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Can the central banks actually pull this off?

November 30, 2011 by Peter

It seems every major financial media outlet is covering (as they should), the move by just about all of the world’s central banks on a coordinated intervention to lower swap rates. In laymen’s terms, European banks have been parched for liquidity, and need access to dollars. The ECB can’t supply dollars unless it borrows them from the Fed. So today’s action makes it easier for the ECB and thus European banks to borrow dollars. This is by no means a solution to the “crisis” in the EU, it simply will just help solve small liquidity problems for the time being.

The markets as well are LOVING this move. US futures had been down by 0.5% at one point this morning, and now the Dow is up 400 points.

**Note that there are some other bullish things going on today. China lowered its Reserve Requirement Ratio also this morning, and we got a strong ADP jobs report.**


While this move may be a positive short-term development on its own it doesn’t do much in the long term”, writes Pimco CEO Mohamed El-Erian in an FT Alphaville column after the announcement.


Supporting “the supply of credit to households and businesses and help[ing] foster economic activity” may be a nice goal, but it’s not one the banks can achieve with these current measures:


“First, these monetary institutions feel that, again, they have to move because other entities have continued to be too slow and too ineffective; and second, they feel that they cannot, and should not ignore an actual or anticipated need to relieve acute pressures within the banking system…

The hope is that central banks are acting because, looking forward, they feel confident that other policymakers will finally catch up with a big and spreading debt crisis that has serious implications for growth, jobs and inequality. The fear is that they are acting because they feel that they must again pre-empt yet another set of potential disappointments.”


And from another part of the Pimco Empire Tony Crescenzi, shares the idea that this is another round of QE via the backdoor.

Keep in mind that any use of the Fed’s swap facility expands the Fed’s monetary base: all dollars, no matter where they are deposited, whether it be Kazakhstan, Japan, or Mexico, wind up back in an American bank. This means that any time a foreign central bank engages in a swap with the Federal Reserve, the Fed will create new money in order to make the swap. Use of the Fed’s liquidity swap line in late 2008 was the main cause of a surge in the Fed’s monetary base at that time. The peak for the swap line was about $600 billion in December 2008. Some observers will therefore say that the swap line is a backdoor way to engage in more quantitative easing.

Now both these men pose that this is all just smoke and mirrors essentially to keep the markets happy another month or to push a political agenda. But it gets us wondering if the Pimco gentlemen are just throwing cold water on an equity rally to get the public back to buying bonds, or if they’re actually right.

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