The bottom-line truth about today’s Federal Reserve-led coordinated effort by six of the developed worlds’ central banks to ease the liquidity problems of European financial institutions is this: It doesn’t change anything. European leaders still have the same tough decision to make. Either impose even stricter austerity measures on Europe’s struggling nations or force Germany and other stronger European nations to come forward with an even bigger bailout, or, of course, kiss the Euro good-bye. And in fact that choice got a little tougher last night, after European bank leaders said that the plan to lever up the funds already in place to help the struggling Eurozone nations may not work.
Another wrinkle: If the move leads to an even bigger bailout the result could be a new round of inflation, particularly in the emerging market countries. That would lead to more rate hikes in China and elsewhere, which could slow the entire global economy.
So if that’s the case, why did U.S. stocks, which have taken a beating recently on fears that the Eurozone’s problems will spread to U.S. banks and the rest of the American economy, rise 490 points on Wednesday on news of the latest effort to prop up Europe’s banks? As one analyst put it, the amount of people who bought stocks this morning on the news that central banks around the world were lowering currency swap lines probably far outweights the number of people who know what currency swap lines are.
In fact, the deal struck today says more about the strength of the U.S. and the U.S. economy than it does about how and whether Europe’s issues will be resolved.
The latest European bank bailout measure is a coordinated effort by six central banks, but the heavy lifting is being done by the U.S. Fed. Recently, overnight lending rates among European banks had been rising on fears that some Euro banks would fail, and not be able to pay off their debts. It turns out the plan to relieve this problem is to put more U.S. dollars in the hands of banks around the world. The six large central banks – including the Bank of Canada, the Bank of Japan, the European Central Bank and others – have all agreed to allow their local banks to effectively borrow dollars at half the rate that they used to be able to. That should drive down lending rates, because if you can get dollars for cheap to fund your short-term borrowing costs why would you do anything else.
The effort is being made possible by the U.S. Fed, which has agreed to make the dollars available to the other five central banks to lend to their local banks. And the Fed has agreed to keep the rate low on dollars for those other central banks until February 2013.
There was a fear after the financial crisis, and there still is, that the U.S. would lose its place as the leading financial power, and all the advantages that entails. But even after the financial crisis, the crippling recession and the building up of $15 trillion dollars in debt, America remains the world’s lender of last resort. The move today by central banks, and the fact that the bailout deal is being made in dollars, says that, for all the worry about the fall of the American economy, the U.S.’s standing in the world remains, for now at least, strong. So strong, that essentially the U.S. is setting rates low for the rest of the developed world through early 2013. And that alone should make U.S. investors feel better about the U.S. economy and stock market, even if they don’t know for certain what currency swaps are – or that they won’t do all that much to solve Europe’s true problems.