Dec 17 2007
$500 Billion “Injection” Hits Euro System
The cost to borrow in euros for two weeks plunged after the European Central Bank added an unprecedented $500 billion to the banking system as part of a global effort to ease credit-market gridlock through year-end. The amount banks charge each other for two-week loans in euros dropped a record 50 basis points to 4.45 percent, the European Banking Federation said today. The rate had soared 83 basis points in the past two weeks as banks anticipated a squeeze on credit through the end of the year.
The fight is on, indeed, with the Euro CB working to paper over the real insolvency problems lurking beneath the surface that are not unlike those in the United States. Continues Bloomberg:
“These are strong-arm tactics intended to show the market they’re seriously committed to breaking the deadlock,” said Marc Ostwald, a fixed-income strategist at Insinger De Beaufort SA in London. “The ECB is helping to bankroll banks out of a problem that they themselves created.’
True enough, Mr. Ostwald. The question is will they break their fiat currencies at the same time? Consider what’s been happening in Italy in another Bloomberg article, for example:
Dressed in his best Sunday suit, Fausto Cepponi took his wife and seven-year-old son out for dinner — at a soup kitchen.
“I never thought I would be in this position,” said Cepponi, 45, a security guard, dining in an 800-seat charity cafeteria near Rome’s main train station. “I have a job, I had a car, but everything has become so expensive and what I earn just isn’t enough. I panic every third week of the month.”
Salaries stagnating… prices rising, mortgage costs going up, house prices still in bloated territory despite the slowdown… Does this all sound familiar to our U.S. readers? “It’s a hidden and humiliating kind of poverty that has emerged, one that the official statistics can’t show,” said Giampiero Beltotto, author of “The New Poor” .
These two stories could be no more related than they are. Bloating the supply of a currency devalues its purchasing power eventually. What’s happened in the last decade in Western nations is much of the inflation was hidden on the front end which goaded CBs to overextend money supply to banks who recklessly loaned into unsupportable markets, and now it is coming home to roosts.
If one studies inflations, you see the patter. First, the upper income earners, and especially those close to the money supply spigot — your investment bankers and so forth — make handsome profits. Some speculators in lower incomes hop on a bubble bandwagon and do well while the sun shines, while others — blue collar labor and lower middle class wage earners start finding times harder and harder. Meanwhile, economic activity is perverted in directions it otherwise never would have gone, an into projects that are otherwise economically unjustifiable.
Eventually, once the inflation breaks to the backside the negatives start showing up. The great boom is exposed to be fiction (ala the U.S. housing and condo markets now defaulting at a record pace) and before you know it, you have runs on the banks and collapses (or near collapses) of boom-related companies. Soon your middle class starts getting pushed off the cliff, while the gilded class at the top is coming out of a cycle of massive wage earning.
Fausto Cepponi above is struggling. Yet on Wall Street — despite issuing $72 billion in losses to shareholders – big banking firms still dolled out $37 billion in bonuses to employees. That’s an act that is nothing short of audacious on its own, but it is all the more smug and arrogant give the Fed (and BCB and ECB) are scrambling to essentially guarantee many of the flimsy deals on which these firms “earned” their record profits over the last few years. Of course, this is because the investment banking ship would otherwise go down with many low-wage homeowners conveniently stuck down in steerage who are coincidentally playing a role of what is functionally banker buoyancy insurance.
Meanwhile, the environment is far from healthy, and still being misjudged. Most notable is the generally approval of foreign central banks (via their “sovereign wealth funds”) bailing out major banking players, actions that are in economic terms functionally neo-fascist. Temasek, Singapore’s official SWF, bailed out UBS with US$11.5 billion. Abu Dhabi’s SWF invested US$7.5 billion in the troubled Citibank. Consequently, these foreign governments will have partial influence these banks and their policies henceforth.
Readers, functioning economies are highly dependent on a reliable market pricing mechanism. What is described above is anything but, and the consequences will continue to be forthcoming, with the oblivious Fausto Cepponi’s of the world suffering for it all.
This is the game being played, readers. Plan wisely, understanding the game’s rules.
Can I try to paraphrase the conclusion:
The too-big-to-fail theory is creating a tax on everyone by inflating the currency.
What is the alternative? Let them fail? It doesn’t seem that bad: It’s not as if all the money flowing through, say, Citibank will suddenly vanish. The viable parts will be bought by someone and the non-viable parts will what?
This sort of macro/micro economics intersection is very confusing to me.
Presumably someone is going to be left holding a giant pile of defaulted loans. Depending on the number of someones and the size of the pile, this could be the start of a cascade (if the number is small and the size is large) or just a minor blip (the number is large and the size is small). Does anyone know?
The foreign inflows seem like a good thing to me: We buy Chinese stuff and they put the money back into America to cover our credit defaults, which were created by buying their stuff. I cannot imagine why they are doing it except to keep the circle going (and a couple billion are a drop-in-the-bucket to the Chinese government).
That may be a worthwhile (i.e. self-interested) goal in and of itself: Holding that much US debt, it is in their best interest to keep us solvent enough that we have a prayer of repaying it.
It is a mess, and it takes two or more to tango. China’s mercantilist treatment of its export sector has assisted the distortion greatly, but as you point out, it is unsustainable.
It is a mess. After a bubble up like this, with all its stupidity and recklessness — and its innocent victims being sucked in thinking it was all real, as well — now we’re at an inflection point.
And, that’s not new. Only the size of it is new with the details unprecedented in scope and rot.
The only question that is outstanding so far as I’m concerned is, will the central banks get away with another attempt to float the bubble’s consequences away. Unfortunately, the proper analogy is more along the lines of giving an addict more junk to help him get back up on his feet when he slips into a very ugly withdrawal. Eventually the addict can’t get enough and his body gives out. With each inflationary response to a bust — from the savings and loan bailout, the Mexico, to LTCM / Russia default, to the dot com tech bust, to recession 2001, etc., the distortions grow more and more perverse.
We’re only in the early innings.
Oh, and you definitely get the gig of too big to fail. Every time this happens, the same big banks who earned obscene profits while creating / enabling the bubble then get their returns guaranteed by inflation of the money supply. The name of the game, some say, is bailout — by design. Note: They always make sure the middle class stands to lose a lot when these things break, and the politicians make sure the people get what they want.