News this week that the Fed could cease its $85 billion-per-month buying of bonds and other instruments as early as September.
This would obviously mean a lot less money being pumped into the economic system. Which has concerned some observers.
But it pales in comparison with potential deflation looming in the European banking system. Due to new rules that are shaking up that sector.
Global regulators recently released a new slate of “Basel III” rules for banks. One of the key points is a “leverage ratio”. Which dictates that banks must hold certain levels of cash relative to their holdings of assets like loans and derivatives.
Many banks don’t currently meet these standards. Meaning they will have to raise money through equity financings (which are now starting to happen). Or cut assets.
Here’s where the numbers start to get eye-catching. A new study by the Royal Bank of Scotland estimated that euro zone banks will need to reduce 3.2 trillion euros in assets over the next three to five years.
That’s equivalent to $4.3 trillion that has to be downsized from asset portfolios. By monetizing securities and calling in loans.
The end result will be a lot of money drained out of the economic system. Perhaps more cash than would be lost if the Fed stops its asset purchases.
This is obviously a headwind to the global economy. And a deflationary force that may take some investors by surprise.
Place your bets accordingly.
Here’s to money coming home to roost,