Wednesday, November 30, 2011

Hurrah! The Fed To The Rescue - Again

Stocks rallied sharply today on the back of a coordinated intervention by the world's central banks, led by the U.S. Federal Reserve.

Market rumors suggest that at least one major bank in Europe was on the verge of failing due to not being able to secure funding.

This would not be surprising: across the globe, financial institutions including American money market funds and Asian pooled investment vehicles have been rapidly reducing their European financial exposure.

It is also apparently consensus opinion among the world's financial leaders that letting Lehman Brothers go under in September 2008 was a mistake.

Today's move puts government money behind this view.

The larger question, of course, is whether this intervention is simply buying time, or whether there is a larger, more comprehensive solution to the euro crisis in the wings.

At the same time, all of these hundreds of billions being tossed around the world is beginning to make me just a little uneasy about how dominant a role that central banks have become in the global economy.

Today's move, for example, effectively inserts our central bank into the midst of the euro zone crisis. Is that really part of the Federal Reserve charter?

Oh, and I understand the argument that says that money is truly a global commodity, and that the Fed is acting to protect US interests.

Still, the real reason the Fed and company needed to act was the refusal of the German government to take any action. And it is not clear that today's actions are doing anything more than delaying a Day of Reckoning for the euro zone.

The United States went off the gold standard* in 1971. President Nixon was desperately trying to figure out a way to frustrate the currency markets, which he believed was unfairly attacking the dollar. Nixon was initially successful, as the dollar rallied, but inevitably economic fundamentals won the day, and the dollar has steadily declined over the next few decades.

Fast forward 40 years. Today we think nothing of literally trillions of dollars being created by central banks around the world that stave off credit market dislocations. Ben Bernanke might be one of the smartest people to ever head a central bank, but the numbers have become staggering.

I don't know how this all resolves itself. Worries that massive injections of liquidity being added to the system will lead to inflation have to date been unfounded. The money has to come back out of the system but until the twin reasons behind our financial system woes are addressed - the American housing market, and the rapidly weakening state of European sovereign debt - it seems more likely that we will see more central bank interventions in the months ahead.

*As I have written numerous times on this blog, I am most decided not a huge fan of investing in gold. On the other hand, having a gold standard definitely created a brake on government actions.