In a sign that the U.S. and European Union are serious about resolving the ongoing debt crisis in the euro zone, the central banks of five countries, including the European Central Bank, the Bank of England, Bank of Japan, Bank of Canada and the Swiss National Bank, announced a plan to infuse banks across the E.U. with fresh capital. The move comes in an effort to assure financial markets that the debt crisis is being taken seriously and policies are being developed to resolve it.
The announcement comes on the heels of global financial markets being battered in the last two weeks as investor confidence has withered in the face of the ongoing debt crisis, as well as the inability of governments to take swift action to alleviate it. The move by the central banks is supposed to reduce the cost of a program under which banks in foreign countries can borrow money from their own central banks by about 40 percent, with much of the money coming from the Federal Reserve Bank in the U.S. This is supposed to infuse banks with fresh capital and shore up their liquidity in the hopes that they will begin lending again.
The news led to today’s rally on Wall Street, one of the biggest yet, with the three main indexes rising 4 percent or more, representing the largest gain since March 2009. Stock markets across followed favorably with exchanges in London, Paris, Berlin, and Euro Stoxx rising from 3 to 5 percent.
However, the rally will be short lived, as they have proven to be in the past. Although investor confidence depends heavily on the perception that governments are taking strong action to deal with avalanche of debt arising from a slowing global economy and shrinking tax revenues, the underlying reality is that the fundamentals of the global economy are not sound. There is too much money controlled by two few private actors, particularly large hedge funds and other investment banks, that can be moved around too quickly, thanks in large part to financial deregulation and advanced communications technology. Moreover, there is too little democratic accountability, particularly in the U.S., which has deregulated banks, insurance carriers, and other financial institutions to the point where the fraud and theft of “complex financial instruments” are legal grey areas.
Plagued by serious unemployment both the U.S. and E.U. cannot jump-start their economies even if the debt crisis is resolved favorably. Assume banks achieve stability and return some of their liquidity to businesses and consumers in the form of loans. Very few companies will enact aggressive expansion strategies that require hiring new workers, and banks will not lend to consumers without jobs. Thus, even if the debt crisis is resolved, there is no guarantee that the labor market will improve, leaving governments in the lurch as revenues from taxes remain stagnant and requiring them to make further cuts in entitlement programs that exist to help citizens beset by difficult financial times.
This catch-22 is not lost on investors, who more than once in the last few years, have rallied markets on some slim piece of good news like the announcement made today by central banks, only to have their hopes dashed the next day by a slim piece of bad news, for example, that jobless claims are up. The surge in markets today is therefore not “good” news in the sense that it does not guarantee that the so-called “jobless recovery” is actually underway.