For European banks threatened by a looming credit squeeze, the US Federal Reserve’s move to cut the cost of obtaining US dollars rescue hasn’t come a moment too soon.
The Fed’s decision to engage in quantitative easing is the result of coordinated action between a number of the world’s major central banks, including the European Central Bank (ECB), the Bank of Japan, the Bank of England the Bank of Canada and Switzerland’s National Bank.
European commercial banks have no problems accessing euro and other European currencies, but the marginal costs of raising US dollars on foreign-exchange markets have increased as the euro currency itself has steadily depreciated.
US dollar hegemony
The Fed’s action underscores the persistence of the US dollar’s hegemonic role in the global economy. US dollars account for over 60% of the world’s foreign reserve assets. The greenback remains the one and only currency with which OPEC nations will do business, which means if you want oil, you need dollars.
The dollar glut means virtually every financial institution worldwide deals in dollar credits – any dollar held outside the US is known, somewhat ironically, as a Eurodollar. The demand for dollars, irrespective of its steady devaluation and depreciation over four decades, appears endless.
Even China, with its central bank bulging with US Treasury bonds, cannot untie the Gordian US dollar knot. In 2009, China’s dollar credit growth – in other words, US-dollar denominated foreign currency loans – exceeded 111%, while in Hong Kong the figure was 62%.
If retail banks pay more to access US dollars, this hits every single sector of the economy: from fuel prices to mortgage interest rates, from Burberry to Bugattis.
During the beginning of the global financial crisis in 2008, and after 9/11, the US Fed put in place swap lines, which meant that overseas central banks could swap their local currency for US dollars.
The Fed’s risk is mitigated by essentially removing these foreign exchange (forex) transactions from the ambit of private forex markets. The Fed and, say, the ECB agree on the exchange rate between the US dollar and the euro before they do the swap. It’s also a short-term swap: exchange one shaky currency for a stable one. Voilà. Stability. Well, for a while.
Bankers and forex dealers do much the same (often illegal) thing when they hold each other’s paper or currencies for each other: a forex dealer who is having a bad run might ask a buddy at another bank to buy his bad position from him or her for a week. Then the dealer doesn’t have to tell the boss, keeps the job, gets the bonus and quietly repurchases the position a week later. Of course, for this to work, you have to trust the other guy. And they have to trust you. A lot.
Central banking works a little like that as well. It’s an elite and invariably polite group of international bankers who have worked together for decades. They have all done their time with the G10, the G20, the IMF or the World Bank. They have, variously, held positions, at Goldman Sachs or JP Morgan. But aside from Ben Bernanke, they’re hardly likely to be household names.
The dog didn’t bark
Why didn’t anyone see the Fed’s dollar liquidity swaps coming? Because this deal was done behind closed doors via the Bank for International Settlements (BIS), headquartered in Basel, Switzerland. Known as the “the central bankers’ bank”, the BIS’s exclusive membership includes the heads of the world’s most important central banks: the US Fed, the European Central Bank (ECB), the Deutsche Bundesbank, the Bank of Japan, the Bank of England, the Banque de France, the Swiss National Bank – and the Saudi Monetary Agency.
Quietly, away from the public’s gaze, within this select coterie of the world’s most powerful central bankers, the BIS can extend credit overnight to faltering economies, smoothing over what might otherwise be troubled waters by morning. Better still, the markets might never even know what was afoot.
By contrast, the International Monetary Fund (IMF) is very public, intrinsically difficult to negotiate with and takes months to make a deal. So for credit swaps and current-account assistance – a few billion here, a few billion there – the BIS’s quiet green room is vastly preferable to the circus that is the IMF. After all, the BIS have been doing this for a long time. It was formed in 1930 to deal with Germany’s reparations payments. They rescheduled all that debt until 1985.
Meanwhile, in Beijing …
You know the world economy’s in deep trouble when China’s central bank starts cutting its bank reserve requirement ratio, which it did by 50 basis points on Wednesday night. That means Chinese financial institutions are compelled to keep less cash and short-term assets on hand and on the books, thus freeing up more capital for domestic lending.
It’s unlikely to be a coordinated action, as Beijing isn’t privy to the inner workings of the G10 central bankers’ club. But it speaks volumes for how seriously China’s financial elites regard a potential slowdown in domestic economic activity.
Moreover, let’s not forget how dependent China is upon the EU economy: it’s Beijing’s biggest export market (the US being the second). There will be a long winter of discontent in Europe that will last at least until the middle of this decade, if not 2020. Years of poor export returns from Beijing’s two biggest trading partners cannot be wholly offset by rising domestic demand within China itself.
Back to the future
The Fed’s swap line treads water and will do nothing to solve the Eurozone’s chronic problem: sovereign debt. After all, Greece (currently on strike) needs a few more billion this month, or it’ll run out of money again.
What the liquidity swap does do is relieve the impending credit squeeze in Europe that was threatening widespread deflation in the EU and, by logical extension, the entire global economy. In a world wracked with debt, questionable bank solvency and a chronic lack of liquidity, a credit squeeze would impact upon consumer consumption, real estate values and new capital investment.
Add to this draconian national fiscal deficit strategies and it’s clear how much cash has been withdrawn from the world economy.
In January this year, the World Economic Forum (yes, the central bankers, national treasurers and Bill Gates) released a report arguing that over the next 10 years, world markets needed an additional $100 trillion – yes, trillion – in credit to keep global growth at acceptable levels. If not, then capital scarcity will provoke a credit crunch that is likely to result in a recessed world economy, deflation, leading to stagnant, negative or zero growth and chronic unemployment.
The bottom line
For the “99%”, it appears the world’s bankers have seen nothing and heard nothing. Despite the “blip” that was the 2008 GFC, it’s business as usual. Essentially, what the World Economic Forum is asking governments to do is create more fiat currency to add to the $US300 trillion-plus that already comprises the global derivatives market alone.
It’s this unquenchable thirst for capital and consumption that got us here in the first place. The alternative is stocking up on tinned salmon, growing lentils and hosting community soup kitchens. And no one, least of all the 1% at the BIS in Basel, is seriously contemplating that.