FINAL UPDATE: [Link]
NEW YORK (Dow Jones)--The euro rebounded strongly from four-year lows Wednesday on market speculation that European authorities are preparing a response to the common currency's rapid decline.
Conjecture in the market that the European Central Bank could take steps to try to arrest the euro's decline--which could be becoming too rapid--has helped boost the currency more than 1% against the dollar on the day by noontime trading.
The Federal Reserve declined to comment on speculation the ECB and other major central banks are preparing to intervene in the foreign-exchange markets to prop up the flagging euro. The ECB also declined ........
The Euro has stabilised somewhat on the believe that central banks will intervene. However, there is great uncertainty and instability due to unwinding of the 'risk trade'. The large currency movements have shakened investments from commodities to emerging market equities. Looking ahead it is pretty uncertain where things are headed.
FURTHER UPDATE: Trichet : Economy in Deepest Crisis since WW2. The only thing good about what Trichet talked about in his interview is the realisation of the severity of the mess they are in. Trying to fix it with austerity now can stall the economy and doing nothing risks sovereign insolvency. There is little they can do except delay the day of reckoning - ultimately living standards will have to fall in the EU. Even buying time is not so simple with speculators eager to bring forward the dire consequences of their past profligacy by sinking the Euro. Graceful degradation is best...but speculators want chaos. The day when you wake up and see the euro plunging 10cents in one day may not be too far away....and that will shock the fragile system reversing the gains of past 12 months. That is why it make sense to intervene to shore up the euro- buy time and some hope the global growth can overcome global problems. The US had debt several times its GDP just after WW2...but rapid growth made the debt manageable. There is little chance of that kind of rapid growth for Europe in today's economy but some growth can make debt servicing less painful... . Now more on the possibility of currency intervention I was talking about. The falling euro hurts confidence in Europe and the rising Yen is threatening Japan's exit from deflation( Read : Tokyo Alarmed by Yen Rise) so there is plenty of incentives to intervene and calm markets ...this is a very worthwhile time to do it. The Japanese used to intervene every other week to keep the Yen down in the 80s so that its exports sector remained strong. These days intervention is a G7 effort done to ensure that all members benefit from from it. We are now at a psychological tipoff point when markets are about to declare the $1T package inadequate and watching the euro plummet makes that idea sink in threatening to plunge the markets into next crisis of confidence. I don't know for sure whether they will intervene but I certainly think it would be one of the most appropriate times to do so.
UPDATE: The Wikipedia page on the 2010 European sovereign debt crisis is up. I remember reading the Wikipedia page on the subprime crisis when that crisis was in the infancy and there was a write up on the "worst case scenario". Most of what was described in that scenario actually happened. The contagion scenario for the current unfolding crisis is described here.
This posting is more for my own reference as I'm watching the current market turmoil closely. Do feel free to post any comments/opinions.
The $1T European bailout package calmed markets in the early part of the week. The package in fact appeared to be working because the ECB was able to narrow interest rate spreads of Italian and Spanish bonds[Link] and the Italian govt was able to conduct bond auctions[Link] receiving good demand. This means the tailend risk has subsided and that was probably the basic idea behind the bailout to buy time, implement austerity to cut deficits over the long term and stem the panic. The ECB was about to get all this done spending only about 20B euros. However, late Thursday, currency speculators started shorting the Euro again bringing it down to the lowest levels since the Lehman collapse. The sharp movements in the currency markets caused equities, commodities and oil to be sold off. The carry trade is again disrupted by the large currency movements. Looking at the turmultous markets one may be led to think that things are falling apart because there is a lack of confidence in the Eurozone countries. But think hard about this is the Euro falling because there is lack of confidence in Eurozone countries or is the fall in the Euro itself undermining confidence? The sharp falls in the Euro is creating a negative feedback loop that will lead self-fufiling prophesy that speculators want and profit from. So what can govts do under such situation? During the Asian Crisis govt were not able to do anything and that led to foreign funds fleeing Asian countries and a catastrophic collapse of Asian economies. Letting the Euro go into a freefall will lead to dire consequences for the global economy for sure given we are still in a nascent recovery. Something has to be done soon....
I did some research on what govts did in the past when the Euro fell sharply. The last time that occurred was in Sept 2000 when the Euro fell 30% from the the level it was launched in Jan 1999. During that period, the Euro's fall also threaten to derail the global economy. The then US Treasury Secretary Lawrence Summers led the coordinated effort to shore up the Euro. 48 hours later, the speculators came back to attack the currency but the central banks kept them at bay for the next 6 weeks...2 years later the Euro was 50% higher. Already there is plenty of reports of behind the scenes coordination of by leaders - Barak Obama was said to be working behind the scenes to persuade the EU get last weekend's package through[Link]. Given how interconnected market are these days, no major economy is immune from EU's problems. There were also reports that Obama himself persuaded Portugal & Spain to accept new austerity measures to shore up confidence[Link].
The US, Japanese and others govts have taken many big steps to get the global economy back to the point where it is starting to grow. It is unlikely they will stand by and watch speculators pick it apart by shorting the Euro and disrupting market. There is also precedence for successful coorperation. I believe the govts will act soon before the damage to confidence becomes permanent....maybe as early as Monday next week. There is really no benefit to wait any longer.