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.
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
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
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
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
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.
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 firstname.lastname@example.org