Global Agenda: Once more unto the breach

The mass media – and the ‘sheeple’ who read, listen to and watch it – won’t realize that the financial system is crumbling until it’s too late.

December 1, 2011 23:33
4 minute read.
Ben Bernanke

Ben Bernanke 311. (photo credit: REUTERS)

Tuesday’s announcement is important. But why it is important depends on how you view the broader canvas of the global crisis.

On Tuesday afternoon in Israel and Europe, or morning in the US, the Federal Reserve announced three moves designed to support the global financial markets. The first, and most important, was to reduce by 0.5 percent the rate of interest on its existing swap lines with five other important central banks: those of the euro zone, Japan, Britain, Canada and Switzerland. The second was to extend the availability of those facilities from August 2012 to February 2013, and the third was an agreement with other central banks on creating swap lines, whereby the Fed can lend foreign currencies to US financial institutions.

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The financial markets judged this announcement so important that share prices immediately jumped by as much as 4% or 5% – and financial shares by even more – while the dollar plunged by two cents versus the euro and similar proportions against other currencies. Although analysts at investment banks such as Goldman Sachs and Barclays Capital noted that this reaction was exaggerated, everyone agreed that this was an important and desirable move. So what was it about? Let’s skip the complicated detailed explanation of how the top tier of the global financial system works and how central banks lend money to each other. The essence of this announcement was that the Fed would reduce the cost of lending dollars to other central banks, thereby making dollars cheaper and hence more accessible. Also noteworthy, although attracting far less comment, was the third part of the announcement: that the Fed had arranged to have foreign- currency lines available for US banks if they should need to use them.

The key to understanding the importance of these moves is that they were carefully coordinated between all the leading central banks and presented as such. The night before, China had cut its reserve requirements for its banks, marking a change of policy there, too, and taking analysts by surprise because they had expected this move later in December. It, too, was probably coordinated.

In any event, we have here a display of cooperation and determination by the biggest players in the world. The message could hardly have been clearer: The central banks were going to provide as much liquidity as was needed, wherever and in whatever currency. This show of strength was aimed to impress – “shock and awe” is the phrase now used for this kind of thing – and the markets’ reaction proved that it succeeded.

But the very need for such a move discloses that there was a serious crisis under way in the global financial system.

Specifically, there was a liquidity crisis in Europe, which was centred on the US dollar; European financial institutions could not get enough dollars to meet the swelling demand.

In plain language, there had developed, over recent weeks and months, a run on the entire euro zone. Confidence was at so low an ebb that banks were refusing to lend to one another, and they, as well as large nonbanks authorized to do so (such as Siemens), were depositing their excess cash with the European Central Bank, rather than with other banks whom they no longer trusted.

This crisis didn’t register with the mainstream media, although other aspects of it did, such as the sharp falls in share prices and the steady rise in the yields on government bonds of most European countries. But that’s just the point.

The mass media – and the “sheeple” who read, listen to and watch it – won’t realize that the financial system is crumbling until it’s too late.

If things reach the stage that the general public catches on, then the ensuing panic will sweep everything away. It was therefore essential for the central banks to regain control of the liquidity situation and thereby demonstrate that they would not allow any institution to fail because of a liquidity crunch. That is what central banks are for. It’s in every textbook for Economics 101: They are the lender of last resort.

That explains why the markets were so relieved; the immediate and pressing threat of imminent disaster at one or other big bank that would trigger a chain reaction had been removed. But nothing fundamental has changed. The underlying problems of solvency of major banks and insurance companies, themselves stemming from the insolvency of sovereign states whose bonds these institutions had bought, are still there and getting worse.

Some commentators made this point in the harshest possible way – by quoting the headlines and reactions from previous occasions when the Fed and its peers had taken dramatic, sweeping and unprecedented measures. Such as in December 2007; such as in September 2008; and in May 2010. All of these had triggered similarly sharp rises in the markets. But those responses were fleeting and quickly faded. The underlying crisis was not solved and could not be solved by these moves. Filling up the breach with more money created out of thin air – effectively government obligations – cannot solve the problem of excessive government obligations; it can only make it worse.

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