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The Cascading Effect of World Bank Debt

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Is the world banking system about to collapse? How will it affect you?

Last week the virtually unregulated US Federal Reserve Bank (FED) and five other countries’ central banks made it cheaper and easier for banks to borrow dollars in emergencies to cover their obligations. US dollar denominated trade with the Euro-zone and other European countries has been severely limited and was already impacting Asian and North American Businesses.

Indirectly, this helps delay the inevitable default of Greek, Italian and other European governments’ debt payments owed. If the banks do not get repaid, many will default on their debts and go bankrupt causing the collapse of the European and world banking system since virtually all the major international banks lend to one another.

The immediate problem arose that many private banks started being reluctant to lend to European banks because they rightly fear the possible collapse of the banks if they do not get repaid on their loans (bonds) to fiscally irresponsible governments. The reason the FED and central banks had to do this is that private banks normally have lines of credit available to other banks in case one of them has a shortfall in funds at the end of the day because it did not receive funds promised to balance its books.

The private international banks have started reducing or cutting these lines of credit to other banks because they fear that they will not be paid back. Let me explain how it affects all of us.

When I was head of the International Division of one of the 13 ‘clearing banks’ in New York City, every day more than 80% of all payments in the entire world were sent (“settled”) through one of those 13 “clearing banks.” Normally we would get written notice from a bank with a list of all the millions of dollars they expected from clients around the world to be deposited into their bank account with us that day and instructions to send out a similar amount of millions of dollars to pay transactions on behalf of their clients.

The reason it was called “settled” was that most major international banks have bank accounts with the other major banks. Many of the transactions resulted in transferring money from one account to another within the bank, making things much more efficient and timely.

Some days not all the money promised would come into their account with us for any number of reasons. For example, the funds might have been sent to another bank by mistake.

Then we would have to decide whether to send out the money they requested to pay their clients even though their account did not have enough money in it.  If we had given the bank a line of credit to cover occasional shortfalls we would lend them the money and put it in their account and make all their requested payments with the expectation that they would pay us back the next day.  

One day we did not receive $250 million promised and had to decide whether or not to pay out the $250 million. You can see how this caused some sleepless nights.

The reason that all banks feel morally obligated to make payments even though promised deposits have not been received is that many times NOT to pay could cause serious economic harm for their clients and a lot of others. For example, if a million barrel oil tanker is sitting at a dock in Saudi Arabia paying for the use of dock space and is not allowed to load the oil and leave to deliver it to a Texas refinery because we did not send 100 million dollars to the Saudi’s to pay for the oil shipment, the purchaser of the oil could have his profit wiped out and not be able to deliver it to a refinery as scheduled, nor will the refinery be able to deliver the refined oil to its distributors who in turn will not be able to deliver to its gas station clients – and you will not be able to fill up your car and go to work and the trucks that deliver food to your supermarket will not be able to deliver either.

Is it now more understandable why Central banks are trying to keep the system from collapsing with these stopgap measures even though irresponsible governments continue not to reduce their unsustainable spending? The entire world’s economic activity and production could be severely damaged if the international banking system collapses. And that will happen unless there is a drastic cutback of benefits promised to citizens by governments such as ours that do not have enough revenue to make good on their promised benefits.

James F. Davis                   12-8-11

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