Another Day, Another Dollar Easing

Another day, another dollar Band-Aid. Today we have more monetary merrymaking by the central banks, in which billions (trillions?) of "liquidity" is added to the system by the printing of mostly US dollars. Markets around the globe rally. But what does this really mean? It means the situation is scarier than you can even imagine.

This morning, the US Federal Reserve lowered the cost of emergency dollar funding for European banks. The interest rate has been reduced to the dollar overnight index swap rate plus 50 basis points, or half a percentage point, from 100 basis points, and the program was extended to February 1, 2013, the Fed explained in a press release. The Fed will coordinate with global central banks, including the Bank of England and the Bank of Japan, to push these cheap dollars out around the world. Global equity and commodities markets are up across the board anywhere from 2% to 4%.

I know what you are thinking: How does this help you? It doesn't. It only helps if you are a bank. And that's the point. Weighed by the crisis in Europe, many banks in Europe have been strapped for overnight cash, specifically dollars, and this helps alleviate what have become a daily funding crises.

Massive "coordinated interventions" such as this are becoming a fact of life in our markets, and that's what depresses me. I remember when the market used to move on economic fundamentals, but now it moves on the basis of the latest press release from a central bank. In fact, we had another coordinated intervention as recently as September. (See: Central Banks Deliver Global Dollar Band-Aid.) Remember that? In that action, dollar-swap lines were opened up around the world, loosening up the availability of dollars.

These actions have become a pattern since 2008, if you haven't noticed -- just when things look like they are falling off a cliff, the Fed prints money. But think of how it has worked. Did it fix the housing market? Did it fix Greece? The answers to both questions are no, because dollar-swap operations are nothing more than short-term loans, and short-term loans cannot fix structural problems in an economy. In other words, if Greece is broke, lending it money for a few months ain't gonna help. If the housing market is broken, you need to wait for inventory and pricing to clear, regardless of how much money you're ready to lend. If Italy needs to reduce its debt and manage its spending, giving it a low-cost loan for a few months does not do fix the problem.

I expect this rally to last a day or two before reality starts creeping back -- and people remember the European banks are still in big trouble because of the bad assets on their books. That's exactly why this action came now. You see, recent measures of dollar "liquidity" -- that is, the ability for Europeans to find funding in dollars -- has been very tight. That's because in the real market, nobody wants to lend to them. They are nervous they will go bust, just as everybody in 2008 didn't want to lend to Lehman Brothers.

Now, a central bank has a defined role as the "lender of last resort." When nobody else is willing to put up money in a system that is stuck, the central banks step it. In the past, this has worked great for sporadic, manageable crises. The only problem with this is that if there are banking crises popping up every days like wildfires in a tinder-dry forest, the central banks must act regularly to prop things up. That appears to be the situation we're in now.

The bottom line is a bunch of dollars flooding the market is not going to fix the European situation, because that's a short-term fix to a long-term problem of over-indebtedness. The trillions of dollars in bad debt still must be addressed.