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Fed action won't stave off threats to euro or global economy

November 30, 2011 |  9:38 am

GetprevThe coordinated action by the Federal Reserve and five other major central banks will help dollar-strapped European banks, but analysts said it doesn’t address the fundamental problems threatening the breakup of the euro and the global economy.

The Fed, with the European Central Bank, the Bank of Japan and three others, jointly announced Wednesday that they would offer cheaper access to dollars in an attempt to quell growing fears of a global funding crunch.

The Fed said the move, which expands on a joint effort by the central banks first announced in September, was intended to "ease strains in financial markets" and mitigate the resulting effects of a credit squeeze for businesses and households.

The announcement gave an immediate huge lift to European markets, and U.S. stocks surged. The euro rose against the dollar.

The markets also got a boost by a separate announcement by the People’s Bank of China, which announced a plan to inject more cash into its economy by lowering bank reserve requirements by half a percentage point. It was Beijing’s first monetary easing in three years and comes amid signs of economic slowing in the world's second-largest economy.

The Fed and other central banks’ action lowers the cost of so-called dollar swap lines by a half-percentage point, a move that would likely increase the flow of cash to European lenders. The new pricing would take effect next Monday.

As the debt crisis has intensified, European banks have seen a dwindling of dollar funding as vital sources such as U.S. money market funds have been reducing their exposure to the continent’s lenders.

“The open market used to be a cheap source of obtaining dollar funding by European banks, but this is becoming more economically unviable,” said Enam Ahmed, senior economist at Moody’s Analytics in London. “Banks are responding by reducing their dollar assets in a bid to raise dollar funds,” which has resulted in increasing evidence that European banks are pulling back from dollar-funded projects around the globe and raising the risk of a credit crunch.

“This action would reduce some of the strains in the global financial system,” he said.

Yet whatever the immediate market impact, Ahmed and other experts said the central banks’ action doesn’t alter the fundamental debt problems threatening the breakup of the euro and the global economy.

Concerns about high debt levels and poor economic growth in the region have pushed up borrowing costs to unsustainably high levels in Italy and Spain and have begun to pinch Belgium and even France, the Eurozone’s second-biggest economy.

European leaders are trying to agree on how to unify the Eurozone more tightly on budgets and economic policies to reassure financial markets that they’ll be able to bring down large deficits and prevent the debt contagion from spreading. Greece, Ireland and Portugal already have sought bailouts, but Italy is seen as too large a country to rescue given the current rescue fund.      

The central banks’ coordinated action “reflects an ongoing healthy relationship –- or stewardship –- between major central banks,” said Jacob Kirkegaard, research fellow at the Peterson Institute for International Economics in Washington.

“They’ve learned quite a few lessons from what happened after Lehman Brothers,” he said, referring to the 2008 collapse of the investment bank that was a big factor in the global credit markets freeze.

But, he added, “this is not a bazooka. It doesn’t reduce the borrowing costs of periphery countries. It’s helpful but not a game changer.”

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-- Don Lee

Photo: Vehicles pass the U.S. Federal Reserve building in Washington. Credit: Bloomberg News

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