The bubble risk, the Fed unknown, the ECB opportunity

The bad, the bad and the good: the financial bubble risk (the bad) was managed in the past thanks to the safety net represented by central bank cooperation, in fact hinged on the Fed's willingness to grant credit in dollars. But if today doubts are raised as to whether the role of the Fed (the bad) can still be relied upon, the opportunities for developing the role of the ECB increase as the international weight of the euro (the good) increases.

The starting point can only be the safety net that central banks have inaugurated since December 2007. While it is true that central banks had already been using mutual credit lines for decades to deal mainly with exchange rate issues, such as in the aftermath of 11 September 2001, to cushion the economic effects of the terrorist attack, the date of 2007 represents a watershed, since the credit arrangements with which the Fed fed the credit capacity of other central banks by creating dollars were subjected to a baptism of fire at the outbreak of the Great Financial Crisis: in the period between September 2008 and January 2009, a total of USD 586 billion was used to manage the global financial instability caused by the domino effect triggered by Lehman Brother's bankruptcy.

On that tragic 15 September, the world's fourth largest investment bank, with 25,000 employees worldwide, collapsed like a house of cards: the financial crisis, which started on Wall Street, became worldwide, and then turned into the hardest recession since the post-war period. The safety net, with which the Fed created dollars, simultaneously fuelling not only its ability to provide credit, but also that of the other major central banks in the advanced countries proved to be a decisive tool in mitigating the real and financial costs of that Great Crisis.

The same safety net came back into action again in May 2010, and became a permanent pact in 2013: credit arrangements linked the Fed and five other central banks - the ECB, the Bank of England, the Bank of Japan, the Swiss Central Bank, and the Canadian Central Bank. The network again turned out to be a crucial instrument to ensure international financial stability in March 2020, when it was necessary to respond in a coordinated and systematic manner to the crisis triggered this time by a non-economic fuse: the Covid-19 pandemic virus; nine more countries joined the network of reciprocal agreements; another USD 500 trillion went into action. Since then, the instrument has been increasingly reinforced: by 2020, there were 170 reciprocal bilateral agreements between central banks.

The mechanism that explains the success of the safety net is the one that underpinned the now famous monetary policy action based on the three words uttered by Mario Draghi on 26 July 2012 - "All (that will be) necessary": credibility. Financial markets respect credible monetary announcements, while they attack what is not. If a safety net is credible in which the central bank that creates the absolute safest financial asset - the dollar - is prepared to supply not only its own needs, but also those of other central banks 'as much as will be necessary' in order to deal with - to prevent or manage - a systemic financial crisis, its probability of being effective is high. And indeed, so far the network has worked.