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Europe replaces US as new source of financial crisis

By Ye Tan (Jiefang Daily)

15:50, September 27, 2011

Edited and Translated by People's Daily Online

European credit markets are freezing.

A new financial crisis, though less severe than the 2008 global financial crisis, is deepening and at risk of spreading from Europe to the rest of the world.

Depositors are leaving European banks. According to media reports, the U.K.-based Lloyds Banking Group has been gradually withdrawing cash deposits away from banks in heavily-indebted peripheral euro zone countries due to worries that troubled governments may fail to save these banks out of the debt crisis. Furthermore, Bank of China has stopped trading foreign exchange forwards and swaps with three major French banks.

As investors become frightened and withdraw their deposits away from European banks, the European banking industry will move toward less cash, higher financing costs and higher debt ratios, and ultimately collapse.

U.S. credit rating agencies have repeatedly lowered the credit ratings of European financial institutions. After lowering the sovereign debt rating of Italy on Sept. 20, Standard & Poor's lowered long-term ratings on seven Italian banks and assigned negative outlooks to the long-term ratings of these banks on Sept. 21. Moody's Investors Service downgraded the credit ratings of Societe Generale and Credit Agricole, two leading French banks, on Sept. 14. The downgrades triggered sharp drops in the share prices of these Italian and French banks.

Debt crisis started in Greece, spread to euro zone core

According to a report released by the International Monetary Fund on Sept. 21, the European debt crisis has caused as much as 300 billion euros in risk exposure in the European banking sector. However, an earlier pressure test conducted in Europe showed that the risk exposure of the European banking sector stood at only 2.5 billion euros. The huge difference in the two data has led the market to laugh at Europe's pressure test.

The Italian, French and German banks have also been embroiled. As of the end of June 2011, German banks held a total of 23 billion U.S. dollars worth of Greek sovereign debt, making Germany the second largest Greek debt holding country only after Greece itself. France ranked third, with French banks holding a total of 15 billion U.S. dollars worth of Greek sovereign debt. Once countries such as Italy default on their debt, financial institutions in countries such as Germany and France will surely suffer from the defaults. The first block of the dominos will be Italy.

The collapse of the dominos will be spread to the entire world through investment institutions. The investors who made losses in Europe will sell off their sound assets to offset the losses, resulting in price drops in other commodity and monetary markets, such as gold and oil.

In a word, the global financial market has fallen into a frozen state again in the face of investor panic. The banks are unwilling to lend money, and investors refuse to invest. With increased credit risks, the real global borrowing rate has risen significantly. Even if the Federal Reserve and European Central Bank implement quantitative easing monetary policies, the global credit market will be unable to become active again.

The second round of the financial storm is coming. In the face of huge risks, the whole world should cooperate again to rescue the market. On the morning of Sept. 23, the G20 released a communiqué and announced it will maintain the stability of the banking system to ensure the banking industry has sufficient capital. The central banks of all countries should be prepared and provide liquidity to banks when necessary in order to ensure that the banking industry has sufficient capital to deal with current risks.

It is expected that the new round of published or covert quantitative easing measures will be put forward soon. The International Monetary Fund lowered the threshold for rescuing Greece and other countries, and the stability fund of Europe may further increase. Means to rescue the market in the wake of the crisis in 2008 will be used again.

The market may rebound in a short time. From the long run, however, monetary market-saving means cannot help the economy and market bottom out.

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