Thursday, November 11, 2010

Banking Crisis vs. Currency Crisis

It is very common for commentators, even economists, to improperly characterize a credit/liquidity crisis as a banking crisis, when a banking crisis is defined by a withdrawal of demand deposits and a credit/liquidity crisis is characterized by a withdrawal of foreign investment, lending, and deposits.  When the perception grows that the sovereign government will not undertake the necessary monetary and fiscal policy actions necessary to counteract and stabilize a credit/liquidity crisis, then, as foreign doubts increase, the risk of a currency crisis grows with the failure of the sovereign government to solve the fiscal and monetary problems behind a credit/liquidity crisis, even if it has been caused by the business activity of systemically dangerous financial institutions of whatever size.

In the case of Ireland, and any other eurozone country, it has no control over monetary policy and is reliant upon the European Monetary Union, the ECB, and the EU to provide monetary policy and backup.  Consequently, as overnight bank funding dries up and bond costs continue to escalate, the European Monetary Union and the ECB are faced with a potential currency crisis, which is a lack of faith the EMU will stand behind its member nations, which would cause a serious, roiling global credit/liquidity crisis.

The ECB, the EMU, and the European Union need to get their act together and act decisively and consistently without the counterproductive interference of member nations promoting their more immediate self-serving political and economic agendas.

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