Saturday, 2 June 2012

Fed May Use More Than Swaps To Save Europe

The European Central Bank isn't as powerful as the Fed.  Legal restraints and the absence of a true federal union mean the ECB has fewer tools to manage monetary policy and cannot facilitate inflation as a solution to sovereign indebtedness (or at least cannot do so as easily and rapidly as the Fed).  That's why the ECB's president is now urgently calling for political actors to provide policy and fiscal solutions to Europe's debt crisis. They won't help, of course, with Greece and now Spain ready to fall into the abyss of sovereign default. 

The Fed is waiting in the wings to supply the liquidity backstop that the ECB cannot provide.  Readers are welcome to do homework on the $16T worth of dollar swap lines the Fed activated during the first round of this crisis.  I would not be surprised if those swap lines have been multiplied several times over.  Hyperinflation in the U.S. and Europe has not yet occurred because all of that magic Fed juice has not leaked out into wages; it has remained locked inside commercial banks' balance sheets. 


I am not sanguine enough to presume that this condition will hold throughout the remainder of this crisis.  Transmission mechanisms are all that is necessary; a politically popular push for home mortgage relief with direct six-figure gifts to bankrupt Americans or Europeans would start the boulder rolling downhill. 


In other words, more gigantic dollar swaps increase the risk of the hyperinflationary genie being let out of the bottle.  Using even more creative Fed tools - like direct loans to troubled European banks to prevent them from collapsing - raises the risk even further.  


Source: http://alfidicapitalblog.blogspot.co.nz/2012/06/fed-may-use-more-than-swaps-to-save.html

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