Too many political leaders around the world have very little understanding of how the banking system works. And, as I will discuss, global sharemarkets gyrate between having faith in politicians to solve the European problems, to utter despair of the political process.

The European political leaders concentrated on countries and austerity, not on the effects the actions taken in relation to this would have on banks.

Contributing to the problem, the ratings agencies have been too slow to recognise the enormous paper losses buried in the European banking system. Last night’s action by Moody’s to downgrade German banks, led by Commerzbank, was long overdue. Eventually the ratings agencies will face up to the problems of Germany’s largest bank, Deutsche Bank.

Instead of making sure European banks raised large amounts of capital when markets were higher, authorities, backed by the politicians, kept lending the banks money to keep the doors open. It did not help the long-term problem of loss of banking capital created the European recession and decline in asset values. And sitting over the whole potential mess are the staggering losses that will be incurred if the euro breaks up.

In Australia, our banks depend on the European banking system for large amounts of their deposits. Our treasurer and finance minister simply ignore this problem when they urge banks to pass on all of the Reserve Bank’s interest rate cuts. The public are left with the impression that the banks are gouging them and keeping the extra profits in the vaults. As in Europe, our politicians will not come to grips with the real banking problem.

As I wrote at the beginning of the week (Business braces for a triple threat), sharemarkets were ready for a major correction rally because they had been oversold. And rallies, of course, gather their own momentum as those who were shorting the market suddenly go long. The current big rises are based on the belief that the European politicians will solve the problem by spreading all around Europe the German wealth built up over six decades.

A lot of the German wealth has already been sent down the European toilet and it is possible that when the German politicians wake up to the depth of their banking crisis, they will flush the rest of Germany’s wealth down the same money-printing drain.

That’s what the market believes will happen and maybe they are right, but there is high risk that this is simply a technical correction. Such corrections can sometimes be major rallies.

In fairness to the politicians, the statistics they have to work with do not always reflect what is happening. Back home, I obviously have no way of checking the latest Australian ABS growth figures. As I move around eastern state businesses, I find a large number of enterprises struggling. Many listed groups are slashing their profits. And then the growth figures show that this is all a mirage and that we have never had it so good. The figures do not reflect what is happening to non-mining Australia and they are very dangerous because they lead politicians into thinking that no actions are required.

It’s the same approach we’re seeing to the global banking system, all over again.

*This first appeared on Business Spectator.

Peter Fray

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