The central banks act
by R.A. | WASHINGTON
THE past 24 hours have seen a flurry of action around the world, in response to growing concern about the euro zone's sovereign-debt crisis. The story begins in Europe, where finance ministers meeting to discuss the future of the European Financial Stability Facility seem to have taken some key decisions regarding the fund. The EFSF will be able to lever its meagre €440 billion in capital (less amounts already committed to rescues for Greece, Ireland, and Portugal) in two different ways. First, by using its resources to guarantee 20% to 30% of the bond issues of struggling peripheral economies and, second, by creating "co-investment funds" that (it is hoped) will attract money from other investors and which can be deployed to buy bonds.
The trouble is that the total firepower of the EFSF is likely to fall short of expectations and well short of what will probably be necessary. It may amount to €1 trillion, but that's far too little to manage serious trouble for, say, Italian bonds. The ministers are increasingly eyeing the IMF for assistance, but its capital is also limited; the IMF has under $400 billion available to lend. There are hints that leaders are exploring the idea of channeling loans from the European Central Bank through the IMF, but it isn't clear that this will fly with the ECB's conservative, German contingent. There is an element of collective breath-holding, as everyone waits to see what will emerge from a meeting of euro-zone heads of state on December 9th—quite possibly a make-or-break gathering.
Against the backdrop of these disappointing outcomes and the deteriorating financial situation in Europe, central banks have once more ridden to the rescue. The Federal Reserve, Bank of England, European Central Bank, Bank of Japan, Bank of Canada, and Swiss National Bank announced today their intention to coordinate action to ease liquidity conditions in financial markets. The Fed will increase its dollar lending to other central banks who will do the same to other financial institutions, and all will reduce the cost of dollar borrowing. The aim is to defuse the growing trouble banks have had borrowing to finance their operations.
This action has contributed to a surge in equities, but the move is less significant than it seems. The central banks are extending and expanding programmes that were already available, and the focus is purely on liquidity issues. The underlying dynamics of the euro-zone sovereign debt crisis are unchanged. As we've seen over the past few years, these actions can delay a meltdown but cannot, in the absence of other steps, prevent it altogether. Central banks have effectively provided hydration to a cancer patient; a useful thing to do, but ultimately just a means to buy time.
News elsewhere is more substantively encouraging. China announced definitive steps toward expansionary policy moves today. Its central bank will lower the reserve requirements for banks as of Monday, reversing a long period of increases in reserve requirements and interest rates designed to take the air out of property markets and soaring inflation. With the outlook for exports to Europe cratering, the government seems to be increasingly concerned about the possibility of a hard landing, and interested in picking up the pace of bank lending. Here, too, the message is bittersweet; policy is conducive to faster growth but also signals a fear that the future is looking ever darker.
In America, too, the policy environment is looking a bit better. Republicans appear to be moving to back an extension of a payroll tax cut passed last year, and which is scheduled to expire at the end of 2011. Failure to extend the tax cut would saddle the American economy with a drag on growth equal to roughly 1.5 percentage points of GDP—enough to wipe out much of the economy's underlying growth. Given the increasing headwinds from Europe, America can use all the cushion it can get.
That leaders around the world are behaving with an increasing recognition of the severity of the situation is a good sign. For now, however, the most significant near-term threat to the global economy—the problems of debt and contagion in the euro zone—continues to grow.
The trouble is that the total firepower of the EFSF is likely to fall short of expectations and well short of what will probably be necessary. It may amount to €1 trillion, but that's far too little to manage serious trouble for, say, Italian bonds. The ministers are increasingly eyeing the IMF for assistance, but its capital is also limited; the IMF has under $400 billion available to lend. There are hints that leaders are exploring the idea of channeling loans from the European Central Bank through the IMF, but it isn't clear that this will fly with the ECB's conservative, German contingent. There is an element of collective breath-holding, as everyone waits to see what will emerge from a meeting of euro-zone heads of state on December 9th—quite possibly a make-or-break gathering.
Against the backdrop of these disappointing outcomes and the deteriorating financial situation in Europe, central banks have once more ridden to the rescue. The Federal Reserve, Bank of England, European Central Bank, Bank of Japan, Bank of Canada, and Swiss National Bank announced today their intention to coordinate action to ease liquidity conditions in financial markets. The Fed will increase its dollar lending to other central banks who will do the same to other financial institutions, and all will reduce the cost of dollar borrowing. The aim is to defuse the growing trouble banks have had borrowing to finance their operations.
This action has contributed to a surge in equities, but the move is less significant than it seems. The central banks are extending and expanding programmes that were already available, and the focus is purely on liquidity issues. The underlying dynamics of the euro-zone sovereign debt crisis are unchanged. As we've seen over the past few years, these actions can delay a meltdown but cannot, in the absence of other steps, prevent it altogether. Central banks have effectively provided hydration to a cancer patient; a useful thing to do, but ultimately just a means to buy time.
News elsewhere is more substantively encouraging. China announced definitive steps toward expansionary policy moves today. Its central bank will lower the reserve requirements for banks as of Monday, reversing a long period of increases in reserve requirements and interest rates designed to take the air out of property markets and soaring inflation. With the outlook for exports to Europe cratering, the government seems to be increasingly concerned about the possibility of a hard landing, and interested in picking up the pace of bank lending. Here, too, the message is bittersweet; policy is conducive to faster growth but also signals a fear that the future is looking ever darker.
In America, too, the policy environment is looking a bit better. Republicans appear to be moving to back an extension of a payroll tax cut passed last year, and which is scheduled to expire at the end of 2011. Failure to extend the tax cut would saddle the American economy with a drag on growth equal to roughly 1.5 percentage points of GDP—enough to wipe out much of the economy's underlying growth. Given the increasing headwinds from Europe, America can use all the cushion it can get.
That leaders around the world are behaving with an increasing recognition of the severity of the situation is a good sign. For now, however, the most significant near-term threat to the global economy—the problems of debt and contagion in the euro zone—continues to grow.
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