Economy • Europe • GPS Show • What in the World?

soundoff (150 Responses)
  1. Aristocles

    This isn't a real save, just a temporary patch. Real, serious structural reforms must be made, the fertility rate must climb, productivity must rise, governments must become more efficient, and real GDP growth must occur and be sustained across the whole Eurozone for a long time before anyone can realistically speak of the Eurozone being "saved."

    February 27, 2012 at 3:49 am | Reply
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