French Fried Banks
by Gary North: Europe's
is in panic mode. The November 30 coordinated announcements of six
central banks regarding their intervention into the currency markets
was exactly that coordinated.
As I shall
argue, this was an action preliminary to (1) Angela Merkel's December
2 speech to the German parliament, which is preliminary to (2) the
next Eurozone summit, scheduled for the weekend of December 9, which
is preliminary to (3) a coordinated violation of the two treaties
that created the European Union, which is hoped will (4) pressure
the European Central Bank to buy newly created Eurobonds issued
illegally by the EU, in order to (5) raise enough euros fast enough
to buy Italian government bonds before (6) the Italian government
misses interest payments, which may (7) bankrupt the largest French
banks, which could (8) trigger a worldwide financial panic.
Bernanke and his peers are in a pre-panic panic.
This was an
announcement of a very specific kind. Ninety minutes before the
American stock markets opened, the six central banks said that they
would increase the availability of money.
Bank of Canada, the Bank of England, the Bank of Japan, the European
Central Bank, the Federal Reserve, and the Swiss National Bank are
today announcing coordinated actions to enhance their capacity to
provide liquidity support to the global financial system. The purpose
of these actions is to ease strains in financial markets and thereby
mitigate the effects of such strains on the supply of credit to
households and businesses and so help foster economic activity.
The FED assured us, they were acting on behalf of the best interests
of common people around the world. They were doing this in the name
of the People. "What's good for the People is good for central bankers."
is, they were silent on why, exactly, the strains of the supply
of credit was threatening the People. On November 29, the interest
rate for 90-day U.S. Treasury bills was 0.01%, or one one-hundredth
of a percent, which is the lowest it has been in history, basically.
To be honest, I do not regard this as evidence of a strain in the
these questions: "Which financial markets? Paying what rates? Why?"
In the good
old days, meaning earlier than November 30, "strain in the credit
markets" meant a frantic rush by investors and speculators to purchase
a financial asset. The asset's price rises rapidly, which is what
happens when there is greater demand than supply for any asset.
The U.S. dollar
has been bumping around in relation to the euro all year. There
has been no indication of a frantic rush to sell euros. On January
1, 2011, a euro bought $1.34. On
November 29, a euro had fallen in price to $1.33. That was not
what I would call a strain on the euro market. We are not talking
even nickels and dimes here. We are talking pennies . . . in single
So, the question
arises: Why was it necessary for a coordinated intervention?
The FED explained:
central banks have agreed to lower the pricing on the existing temporary
U.S. dollar liquidity swap arrangements by 50 basis points so that
the new rate will be the U.S. dollar overnight index swap (OIS)
rate plus 50 basis points. This pricing will be applied to all operations
conducted from December 5, 2011. The authorization of these swap
arrangements has been extended to February 1, 2013. In addition,
the Bank of England, the Bank of Japan, the European Central Bank,
and the Swiss National Bank will continue to offer three-month tenders
until further notice.
This is central
bank gibberish. It refers to the practice of lending U.S. dollars
for a period of time. These are central bank loans to other central
banks. They are called central bank liquidity swaps. For a description,
Wikipedia. Say that one central bank needs dollars. It can swap
its assets for dollar-denominated assets for a fixed period of time.
In this case, the deadline is February 1, 2013.
The five other
central banks promised to supply liquidity, meaning their own currencies.
a contingency measure, these central banks have also agreed to establish
temporary bilateral liquidity swap arrangements so that liquidity
can be provided in each jurisdiction in any of their currencies
should market conditions so warrant. At present, there is no need
to offer liquidity in non-domestic currencies other than the U.S.
dollar, but the central banks judge it prudent to make the necessary
arrangements so that liquidity support operations could be put into
place quickly should the need arise. These swap lines are authorized
through February 1, 2013. It can therefore supply dollars to those
who demand them.
So, the problem
is the dollar. Better put, it may soon be the dollar. But, just
in case, the central banks are willing to inflate.
At this point,
I can imagine an exchange between a confused caller and some call-in
satellite radio investment show.
the free market do this? "Yes, but at a higher price."
coordinated action was a move to keep down the price of the dollar.
"You've got it, Sherlock."
other five banks are working with the Federal Reserve to keep
the dollar low, which will reduce their nations' exports to America.
"That's one effect."
means the central banks are acting to hurt their own export markets.
"That is one effect."
bankers never do this. "This time, they are."
they are scared out of their wits."
To get some
indication of what the coordinated action is intended to accomplish,
pay attention to this.
addition, as a contingency measure, the Federal Open Market Committee
has agreed to establish similar temporary swap arrangements with
these five central banks to provide liquidity in any of their currencies
if necessary. Further details on the revised arrangements will be
So, the FED
thinks there is a chance that there will be an increase in demand
for dollars in other currencies: "to provide liquidity in any of
their currencies if necessary." So, more than one of them are afraid
of a panic-driven sell-off of their currencies.
Are they all
equally at risk? No. There has to be one targeted bank: the central
bank of the currency that is being dumped by investors in order
to buy any of the others. Which might that be?
It is obvious:
the European Central Bank.
But the euro
has been stable in relation to the dollar all year. It is obvious
that Bernanke and five other central bankers think that this rosy
scenario is about to end.
financial institutions currently do not face difficulty obtaining
liquidity in short-term funding markets. However, were conditions
to deteriorate, the Federal Reserve has a range of tools available
to provide an effective liquidity backstop for such institutions
and is prepared to use these tools as needed to support financial
stability and to promote the extension of credit to U.S. households
The FED said
that U.S. financial institutions are not having problems getting
access to dollars. Furthermore, the FED "has a range of tools available
to provide an effective liquidity backstop for such institutions."
Then why the swaps? Why would five other central banks join in?
Why should they need to worry about "such institutions"?
central bankers are not worried about U.S. financial institutions.
They are worried about their own financial institutions. They have
good cause to be worried.
useful interactive graph in the New York Times, we can
see which nations owe how much money to which other nations' commercial
reveals something ominous. French banks are sitting on top of a
mountain of Italian bonds. What if Italy decides to create what
I have elsewhere called an "Iceland event"? It
could be a disaster!
then have French fried banks. Then the question arises: What will
Sarkozy do? How will the French government get the money it needs
to bail out its now-insolvent big banks? Who will lend it this money?
needed will be euros. But, under the present laws governing the
European Union, the ECB is not allowed to buy bonds of nations that
are considered poor credit risks. France will be a bad credit risk
if Italy skips interest payments, let alone defaults.
is the FED's problem? This: if Merkel does not get her government
to accept instant inflation by the ECB, but without a revision of
the Maastricht and Lisbon treaties, then she will go into the December
9 summit as a barrier to a quick decision by the ECB. The summit
will be stuck.
of Italy's default is imminent. If the ECB does not act, and act
fast, then the Eurozone will be seen as approaching a break-up.
This means the euro may not survive. That fear may trigger a run
on the euro: a mad dash to sell it and buy U.S. dollars. If dollars
are not available at a price people are willing to pay, then there
will be a rush to buy other currencies.
This is the
much-feared, long-denied domino effect. The orders to sell euros
are placed by people with big money: hedge funds. They want instant
conversion. They will also start looking for safe-haven banks located
outside the Eurozone. They will fear a Lehman event. This is what
an Iceland event can become if Italy defaults. It owes too much
At that point,
the ECB will be pressured to intervene to prop up the euro. Question:
Intervene with what? With U.S. dollars. Where will it get these
dollars? From the FED.
This is what
the coordinated announcement was designed to forestall. This is
What is the
bazooka? It was the word used by then-Secretary of the Treasury
Hank Paulson to describe his promise that the Treasury would provide
funding for the two visibly tottering, over-leveraged mortgage companies,
Fannie Mae and Freddie Mac. He told Congress: "If you've got a squirt
gun in your pocket, you may have to take it out. If you've got a
bazooka and people know you've got it, you may not have to take
it out." This has been identified as one of the 21
dumbest business moments in 2008. Two months later, both outfits
went bust, and Paulson, on his own authority, nationalized them.
The taxpayers picked up the tab. Michael Pento commented on this
on November 14.
after Secretary Paulson fired his bazooka, those formerly thought
of as "safe" investments are now trading at just pennies a share.
And just last week the government or more appropriately
the taxpayer was forced to throw an additional $7.8 billion
at the GSEs for the last quarter's losses. That was on top of
the $169 billion they have already spent to rescue the black holes
known as Fannie and Freddie since 2008.
then commented on the newly installed head of the ECB: "Similarly,
Draghi now believes that the problem with European debt is fear,
not one of insolvency."
just like Hank, Mario will soon learn that offering to purchase
an unlimited amount of Italian debt does nothing in the way of bringing
down the debt to GDP ratio. In fact, it has the exact opposite effect.
It encourages more profligate spending, just as it also lowers the
growth of the economy by creating inflation. What's even worse is
that yields on Italian debt will reach much higher levels in the
longer term. That's because the purchasers of sovereign debt have
now become aware that their principal will be repaid with a rapidly
depreciating currency. Therefore, the yield they will require in
the future must reflect the decision to use inflation as a means
of paying off debt.
This is the
first bazooka. The joint announcement of the six central banks is
the second. This one tells the world that any rush out of euros
into dollars will take place in an orderly way.
I assume that
Prof. Bernanke understands the #1 principle of chapter 1 of any
college-level economics 1 textbook: "When the price of any scarce
resource falls, more is demanded (other things remaining equal)."
This is described graphically in the famous intersecting S/Q supply
and demand curves.
assumes that the reason why demand increases faster than supply
does is because speculators believe that the price of an asset will
rise. So, they buy it now. In the case of currencies, they sell
one and buy the other.
speculators buy dollars and sell euros? Because they fear a major
event that will threaten the euro as a currency. So far, the price
of dollars in euros has not revealed any such imminent fear.
It is clear
that the central bankers think this lull in the storm is unlikely
to last much longer. So, they hauled out the bazooka.
What are they
aiming at? They did not say. We can figure it out.
banks lose the value of Italy's bonds on their balance sheets, some
of them will face bank runs. This could easily cause a system-wide
banking panic in France. That panic could spread to other nations'
not be allowed by the Powers That Be. They will find some loophole
to bail out the banks. But they would prefer to implement it soon,
before the dominoes start falling.
the public support of Italy is wiser. The Powers That Be don't want
to face an Iceland event. At that point, they would have to save
France's big banks. But the Powers That Be are the big banks. There
will be panic, bank to bank, national banking system to national
banking system. They want to forestall this.
The first bazooka
the ECB saving Italy needs a legal cover. There has
to be an annulment of the treaties. The ECB will be hesitant to
fire the bazooka if it is not given authorization.
What if it
isn't? What if the crisis hits Italy before the annulment can be
codified by some cooperative announcement by the summit an
announcement that the members can get their governments back home
to agree on?
the second bazooka comes in. The FED will supply dollars to the
ECB, which can then sell them to investors fleeing the euro.
Back to economics
1. If you can see that the supply of any asset will run out, and
there is a rush to buy, it will do no good for the sellers to promise
more of the sought-after asset. They will not be believed. The low
price subsidizes skeptics to buy even more. At a lower price, more
So, the central
bankers have to hope that there will not be a panic run out of the
euro into the dollar. They are buying time. They have a deadline:
February, 2013. So, they think that the panic will be short-lived.
A show of force a bazooka may cut it off before it
Note: it didn't
work for Paulson.
assume that a panic will force the hand of the ECB to inflate and
buy either Italian bonds (early) or the debt of the French government
(late), which will lend money to the largest French banks. The second
bazooka is supposed to lend credibility to the first one: the one
the ECB could use to save Italy from default. The ECB's managers
at present are afraid to invoke it. "We are not going to use it."
If the ECB
fails to act fast enough, Italy could cease making payments. A run
on large French banks could begin. That will force the hand of the
ECB. The central banks have handed the ECB lots of bazooka ammunition.
his peers are in panic mode. They are taking steps to deal with
a run out of French banks and maybe out of the euro. They are in
effect subsidizing this run, assuming that the ECB sells dollars
to all buyers who bid. I think the goal is to sell to big banks
only those being hit by runs. They will do this because they
don't think the panic will last beyond January 2013.
We shall see
how much longer Italy continues to make its interest payments. Long-term,
Italy will default. There will be an Iceland event. I think there
will be more than one.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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