The credit crisis puzzle

The credit crisis puzzle

Good morning and welcome to today’s foreign exchange market commentary on Thursday, the 13th of December.

It is widely agreed that excessive bank lending caused the 2008-2009 financial crisis. Also the banks’ refusal to lend adequately now due to broken balance sheets is slowing down the recovery. A typical theory, made popular by the Austrian school of economics goes like this; banks typically lend more money to the borrowers than savers would otherwise agree to lend in the run up to a crisis, thanks to accommodative policies of central banks, particularly the US Federal Reserve. Commercial banks, flush with funds from central banks, make loans to many unsound projects that is supported by an explosive growth in innovative products, especially derivative instruments, feeding the frenzy.

The debt pyramid, or the inverted version of it rather, collapsed once the Fed applied brakes on cheap interest rates and raised the Federal Funds Rate (FFR) from 1 percent in 2004 to 5.25 percent in 2006 and held it there till August 2007. As housing prices collapsed, a huge number of zombie banks emerged whose assets had fallen far below the liabilities.

Restarting bank lending seems to be the new problem now. To repair the impaired banks, vast bailouts in the US and Europe has been arranged. Central banks have run several rounds of quantitative easing and pumped liquidity into the banking system through non-standard channels. Followers of Friedrich von Hayek of the Austrian school however object to this, arguing that since excessive credit caused the crisis in the first place, more of it can’t solve the malaise.

Regulatory regimes, on the other hand, have been made stringent to prevent banks from jeopardising the financial system again. The Bank of England, for example, apart from its price stability mandate, has been given the added responsibility of maintaining the stability of financial system.

The above analysis, which seems logical, is based on the argument that the supply of credit should be monitored closely. Too much of it destroys the economy while too little of it ruins it too.


GBP/EURO – 1.2328
GBP/US$ – 1.6128
GBP/CHF – 1.4942
GBP/CAN$ – 1.5952
GBP/AUS$ – 1.5282
GBP/ZAR – 13.9324
GBP/JPY – 134.64
GBP/HKD – 12.5028
GBP/NZD – 1.9093
GBP/SEK – 10.7355

EUR: The single currency performed strongly against most of its peers yesterday and reached the 1.3100 level against the dollar after the US Federal Reserve announced further bond purchase plans unless unemployment rate fell below 6.5 percent. Euro got further support after Italy successfully conducted short-term bond auctions with yield on one year notes falling to their lowest level in nine months. Also the deal clinched on Thursday that gave the ECB supervising powers for eurozone banks buoyed risk sentiments. Investor focus will however remain on the EU Economic Summit in Brussels where heads of states are due to meet to discuss plans for future monetary and economic integration.

USD: The greenback fell against most of its global peers yesterday, save the JPY, after the US Fed announced further monetary stimulus as expected. The US central bank announced plans to add $45 billion in Treasury purchases starting January to its $40 billion a month purchase of mortgage-backed securities it started in September. The Fed also made the unprecedented announcement of holding interest rates at record low levels until unemployment rate fell below 6.5 percent and inflation forecasts did not exceed 2.5 percent. Sterling started the day on a strong footing yesterday after employment data came in better than expected and this, on the back of the US Fed announcement, pushed the GBP/USD pair to a six week high of 1.6170. We have the retail sales and inflation data due from the other side of the Atlantic today though investors will continue to watch the progress on ‘fiscal cliff’ negotiations. The GBP/USD pair opens at 1.6125 this morning.

Have a great day!


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