Global markets surged higher this morning after news broke that the world’s central banks will work together to increase global liquidity. The players in this game are the Federal Reserve, the European Central Bank, the Bank of Japan, Bank of England, Bank of Canada and the Bank of Switzerland. They plan to accomplish this goal by lowering interest rates on dollar swap lines by 50 BPS. This was necessary due to the freeze in lending that was occurring in the European financial system. The news of this action sent the euro skyrocketing against the dollar.
This coordinated action represents a significant commitment to the solvency of the world’s money markets. It is a preemptive strike that will hopefully restore confidence in Europe’s financial system. What worries me is that the central banks felt that things had deteriorated to such a level that this action was necessary. Apparently, these large European banks had stopped lending to each other. Without a major move to unfreeze the credit there could have been serious repercussions for the system as a whole. This is eerily similar to the situation that the United States' financial institutions faced in 2007 and 2008. However, instead of a collapsing subprime mortgage market bringing banks to the brink, this time it is sovereign debt. Clearly the situation in Europe has reached a level where the central banks of the world felt obligated to intervene.
As big as this news is it still does not get to the heart of the problem. This action is simply treating the symptoms of the original disease. The fact remains that many of Europe’s banks are carrying a tremendous amount of rapidly deteriorating sovereign debt. There is still the problem of the fiscally conservative Germans and their unwillingness to bailout other irresponsible members of the eurozone. The German tax payer is not willing to loosen the purse strings without some measure of fiscal oversight, nor should they. At its core this is a clash of different cultures that have chosen to live together under one roof. I am of the opinion that in five years the eurozone will look almost unrecognizable in comparison with how it is today. That is if it even exists at all.
This is an extremely dangerous situation for European banks. Coordinated action of this magnitude is in my opinion bigger news than the action itself. It gives us some insight into the minds of the central bankers around the world and their lack of confidence in the European financial system. Jim Cramer on CNBC this morning referred to this as an “Economic D-Day” and implied that there may have been a major European bank on the verge of failure in order to bring about this type of action.
What does this tell us about the health of the system? The central bankers of the world must have felt that a run on the banks was actually plausible.
How do we as individual investors react to this type of news? I am reminded of a widely held maxim that you “can’t fight the Fed." If this is true, then it can’t be very practical to fight all the central banks at the same time. I agree with this principal in the near term. It is my opinion that the coordinated action by central bankers and the improving economic data coming out of the U.S. could push the markets into some type of Christmas rally to end the year. However, on a longer time line I am extremely bearish about the prospects of the European system and the ramifications that it holds for global economies including the United States.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.