Because the eurozone's precarious financial situation has become an intolerable strain on world economies, several of the major banks have decided to step in and do something about it.
“This was in response to increased tension in global financial markets,” Bank of Japan (8301) Governor Masaaki Shirakawa said at a press conference in Tokyo today. “Coordinated action will give markets a sense of security.”
In an effort to help the EU, the Federal Reserve decided Wednesday to make it cheaper for world banks to borrow U.S. dollars.
“The Fed -- along with central banks of the eurozone, England, Japan, Switzerland and Canada -- announced a coordinated plan to lower prices on dollar liquidity swaps beginning on Dec. 5, and extending these swap arrangements to Feb. 1, 2013,” reports CNN Money.
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Overall, these efforts are meant to "ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity," the Federal Reserve said in a press release.
“It’s a step in the right direction,” said Jay Bryson, global economist with Wells Fargo Securities, in a recent Bloomberg report. “It doesn’t solve the problem in Europe, but to the extent that European banks are having trouble raising dollar funding, it makes it easier and less costly for these banks to borrow dollars.”
In response to the announcement that world banks would make a concerted effort to assist the EU, markets surged:
“Together, the six central banks also created a temporary mechanism, making it easier for them to exchange their foreign currencies -- not just U.S. dollars,” writes CNN. “That tool gives any of these central banks easier access to euros, Japanese yen, British pounds, Swiss francs and Canadian dollars should they need those currencies to assist their region's banks in the event of a crisis.”
The theory is that these “liquidity facilities” will come to the aid of Europe's debt crisis if, for example, things get to the point where foreign banks will have to step in to fund normal business transactions.
"These swap lines are being implemented as a contingency measure, so that central banks can offer liquidity in foreign currencies if market conditions warrant such actions," the Federal Reserve said in a Q&A about the plan.
CNN Money reports:
Since May, the cost for European banks to borrow dollars from other European banks has been enormous. Through central bank auctions announced in September, these banks can borrow dollars at reduced interest rates, for periods of three months.
This is meant to lower the cost of short-term borrowing for troubled European banks, as well as give them immediate access to dollars. Today's actions continue that plan and further reduce borrowing costs.
Rest assured, the Fed promises that the U.S. taxpayer won't be on the hook is eurozone banks fail.
"The European Central Bank is the one actually making the loans, so the Fed is not on the hook if a European bank fails," said Paul Ashworth, chief U.S. economist with Capital Economics.
At the same the Fed made its announcement, the People's Bank of China announced that it planed to increase liquidity by "lowering its reserve requirement ratio for financial institutions by half a percentage point."
“Two hours before the Fed announcement, China cut the amount of cash that the nation’s banks must set aside as reserves for the first time since 2008,” Bloomberg reports. “The level for the biggest lenders falls to 21 percent from a record 21.5 percent, based on past statements.”