This post is an excerpt of "Rising Risk of Financial and Economic Chaos, Part 2." It's so important that I felt it deserved to stand alone as a unique post.
The actions of the ECB to drive interest rates to negative levels is the most irresponsible monetary "experiment" in the history of the world. It's artificially driven up bond prices to truly absurd levels. There are still some $17 Trillion of debt in the EU that have negative yields. It's the biggest bubble in the world! And there's no way out!
But now there's a chorus of "economists" across the world, especially Europe, who are also increasingly critical of negative yields. It's becoming a consensus. It's because QE and negative rates haven't helped; they've hurt and caused damage to retirees, pension funds, insurance companies and most importantly the banking system (especially Europe). Just a week ago, Sweden raised it's interest rate from -0.5% to 0% because of the damage negative rates are causing: housing market price bubbles, bank and pension troubles were cited.
So, we're one populist revolt in a single EU country like Italy or Greece leaving the EU that could begin a real bond rout. Or it could simply be credit markets revolting due to rising risk. What if the ECB, like Sweden, decides to abandon negative rates now that there is consensus that it's actually crazy?
EU banks are large holders of dicey sovereign bonds like Greece and Italy - countries suffering under the yolk of the Euro currency. Germany has loaned 100s of billions to Southern Europe as the Euro currency has imposed a non-stop economic depression on the southern countries. This was predicted long ago by Margaret Thatcher. Such transfers are not sustainable. Even so, economic hardship is causing unrest and populist and/or separatist movements all over the world including Europe. Brexit was first, but who's next? If a country like Italy leaves the Euro currency, it's bonds would drop by about 70% to yield something like 7% from 1.4%. Since European banks are big holders of sovereign bonds, such an event would tip every bank in the EU into insolvency. One hiccup in a EU member's bond market (like Greece or Italy) and say hello to bank failures galore in Europe. Suffice it to say that EU banks are an ongoing problem for the world and probably an existential threat to the world of finance.
The effect could include the instant bankruptcy of nearly all EU banks and this would easily spread to the US and World (like a virus?). The ECB itself would be understood to be technically bankrupt. It CAN go bankrupt unlike our Federal Reserve. Bank runs could easily erupt since large depositors are at risk of losing their money for bail-ins in the event of an EU bank bankruptcy. A flood of money to the US would ensue. The dollar would rocket higher as US causing crises in emerging market countries that have issued dollar-denominated bonds --which is a huge amount.
In my post titled Declining Global Money Supply Taking World Economy With It, I mention that the real dollar money supply for world commerce was found in the Eurodollar markets of European banks. See the graphic.
Essentially all world trade uses the dollar as the core of virtually all international financial and trade transactions, the Eurodollar market therefore facilitates all of the trading and financial transactions for the international and emerging markets and China. Really, it's the "money" supply and lubricant for world trade.
The "Eurodollar" has developed in past decades as unregulated liquidity that exists on (and mostly off) the large bank balance sheets in Europe and the US. It's really a sort of a "trick" designed to allow banks to skirt regulator's capital requirements. And the regulators, including our Federal Reserve, remain oblivious of what's going on--even now.
The "Eurodollar,"includes all of it's derivatives. Parentheses around "eurodollar" means it's the aggregate of credit default swaps, interest rate swaps, currency forwards/swaps, repos/reverse repos and other derivatives used mainly to facilitate global and financial trade. "Eurodollars" are only backed by "balance sheet capacity" of the European banks. It's a huge "product" of EU banks and it's designed to bypass and skirt capital requirements set by the government. It'a a way that banks can improve profits through higher-than-permitted leverage.
But there are nearly no dollars backing these instruments. It's nearly pure leverage and very unstable in times of crisis -- as we found out in 2008 (see the graphic above). I'm confident that banks are now attempting to flee these markets again since we're in the Great Financial Crisis #2. But shrinking "Eurodollars" means a shrinking world economy. That's exactly what's happening.
"Eurodollar" liquidity is literally the antithesis of sound money. It's like "internet money." It's pure leverage with no real "backing" except faith in the money center banking system of Europe. But faith in the European banking system has been dropping for decades. If you didn't know better, you might assume that the EU has been TRYING to ruin their financial system. Major EU bank stock (equity) prices are at 30 and 40 year lows, indicating extreme lows of faith and high fear concerning these institutions. Fear is rising as indicated by rising LIBOR rates which are considerably higher than the largely irrelevant Fed Funds rate of 0 to .25%.
Deutsche Bank, one of the largest banks in Europe is at the heart of the EU banking industry. But the IMF has labeled Deutsche Bank as the world's most dangerous systemically important bank.
But I'll say it again; there's no dollars in Eurodollars! There's a high risk that demand for the USD will soar in an acute phase of this 2nd Great Financial Crisis--not unlike GFC1. Crucially all of this "money" relies on the faith in the EU INTERBANK market and the failure OR EVEN DISTRUST of even one of the EU banks would send the entire Eurodollar market scrambling for the safety of USD securities. And a rising USD in a crisis is like adding gasoline to a fire, but that's what could happen when the entire world financial system is structurally short of US dollars.
Shrinking Eurodollars means a shrinking world economy. Shrinking can easily turn into collapse.