European Debt Crisis Essay Example | Topics and Well Written Essays - 1500 words

European Debt Crisis - Essay Example According to Investopedia (2012) the crisis led to the reduction of the confidence of the market for European businesses and economies. In contrast, according to the version of Constancio (2012), the European sovereign debt crisis emerged only in spring 2010. The European sovereign debt crisis is the climax of the banking crisis resulting from the demise of the Lehman Brothers and the resulting bailout extended by governments to their banking system (Constancio 2012). In other words, it is held that the European debt crisis started out as a financial crisis from the Lehman Brothers. In the climax of the crisis, government was forced to support the financial system, creating large debts for government leading to the sovereign debt crisis. II. Impact on bond and other markets (equity, derivatives, commodities, forex, gold, etc.) Constancio (2012) has a good discussion on the emergence of European sovereign debt crisis and its impact on the financial markets. We use his interpretation. After the failure of the Lehman Brothers, the ECB or the European Central Bank implemented a policy of strong credit support and measures to boost liquidity way above than what could be achieved by a mere interest rate policy. The European government implemented measures to increase the maturities for debts, more access to foreign currencies and a program of bond purchases. The European sovereign debt crisis became severe with Moody’s downgrade of Portugal on 5 July 2011 (Constancio 2012). The situation plus the risk of a Greek default triggered a sell-off of Italian and Spanish assets. The initial effects of a sovereign debt crisis are for bond yields to go up. However, investors find it appropriate to reduce their exposures to government bonds in view of risks that governments may not be able to pay for their debts. Simultaneously, markets can expect that the foreign exchange markets can be affected substantially as demand for currencies affected by the crisis can significa ntly go down, proportional to the perception of the extent that the would be affected by the sovereign debt crisis. The effect on the foreign exchange market is important as the effects reverberate on the equities, commodities and derivatives markets. Expected depreciation of currencies affected by the sovereign debt crisis can lead to falling equities, commodity prices and derivative prices. However, as markets are interrelated, or as companies in one country may have investments in companies directly affected by the sovereign debt crisis, all of the financial markets are affected. The more correlated the companies in a region, for example, the more the rest of the markets are affected by the sovereign debt crisis in one country and soon, especially as governments respond to the crisis with bailouts and enhanced liquidity, the correlated governments and economies are affected by the sovereign debt crisis and not only the countries that were initially affected by the sovereign debt crisis. In contrast, to the extent that gold is seen as a store value of value, gold prices can pick up and enjoy a better market. When the financial markets are in doldrums and gold is seen as the better store of value than the bonds, equities, commodi