The massive risk-asset rally generated by a global central bank liquidity-bailout on Wednesday pushed gold back onto center stage.
FORBES: Gold Revving Engine To Jump Start Rally All The Way To $2,025
French banks like Societe Generale, BNP Paribas, and Credit Agricole surged on the global central bank liquidity bailout presented last week.
Central bank liquidity policy needs refining and harmonising, as the Financial Stability Forum, a group of banking-industry regulators, made clear in a report in April.
If the European banking crisis or the U.S. economy turn problematic again, then even torrents of central bank liquidity will not offset an increased risk profile for underlying investments.
The announced intervention reassured markets that policymakers stood by to support banks, leading to rallies across Europe. (Read Coordinated Central Bank Liquidity Bailout For Euro Banks Feeds Global Rally).
FORBES: Stocks Cap Off Fourth Consecutive Daily Gain On Euro Liquidity Bailout
This follows very highly correlated moves between both MSCI indices in 2012, and a backdrop of very supportive central bank liquidity, robust EM growth prospects and large portfolio inflows in January.
FORBES: Emerging Markets GettingTired; U.S. Better...For Now
Against the backdrop of improving employment, accelerating U.S. economic growth and the resolution of the European debt crisis, we are witnessing massive injections of central bank liquidity into the global financial system.
The central bank liquidity injection to help make it easier for European banks to access U.S. dollars is considered bullish for gold (and other hard assets) as more money is flushed into the global economy.
Lending between banks remains stifled, and demand for central-bank liquidity is consequently extremely high.
ECONOMIST: Are European banks insulated from the panic in America?
But it remains to be seen whether liberal amounts of central-bank liquidity will encourage banks to do more than hoard cash.
Unlimited central-bank liquidity may help to reduce the gap, but only if banks do not find more reasons to question each other's creditworthiness.
But because banks are using central-bank liquidity to plug holes in their short-term funding, the money multiplier is collapsing: even as reserves swell, broad-money and credit growth is wilting.
The Bundesbank, Germany's central bank, which monitors bank liquidity, certainly does not.
Should the crisis extend beyond eight days and the European Central Bank pulls the liquidity it has been pumping into Cypriot banks, the ATMs may become cashless.
European and U.S. stocks fell after Federal Reserve Chairman Ben Bernanke quashed any hopes of further quantitative easing and as investors debated the European Central Bank's second liquidity injection.
Now banks are forcing their counterparties to pay a much higher price to roll the paper over, and it is not clear how quickly central-bank injections of liquidity will ease the squeeze.
In some cases, as in our programs to backstop money market mutual funds, the purpose of the facility is to serve, once again in classic central bank fashion, as liquidity provider of last resort.
"The reserve ratio rise is a signal that the central bank is still in liquidity tightening mode and is very keen to control loan growth, " said a trader at a European bank in Shanghai.
Corporate bank borrowers such as Credit Agricole, BNP Paribas and Societe Generale were given more time, after a lifeline was thrown to them by the European Central Bank when it flushed liquidity into the system on Dec. 21.
Should it exit, all bets are off and an exit becomes a real possibility if the European Central Bank pulls out the liquidity it has been pumping into Cypriot banks, which on Thursday it threatened to do if the Cypriot parliament doesn't pass legislation to implement its end of the bailout agreement.
The euro regained some momentum after a consortium of central banks agreed to fund liquidity to the European Central Bank to give eurozone banks easier access to the dollar.
But if the Fed was a truly global central bank, it would provide liquidity globally and of course the Fed mainly provides this liquidity into the U.S. economy.
The country's two biggest banks, Bank of Cyprus and Laiki, are believed to be reliant on Emergency Liquidity Assistance provided by the Central Bank of Cyprus.
Bank of Japan Governor Masaaki Shirakawa reiterated that the central bank would continue to provide ample liquidity to ensure market stability.
FORBES: Japanese Stocks Recover After G7 Currency Intervention
And she did not strike down the European Central Bank for creating a torrent of liquidity for banks (see article).
By contrast, by removing excess liquidity, the central bank can cause the sudden collapse of speculative excess, and it can also hurt healthy recovery or growth by constricting the money supply.
It could bring about the dismissal of Bernanke, the taming of fiscal deficits, the painless elimination of excess liquidity from bloated central bank balance sheets and the restoration of robust economic growth.
Owen points out that the Greek central bank significantly hiked the amount of liquidity it pumped into the economy in May (ready money) by 10bn euros - and that this would have been provided effectively by the German central bank as part of the Eurosystem.
The lack of a developed financial market has the flipside of making it difficult for the central bank to inject or withdraw kyat liquidity or to intervene in the dollar market as a way of combatting any sharp moves in the exchange rate, as most of it occurs with back-alley money changers.
As a second cushion against a liquidity crisis, the central bank acts as lender of last resort.
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