Central Banks in Liquidity Action…Not Solvency Action

Here we go again!

The central banks acted yesterday and the markets went wild! Six central banks acted in concert to make sure that European banks…and others…could get dollars if they wanted them.

This is a liquidity action!

It is an act to keep the flow of short-term funds flowing in world financial markets…just as these six central banks did after the Lehman Brothers failure.

Once again, the definition of a liquidity crisis is that there is a short term need for “buyers” in a market because, for the short term, the “buyers” that are usually there are not there. The “sellers” want to sell assets and obtain dollars.

“Buyers” without dollars are not what is wanted. So the central banks are making sure that there are plenty of dollars available so that the “sellers” can sell their assets.

The emphasis, however, should be on the short-term nature of a “liquidity” crisis.

The fundamental problem is still the solvency problem facing several of the sovereign nations of Europe. (See my post from yesterday, “European Debt Must Be Restructured”)

Providing liquidity to the market will not resolve the solvency problem. As almost everyone except the officials in Europe know, the efforts of the last two years or so to treat European debt problems as a “liquidity” issue has resulted in the situation we now find ourselves in.

As in the past, central bank action has gotten a favorable response from stock markets around the world. In the past, the quick, dramatic response to the central bank action has been followed by a retreat. If nothing is done on the sovereign debt restructuring need, the stock markets will, in all likelihood, retreat once again.

The word out is that this liquidity action on the part of the central banks gives the officials in Europe some time to deal with the restructuring.

But, the restructuring is also only a short-term response for eventually the eurozone must deal with the whole question of how the fiscal affairs of the eurozone will be handled. The concern is that restructuring of the debt without reforming how the nations of the eurozone discipline their fiscal affairs just creates a situation in which fiscal irresponsibility can survive into the future.

Revising how the eurozone conducts its fiscal affairs, however, cannot be done overnight. Yet, the financial markets must be given some kind of credible assurances that fiscal discipline will be forthcoming before they will really settle down.

This seems to be the unknown…for the single currency framework will not last without the eurozone achieving some kind of fiscal unity. Is this what Germany is holding out for?

So, is the problem going to be resolved now…or, are we just going through another cycle?

I still am not convinced that the Europeans, at this stage, possess the backbone to do what is necessary!

Oh, and once all these dollars get out into world markets…will they be withdrawn once the “liquidity” crisis is over?

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About John Mason 79 Articles

Professional history: Banking--President and CEO of two publically traded financial institutions; Executive Vice President and CFO of another. Academic--Professor at Penn State University and at the Finance Department, Wharton School, University of Pennsylvania. Government--Special Assistant to Secretary George Romney at Department of Housing and Urban Development; Senior Economist in Federal Reserve System. Entrepreneurial--work in venture capital and other private equity; work with young entrepreneurs in urban environment.

Visit: Mase: Economics and Finance

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