Israel Matzav: Maybe they'd like to borrow from Israel instead

Tuesday, February 25, 2014

Maybe they'd like to borrow from Israel instead

As an Israeli who earns a substantial portion of his income in dollars, I can tell you that the strength of the Israeli Shekel and the dollar's weakness has been killing me financially. We're now around NIS 3.50 to the dollar - we probably would be around NIS 4 to the dollar if the US economy weren't in such lousy shape (we've been as high as NIS 4.20 in the last few years).

Now, there's hope. You see, one of the reasons that the dollar and the US economy has been so weak is that the US Federal Reserve has been subsidizing the European banking system - and with it their bloated social welfare states - with virtually interest-free loans for the last six years. (Did you know that? I didn't). Now, that's going to stop. That means that some of the trillions of dollars floating around the world will find their way back to the US, US interest rates will hopefully drop, and the dollar will be strengthened.

By delaying foreign bank compliance with the stringent capital and borrowing requirements of section 165 of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) imposed on American banks, the Fed was engaging in the moral hazard of allowing Europe to borrow at virtually zero interest from the Fed to fund its bloated social welfare states. Chair Yellen’s actions mean the Fed is cutting off Europe and providing greater support for U.S. borrowing.

People around the world often complain about the “exorbitant privilege” America enjoys from sponsoring the U.S. dollar as the world’s reserve currency. Of the $1.25 trillion in circulation, about $700 billion is held outside the United States. Foreign holdings of the dollar essentially act as a perpetual, interest-free loan to the U.S. government and force foreign businesses to lose money exchanging their foreign currency into dollars. The privilege also reduces the interest costs the American government pays on the $5.8 trillion of U.S. Treasury debt held by foreigners by one half percent. This privilege adds more than $120 billion to U.S. consumption each year.

However, with the privilege of sponsoring the dollar as the world’s reserve currency, America also bears “extraordinary risk” in times of financial crisis. The Fed is morally expected to provide liquidity at virtually zero interest rates to foreign banks as the lender of last resort.

According to Fed data, at the peak of the financial meltdown on Oct. 29, 2008, almost half of the $111 billion in central bank emergency “discount window” loans went to the U.S. subsidiaries of France/Belgium-based Dexia Bank and German-based Depfa Bank. Although the parent banks of both of these institutions were grossly insolvent, money borrowed from America’s Fed was quickly wired off-shore to prevent imminent bankruptcy filings of the institutions’ European parent banks.

The 2008-2009 financial meltdown was caused by what economists refer to as “moral hazard,” a situation in which one party takes undue risks if it knows the potential costs of the risk will be born by others. U.S. and European banks knew the moral hazard of using risky valuation models to profit from mortgage securitization was inappropriate, but they expected that America’s Fed would bail them out of potential losses.

...

From Nov. 2008 through Jan. 2014 the Fed flooded the world with liquidity by engaging in three rounds of “quantitative easing” to buy $2.8 trillion in bank debt, mortgage-backed securities, and Treasury notes. During the same period, the European Central Bank and the Bank of England also engaged in another $1.4 trillion of quantitative easing.

Almost none of this liquidity was loaned to U.S. operating businesses, as private non-residential investment in America fell by 80% as a percentage of the total GDP of the U.S. between 2007 and 2009. Although capital spending has somewhat recovered, American business investment is still at its lowest level as a share of GDP since 1947.

Most of the Fed’s cash appears to have gone to European Union (EU) banks to cover loan losses and buy sovereign debt of EU countries. Bank balance sheets in the EU are still leveraged at 25 to 35 times equity. Despite the GDP of the EU nations since 2008 falling by .4%, their debt outstanding rose by 34%, from $10.3 trillion to $14.5 trillion.

Congress and financial regulators sought to avoid future moral hazard by passing Dodd-Frank’s Section 165 “Stress Testing” requirements in 2012 to impose strict leverage limits on U.S financial institutions with “consolidated assets of more than $10 billion.” Large banks, brokers, and insurance companies were forced to raise $450 billion in capital and their leverage was cut from 18 times to less than nine times, a 50% reduction.

Just 16 day after her confirmation, Chairman Yellen seems determined to root out the expectation that the U.S. Federal Reserve will continue the moral hazard of allowing excess risk taking in the expectation the Fed will provide bail-outs as the sponsor of the dollar. President Teddy Roosevelt said, “Speak softly and carry a big stick; you will go far.” New Federal Reserve Chairman Janet Yellen on February 18th picked up her big stick and softly announced the Fed is about to cut off its massive cash lifeline keeping Europe afloat and will now concentrate on supporting the credit needs of Americans.

The question remains: Where will the Europeans borrow money to avoid their own meltdown? I would like to suggest that they borrow money from Israel. After all, our economy has been the strongest in the world for the last 6-7 years. And we also have a bloated welfare state, although it's not quite as pricey as Europe's.

What's that, you say? Europe doesn't want to borrow money from us because our banks all operate in Judea and Samaria. Well good. Let them eat cake.

Labels: European anti-Semitism, Federal Reserve, Israeli economy, US economy, welfare state