Central Banks Inject $112bn into Financial Markets to Restore Trust

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“Central bankers of the world, unite!”

Karl Marx didn’t actually write that. Marx died in 1883, many years before modern central banking became the credit-dealing kingpin that it’s become today. But his famous quotation captures the spirit of yesterday’s action by five central banks.

Five big central banks combined their powers to announce a US$112 billion dollar injection of liquidity into global financial markets. The Fed chipped in US$40 billion. The Bank of England anted up for US$46.4. The European Central Bank is in for US$20 billion, while the Swiss National Bank offered US$4 billion and the Bank of Canada US$3 billion.

Think of these bankers as manufacturers. Only their product is money. The credit crunch has damaged confidence in that product. In order to restore confidence and get people to use more of the product, the bankers are putting the money on sale. Everything must go! Act now while supplies last…or we’ll make more!

What really is going on? There’s a bear market in trust. This coordinated policy announcement is designed to restore trust by attacking…something. “This is shock and awe,” Lehman Brothers (NYSE:LEH) fixed-income strategist Fred Goodwin told Bloomberg. “The fact that it’s coordinated means they have joined together in the war to attack the problem, which is that banks don’t trust each other.”

Of course bankers don’t trust one another. They know how the whole game works. And they know that right now, lending to one another is a bad risk. Or, as Bank of Canada Governor David Dodge said, “The interbank market isn’t working very well, and when the interbank market doesn’t work very well globally, this creates some problems…It’s part of our normal role as central banks to try to, if you will, unblock that.”

Is he trying to say the credit market is constipated?

Stock markets at first cheered the news that the credit markets might become “unblocked”. “News that global central banks are pledging liquidity was a positive for the market early in the trading day, but, upon further reflection, some might be pondering if it’s really a solution, or further evidence of just how deeply embedded the problems in the financial system have become,” Frederic Ruffy at Optionetics told Bloomberg.

Upon further review, stocks were not convinced. The Dow opened up early, but fell over 300 points from its intraday high before finally settling on a modest gain for the day. It looks like the central bankers are going to have to try something else to get stock market on their side.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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  1. The Central Bank Rhyme of 1927 and 2007

    “What we haven’t really had yet, outside China, is a traditional end-of-cycle rally in equity that takes us beyond the atmosphere to the edge of space. I believe we will manage that within the next 18 months, before most people in Wall Street and the City have to move on to organic farming, bartending, or their parents’ spare room” (John Dizard quoted by Dan Denning, New Money Supply Provides Catalyst for Rising Stock Prices, dailyreckoning.com.au, October 30, 2007).

    In formulating the stockmarket component of the Future Watch Anglo-American Hegemonic Cycle a “global crisis” was identified as an indicator to the final/mania stage of a stockmarket cycle.

    For instance the potential international crisis (war) in September 1822 when England discovered that the French were moving into Spain to support the ‘royalist’ against the ‘liberals’ in the Spanish Civil War 1820-23 was, arguably, the indicator for the start mania stage of the boom up to 1825.

    This is the lead to the Central Bank Rhyme of 1927-2007.

    Scott Lanman of Bloomberg had this to say about the recent Cental Bank intervention:

    “The Federal Reserve, European Central Bank and three other central banks moved in concert to alleviate a credit squeeze threatening global growth, in the biggest act of international economic cooperation since the Sept. 11 terrorist attacks…

    “”By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity,” the Fed statement said” (Fed, ECB, Central Banks Work to Ease Credit Crunch bloomberg.com, December 12, 2007).

    But it was the “European” aspect to the response, reported in an AFP article, that is of interest:

    “Robert Brusca at FAO Economics said the plan appears aimed at addressing the cash squeeze facing European banks after the collapse of the US commercial paper market – short-term loans that may be backed by European banks.

    “”It’s an attempt to get dollar liquidity to European banks that were caught short when the US commercial paper market collapsed,” Brusca said.

    “”This should help (ease the credit crunch) if the nature of the problem in Europe is a shortage of US dollars,” he added. “Banks will be able to get liquidity if this facility is big enough”” (Fed other central banks in joint effort to ease credit squeeze, @smh.com.au, December 13, 2007).

    The three key points from above are (1) potential global crisis; (2) Central Bank intervention; and (3) the intervention provided American assistance to Europe. This leads into the 1927 “crisis”.

    A quote from Robert Sobel rhymes the above with 1927:

    “Winston Churchill was Chancellor of the Exchequer in 1925. Eager for Britain to once again to assume world leadership, and viewing the pound sterling as a symbol of Britain’s greatness, he insisted on returning the pound to its prewar relationship to the dollar and gold. In that year the pound as pegged at $4.86.

    “The rate was unreasonable, and had the effect of pricing many British goods out of the world market. A flight from the pound to the dollar began at once, as Britain had its first of several financial crises in 1925. Indeed, gold from all parts of Europe came to America in great quantities in the next two years.

    “Had the situation continued, most European nations would have had to leave the gold standard. Given the complexities of the reparations situation, the United States would be dragged down with them in a major financial crisis. Accordingly, Secretary of the Treasury Andrew Mellon and Benjamin Strong eagerly accepted initiations from European central bankers too a conference on the question. In 1927 Montague Norman of the Bank of England, Hjalmar Schacht of the Reichsbank, and Charles Rist of the Bank of France met with their American counterparts. The situation might well be saved, the argued, if the Federal Reserve cut its discount rate. Such an action would lower American interest rates in relation to those in Europe, and therefore attract funds to European banks. At the same time, low rates would encourage borrowing in America and stoke the speculative furnaces. Strong was unhappy about the latter probability, but in the end proved willing to further stimulate an already active American economy in order to save international liquidity. In 1927, the Federal Reserve lowered its discount rate from 4 to 3½ percent.

    “Wall Street greeted the lowered rate… Thus, the international situation was resolved in such a way as to encourage speculation on Wall Street” (Panic on Wall Street, New York: Macmillian, 1968), pp.360-61).

    “There was a vigorous cyclical recovery after the trough in mid-1924, accompanied by a real estate boom that leveled off in 1926 and the beginning of a stockmarket boom. Towards the end of 1926, moderate restraining measures were taken before the cyclical peak which occurred in October 1926. The subsequent contraction was mild. Not long before the cyclical trough in November 1927, easing measures were taken. The buying rate on banker’s acceptances was reduced ¼ of 1 percentage point from July to August 1927, and the System’s bill holdings rose by $200 million; the discount rate was reduced by all Banks from 4 to 3½ between July and September 1927; and open market purchases of government securities totaling $340 million were made between late June and the middle of November 1927…” (Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960, Princeton: Princeton University Press, 1963, p. 288).

    I would like to add more but I do not have the time. But will go out on a limb and speculate that a crash will occur, after a stockmarket rally, during the Huckabee Republican Administration.

    * US – presidential election ’08, inthenews.co.uk, December 11, 2007:

    This election season marks the first time since 1928 that neither an incumbent president nor vice president has run for their party’s nomination.

    John

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