On Wednesday, the Bank of Canada, Bank of England, Bank of Japan, European Central Bank, Federal Reserve, and the Swiss National Bank announced coordinated actions to shore up international banks. The purpose is to ease pressure on European mega banks which are in increasing danger of insolvency due to the sovereign debt crisis in Europe, are heavily short the dollar, via various mechanisms, and must now incur big interest costs in funding dollar-denominated assets.
The central bankers agreed to lower the price of existing U.S. dollar liquidity swap arrangements. Even before the recent action, the ECB and other central banks, were offered as many dollars as their banks would borrow. But the cost was higher. The potential size of the swaps are unlimited, as the Fed has agreed to supply as many dollars as its peers request. The Federal Reserve, of course, does not have an unlimited number of dollars currently available. Its books are evenly balanced between assets and liabilities. It is not talking about selling assets to pay for these swap lines. To supply the dollars, the Fed must print them without limit.
The cost of dollar loans is being reduced by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points. That compares with the previous arrangements, whereby it was OIS plus 100 basis points. By making ECB dollar funding much cheaper than dollar funding from the free market, the hope is that solvent Euro-banks will also start using lines of credit from the ECB. This would serve to reduce the stigma of insolvency currently arising out of accessing central bank swap facilities. The pricing will be effective from December 5, 2011.
Investors can be relatively sure that, if and when a lot of European banks borrow dollars through these swap lines, the newly printed cash will plump up the value of stocks. More accurately, the money will stop the stock market from falling as deeply as otherwise. It might even cause a Santa Claus rally. But, assuming the eurozone does not implode, banks will eventually begin to pay back this money, That will cause liquidity contraction. The Fed cannot tolerate this because its masters have a business model that requires inflation. So it will engage in quantitative easing, converting "temporary liquidity" into a permanent part of the system.
The actions of the Federal Reserve will insure another permanent and major devaluation of the American dollar, similar to that of 2009. American buying power will be reduced, and retirees and others on a fixed income will, as in the past, be the people most severely impacted. That is because money printing is, in the end, an orchestrated theft from persons with savings, and/or bonds denominated in the currency being printed. But, there is an even greater risk.
Fed Chairman Ben Bernanke says this type of lending between central banks is "risk-free". He alleges that the loans are to the other central banks, not to the commercial banks in foreign countries who might default. Therefore, according to him, it is impossible for the Federal Reserve to lose money, because it is impossible for the loans not to be paid back. In this view, only the ECB has counter-party risk, because it is the entity to which the commercial banks owe dollars.
Bernanke's claim of risk-free lending between central banks, however, is false. Aside from debasement risk, the opposite risk is even greater. There is a very real risk that the ECB will never pay back the swap lines. In other words, the eurozone may end, and with it, the ECB is likely to cease to exist. If the ECB no longer exists, there is no counter-party to pay. A big export oriented nation, like Germany, with a strong Mark, may have no trouble. But, how about a nation like Greece, Italy, Spain, et. al.? Many new national central banks may not be able or willing to repay.
In the event of a Euro collapse, it may take years for the Federal Reserve to collect. It may be forced to forgive loans. That means the American people, who ultimately "fund" the Fed, with their work and assets, will suffer deep losses. Writing off hundreds of billions or trillions of dollars would usher in an era of heavy deflation. But again, the casino bankers that control the Fed cannot tolerate long-term deflation. They will make sure that more money is printed.
Providing unlimited US dollars to the ECB is yet another mistake by a group of "economists" who do not understand economics. Too bad Bernanke and his cronies never read Ludwig Von Mises. If they did, they would know that a bust brought on by the collapse of credit expansion cannot be undone, except by the destruction of the currency system involved. The Federal Reserve has, yet again, put America at great risk. The fate of the dollar is now tied tightly to that of the Euro. God forbid the Euro should die alone. If and when the eurozone collapses, the dollar will go with it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.