Derivatives positions in FX and interest rate swaps are staggering and the total derivatives market is estimated at $700 trillion

Europe May Be in the Calm Before the Storm

by Andrew Cullen

Austrian business cycle theory explains that the “bust” phase of that cycle is created by extension of the cheap and plentiful credit by a fractional reserve banking (FRB) system. A FRB system is inherently fragile during the bust phase as its leverage (lending as a percentage of its own capital) exposes the banks to the emerging tsunami of non-performing loans and impaired collateral that are the manifestations of malinvestment.

Yet, in today’s protected and regulated banking industry, the “bust” phase of the cycle is delayed and distorted by the wide-ranging interventionism of regulators, central banks, and governments. The ongoing crisis in the European banking sector is evidence of this. Its problems of insolvency are unresolved. The ECB is at the center of interventionist efforts to stall and mitigate a European banking sector collapse that looks increasingly likely within the next 18 months.[1]

Early this month, the ECB kept interest rates unchanged at 0.25 percent. The exchange value of the euro rose and the mainstream media and financial industry pundits all bemoaned Mr. Draghi’s immobilism in the face of worsening price deflation.[2] As my November 2013 commentary indicated, there is growing political pressure on the ECB from southern European governments to launch a new round of Eurozone members’ sovereign bond purchases, as public debt to GDP ratios are increasing for countries on the periphery.[3],[4]

So why has the ECB president kept his powder dry, and is the European banking crisis contained or still perilously at risk?

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