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Much Ado About Nothing

December 1, 2011 Leave a comment

There was a lot of noise, yesterday, about the main central banks’  decision to coordinate in maximizing liquidity provision (in dollars) to households and firms. An excellent and clear explanation of what they exactly did can be found here.

Are we effectively at a turning point? I am afraid not, for essentially two reasons:

  • The first is that, after an initial moment of euphoria, markets may realize what really happened, i.e. that central banks are preparing for a major Lehman-like event: If the euro breaks down, and if investors flee from it, central banks are ready to act to avoid contagion. This is reassuring, but it also informs us that the main monetary authorities of the planet are seriously considering the possibility of such an event occurring.
  • Second, this move, per se,  does nothing to address the main source of the problem: the lack of  proper Eurozone governance, and the unwillingness of the ECB to act as a lender/buyer of last resort. Major changes on these issues would be a turning point, reducing the risk of a euro crisis, and hence making liquidity in dollars unnecessary.

A safe bet: Financial market euphoria will be short-lived.