Central banks: Shooting blanks or hitting the target?
Central banks intervened on Wednesday to prevent a credit crunch but are they hitting the target or are we on a crash course in financial reality?
The cavalry has charged over the hill shooting hither and thither at all targets but it is not clear whether they have hit anything. Looking at the markets’ reaction, you’d think that the central banks’ intervention has saved the world.
Now of course markets like cheap money but the reaction is a tad overstated when you look at the reasons behind the actions.
By cutting the rate of the temporary dollar liquidity swap and extending the basket of currencies that can be used, banks will be able to get credit at a cheaper rate, providing liquidity at a time when the US funding market is all but shut to France and the like.
There is good reason why the market is all but shut to the Europeans. Who would provide money to banks that are overexposed to Greece, Italy and Portugal? Why risk your cash on banks that could go bust if a country falls?
In effect, the Federal Reserve, assisted by other banks, has become the lender of last resort for Europe.
Yes there was a degree of thumbing their noses at European leaders; an exasperated sigh of ‘well if you won’t do anything, we will’. But there are some fundamental issues underlying the move.
There were loud, if unsubstantiated rumours, that central banks had to intervene to prevent a French bank from going bust, prompting the action by them and China on Wednesday.
Whatever the rumours, it is clear that French banks are a huge concern to the central bankers. In the short-term wholesale market, French banks have lost more than €120bn (£103bn) of funding from the US and the duration of the funding plummeted from an average 44 days to less than five.
This is the lynch-pin to the concerns over Europe. If French banks fall, there goes German, UK and US banks. The interconnectedness of the financial world means that it is vital for the system to keep France going.
Now, it is clear that UK and US banks have cut their exposures to Europe, some by at least 80 percent, but there is no clear picture on who exactly is holding the insurance policies in the form of credit default swaps. With these countries being the largest players in the market, the worries of the Fed and the Bank of England become apparent.
Even without fears over France, Europe is entering another recession - although whether we actually left the last one is a moot point - dragging the globe with it. Chinese manufacturing went into negative territory this week and concerns about its housing bubble are growing.
Cash is being held onto. Central banks are finding more and more being deposited with them and not being lent out.
The actions are designed to grease the wheels again, pump some fluid into the system but these actions have already been in place since September via the European Central Bank which had been supplying eurozone banks with dollars and that is going well isn’t it?
And of course there is the doomsday scenario. If the eurozone crashes or a big player like Italy crashes, what is a credit squeeze would become the ultimate credit crunch. The flow of money would seize up. By taking this action, it allows the central banks to provide cash flows for those outside the eurozone, keeping the global economy flowing.
Whatever the reasons for the action, it is now clear that the financial system is being socialised. Private funding is being eased out in favour of state funding and to hang with moral hazard.
However, cheap money got us all into this mess, and it is very unlikely that cheap money will get us out of this.
It is apparent that the boom years of cheap money and pricey assets no longer work. Everything is being re-evaluated. Money could become expensive again and assets could see themselves being priced more realistically.
One asset manager told me last week that there appears to be a fundamental shift in the financial system and one that could see growth terms of 3 percent or less become the norm.
The central banks acted last week but it is not yet clear whether they have managed to hit the target or whether this is just another round of blanks that we have seen fired over the past year.
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