Sunday, May 9, 2010

Euro Crisis: US Federal Reserve to the Rescue?

I have no basis for this, to make it clear up front. Just my hunch.

As EU ministers (particularly of those 16 countries that uses Euro as their currency) try to come up with a grand plan (nuclear, bazooka, whatever) to "stabilize" the Euro before the Asian markets open for trading, people are speculating what kind of plan it will be, given the lack of details.

One speculation (or rumor) says this "stabilization" plan may include more than 600 billion Euro bonds issued by the European Commission to fund basically a bailout fund for European banks who holds underwater sovereign bonds. (See this Reuter's article that says "Euro zone sources said late on Friday that the mechanism could be funded by bonds issued by the European Commission with guarantees from euro zone states.")

My question is: Where will the money come from to buy the EC bonds? Who is going to buy them?

My hunch is the US Federal Reserve. There's a chatter about the Federal Reserve re-opening the liquidity swap lines with the ECB. At the height of the credit crisis in 2008/2009, the Fed's liquidity swap lines with foreign central banks swelled to over $600 billion.

The Fed could either extend the swap lines so that the ECB, Bank of England, and other central banks in Europe could buy these bonds, or so that they could funnel the money from the Fed to their financial institutions who would then buy the bonds with that money. I wouldn't be surprised if the Fed directly buys such bonds.

Otherwise, the money to buy these bonds would have to come from the EU member countries' savings. Talk about misallocation of capital. Instead of these capitals deployed for productive means and investments, they would have to fund the "stabilization" mechanism, a sink hole, to prop up the financial institutions.

Just so that you know, the US Treasury has raised $200 billion for the Federal Reserve since late February under the Supplementary Financing Program (SFP), which allows the Fed to use the money raised any way it sees fit to help stabilize the financial markets.

Do you see a depression coming?

If the funding of the mechanism comes from the savings of the member countries, they will (and the world will, probably) get a deflationary depression. If it comes from the Fed's printing press (or the ECB's), it will be an inflationary depression.

Take your pick. We will know soon enough. Maybe as soon as a few hours from now.


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