Okay, leadership, but by whom?

And heading where?

The deficit in political leadership, both in the US and Europe, is the focus of FT commentary today (see here, here, and here). It seems clear that another financial crisis is brewing, with its epicentre this time in European sovereign debt problems rather than U.S. subprime mortgages, but policy response has so far been woefully inadequate to the task.

But what would you have them do?

As John Authers points out, “sovereign credits are no longer available for use. The rebound of 2009 came once it was clear that governments were prepared to put their own credit behind the troubled banks. This time around, sovereign credit itself is at issue.”

All eyes then to the world’s central banks, where the ECB’s resumption of bond buying for Ireland and Portugal only focused attention on what the ECB was not yet buying, namely Spain and Italy. Meanwhile, in the U.S., traders eagerly read the entrails of Bernanke’s speeches looking for signs of delivery from on high, QE3.

No question about the immediate liquidity crisis. We see it in the demand for yen and Swiss francs, in gold, and in the negative interest rates at BNY. The Fed may well be gearing up to respond, even now. But I would raise serious questions whether conventional lender of last resort is the right answer.

The ECB is following in the footsteps of the unconventional Fed last resort intervention during the last crisis, a new kind of intervention that I have characterized as dealer of last resort rather than lender of last resort. But even dealer of last resort just puts a floor on the crisis; it doesn’t fix anything.

It doesn’t have to be that way.

I propose that we should think about these crises as the birth pangs of a new financial system, a new GLOBAL financial system, a system based on inside liquidity rather than outside liquidity, and a system that requires a fundamental rethink of the role of the central bank.

In my last post, I provided a verbal sketch of the outlines of that new system, but it was apparently too sketchy. Readers asked for a video. The video attached to this post could equally well go with that previous post.

Bottom line, the pressure to move funding markets onto the balance sheet of the Fed can be seen as a symptom not of immediate crisis but of deeper structural shifts in the organization of global finance. Unless and until policy makers engage those structural shifts, bailouts will be the order of the day.

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