Thursday, 1 December 2011

Bernanke Locks Down Sarajevo

On Monday someone asked me the right question: 'So just how does it end?'. And, being the right question, I was stuck for an answer. 'I don't know, but eventually Princip will run into the Archduke.'

Most of you will know the reference: it was Gavrilo Princip's assassination of Archduke Ferdinand of Austria in Sarajevo in 1914 which triggered the explosive set of mutually-dependent alliances and relationships and tumbled Europe into all-consuming war. Could it have been otherwise? Hefty precautions had been made in Sarajevo for the visiting Archduke's visit, and an 'official' attempt on his life by Princip's co-conspirators had failed in the day, when the thrown bomb bounced off the his car's bonnet). Shaken but alive, the Archduke later abandoned his schedule in order to visit the bomb's survivors. On the way there, fatefully, his driver took a wrong turning, delivering the Archduke to the street where Princip was resting up in a deli, recovering his nerves. Whilst the Archduke's driver realized his mistake, Princip realized his date with destiny. How unlucky was that? Despite everything, the Archduke met his Princip.

My reading of yesterday's announcement of a coordinated commitment to abundant dollar-funding is the equivalent of Ben Bernanke putting Sarajevo on lock-down. The end of the Euro won't be triggered by a lack of dollar liquidity at Eurozone banks – at least not on Bernanke's watch. The Archduke may yet meet his Princip, but it won't be right here, right now. Hence the globally-coordinated cutting of interest rates by 50bps on dollar liquidity swaps by the Fed and the central banks of England, Japan, Switzerland, the Eurozone and Canada.

Actually, though, as I've been tracking for months now, foreign banks' US$ positions are probably the least of their very considerable worries. The latest data from the Fed shows that foreign banks operating in the US have built up a net dollar asset position of US$265 bn directly attributable to loans or deposits from their related foreign offices – and this represents a net improvement of US$672 bn during the last 12 months. In London too Eurozone banks have been careful to ensure they're running net long positions in both sterling (in September they had a net sterling asset position of £1.7bn, reversing a net £32.7bn short sterling position in Sept 2010), and in other fx (a net long position of £21.95bn, reversing a net short of £21.28bn in Sept 2010).

At a consolidated level, the Eurozone's banks look in good shape in terms of their external balances: they report a net external asset position of Eu905.2 bn at end-October.

But balance sheets are one thing, liquidity mismatches another. What matters is the pace at which these banks' fx liabilities are shrinking. And here the picture is sobering. Even at a consolidated level, gross external liabilities owed by Eurozone banks are down 7.3% YoY in October, having contracted by Eu327bn during the previous 12 months, of which the majority has left during the last six months. Over in New York, the deposit base of all foreign banks has contracted by US$182bn over the last year – that's a fall of 17.2%. In London, Eurozone banks have seen their foreign currency deposits fall by 12.6%, or by £124bn, in the year to September – and since their Euro deposits fell by only 5% during that period, we can be pretty certain it's the dollars that have left.

Remember, deposits are meant to be the 'sticky' part of a bank's liabilities. If they are leaving, one shudders to imagine how quickly other more mobile foreign liabilities are leaving.

Since we have established that these banks also have net long dollar positions, the central banks' cheap liquidity swaps should provide a way of presenting that rout as orderly, buying time to wind down the dollar assets without triggering economic meltdown.

As for its contribution to defusing the Euro Doomsday Machine – it does nothing for that.

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