Apprehension is growing

The fall of world markets seems open-ended. Neither the intervention of the European Central Bank (ECB), nor Obama's dramatic message to dispel the doubts about the American economy, sufficed to prevent another disastrous day on Monday before Tuesday's partial recovery. The sovereign debt and variable yield markets responded unequally to recent economic events- that is, to the downgrading of the American debt rating by Standard & Poor's; and to the ECB's purchase of Spanish and Italian debt to stabilize the debt differentials of both countries, and to forestall the risk of bailout.

World stock markets, including the Spanish Ibex 35 index, suffered sharp drops on Monday, as investors took it for granted that budget adjustments on both sides of the Atlantic (especially in the United States) will cause a general slowdown of economic growth. The OECD is of the same opinion; considering that throughout 2011 world growth will be slower. The inherent contradiction between budget cutbacks and growth, ever more important for investors, compromises the expectations of world recovery -at least in the short term.

The debt markets, on the other hand, reacted well to the ECB announcement. The Spanish risk premium fell sharply by 100 basis points (80 at Monday's close), improving the solvency of the debt. This may also have to do with the announcement of a planned new budget cutback which, of course, will further reduce the expectations of Spanish growth in 2012. A similar pattern was followed by Italian debt, though the ECB has pointed out that Italy urgently needs to implement austerity plans and a program of privatizations.

But if there had been a clamor in Europe that the ECB had to act by purchasing Spanish and Italian debt to save the solvency of both countries, why did Trichet not announce it on Thursday? The explanation is that the ECB is using the tactic of minimum-cost intervention. Last Thursday it attempted to persuade the markets that the bank was ready to intervene, but the message failed because it made a feint at purchasing Irish and Portuguese debt (the cheapest option), and investors wanted to locate with precision the red line beyond which the ECB would step in. Since Sunday night they have known this red line.

Now the EU's action can no longer be limited to the ECB intervention. The prudent course would be to accelerate the announced reform of the European Financial Stability Fund (EFSF), enabling it to intervene in the market, and to act as a mechanism for stability in the euro zone. It is highly impolitic that, with the risks involved in the ongoing financial convulsion, discussion of the Fund's reform is to begin only in September. The cost of the absence of a Europe-wide economic authority may well turn out to be unaffordable; and not only for Spain and Italy, but for Europe as a whole.