Europe on the "Short" End of the Stick

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This article from the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas details how Europe is being pummeled by the current financial crisis. In a previous post, I characterized the bailout reaction of the U.S. and the subsequent proposed bailouts by most other countries as an "international bailout arms race." It looks like Europe is quickly showing signs of losing that race. The most powerful graph is the following which details the increased credit spreads and the flight to quality in Europe.

EuropeSpreads2008-10-30.gif

The blue area shows the difference between the three-month euro interbank offered rate and the three-month euro overnight index average swap rate, which is a measure of the default risk over the next three months. The red area shows the difference between the three-month French Treasury bill and the euro overnight index swap rate. This negative spread "shows a flight to quality as investors are seeking the safety of government bonds and are willing to accept lower interest rates in return."

Overall, it looks like Europe is in big trouble. For countries that can afford to pay for a bailout (stay in the game), I would expect them to gain economically relative to the rest of the world. However, what we are seeing now can be interpreted as insights into which countries are least able to pay for a bailout and thereby most likely to fold in the bailout arms race.

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But what does this say about Europe relative to they US? The "red area" is basically like the negative of the TED spread, which is still near 3% (http://www.bloomberg.com/apps/cbuilder?ticker1=.TEDSP%3AIND), which would be off the chart here.

I think you are right the Europe is getting hammered, but I'm not making the connection with the graph shown here.