FRANKFURT: Central bankers are refining their battle plans for coping with the upheaval that an Iraqi war could cause in financial markets and their economies.
Their weapons proved their worth when Wall Street almost seized up after the Sept 11, 2001 attacks and central bankers said they had no need of new artillery.
Rather they can rely on the tried and true – cutting interest rates, pumping money into stressed markets or lending to troubled banks if a crisis emerges.
Only a massive disruption to trading in financial markets or a dangerous hit to growth prospects is likely to trigger any such response, according to analysts.
“If war goes badly, if Saddam Hussein is able to blow up Kuwait and drive up oil prices sharply, then they may need to offset that,” said Todd Buchholz, a White House economic adviser during the 1991 Gulf War and now a hedge fund manager at New York-based Enso Capital.
Perhaps surprisingly in a high-tech rule-driven age, the chieftains of global finance rely on informal mechanisms for managing a global economic or financial crisis.
No hotline sits on the desk of Federal Reserve chairman Alan Greenspan linking him to his counterparts in Europe and Asia. No flashing screens alert central bankers to market panic or bank collapse.
Instead, old-fashioned personal friendships forged over years attending financial summits – Group of Seven meetings four times a year and the monthly Bank for International Settlement (BIS) sessions – serve as the bridge to discuss problems.
So far it has worked well.
“It does not surprise me there is no equivalent of the red phone on Alan Greenspan’s desk ringing to Andrew Crocket at the BIS because they have performed wonderfully,” said Thomas Schlesinger, analyst at the US-based Financial Markets Centre.
“They have shown their capacity to work as a team,” he said.
Certainly, some refinements have been made since the testing events of September 2001.
The New York Fed now recommends banks locate back-up trading rooms away from their main offices, on different telephone systems and electrical grids. Key financial players in clearance and settlement are better trained and practices improved.
More tests of back-up systems were conducted, said NY Fed senior vice-president Peter Bakstansky.
“Everybody from the corner grocer to central bankers has worked on emergency plans and business continuity,” he said.
The eyes and ears for central bankers, though, remain their trading desks. They monitor 24 hours a day whether cash and currency is flowing smoothly through global markets, whether trades are settling quickly and prices are orderly.
In Frankfurt, for instance, the European Central Bank’s (ECB) markets desk talks several times a day with New York, Tokyo and London on market activity, said ECB spokesman Manfred Koerber.
“There is not a special mechanism that has been established for market monitoring purposes because that is something the desks are doing every day,” he said.
It worked on Sept 11 when two planes crashed into the World Trade towers and brought them crumbling to the ground almost closing Wall Street. The Fed and ECB within hours issued statements that they were ready to help banks needing money.
Some needed help badly. Panicked dealers did not know whom they had lent money to when computer systems crashed. The next day the Fed lent US$45bil from its emergency discount window to deposit-taking banks to keep them in business.
Then it flooded the money markets with cheap cash. This sent interest rates on overnight lending among banks, the very grease that keeps financial markets operating smoothly, plunging from 3.50% to 0.25% a week later.
They did it by adding huge temporary reserves through auctions to 25 primary dealers – US$80bil on Sept 14 alone, about 10 times the usual auction size, US$57.25bil on Monday, Sept 17, and US$36.5bil on Sept 18.
The ECB likewise added US$69.3bil euros on Sept 12 via quick tenders, whereby 120 banks bid for short-term money at low cost, to pump money into the European banking system on Sept 12. Again the ECB added 40.495 billion euros the next day.
The ECB also hammered out an unusual US$50bil foreign exchange swap with the Fed so that European banks could settle dollar deals despite problems at their New York clearing agents.
Finally the Fed, the ECB, the Bank of Canada, and a day later the Bank of England, all cut benchmark interest rates. This longer term action was designed to bolster business and consumer confidence, thus shoring up the economy, by making credit cheap on business loans, mortgages and credit cards.
These actions followed a script honed in the 1987 stock market crash and in the 1990s during the Mexico peso crisis, the Asian debt crisis and the Russian rouble collapse.
The BIS, based in Basel, Switzerland, acts as the world's central bank and is their formal coordinating body. It clears transactions among its members and it can make emergency loans.
“There is a well established coordinating mechanism that has proven its worth and is very effective in providing assistance,” said BIS secretary general Gunter Baer.
But the BIS only reacts to central bank needs. It is not the watchman raising the alarm at the first sign of financial trouble, he said.
That’s the job of central bankers. – Reuters
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