Six central banks took coordinated action to ensure liquidity for the global banking system. During the European crisis, banks in Europe in particular have had trouble securing lending, which could lead to an event not unlike the fall of Lehman Brothers. The European Central Bank, the Federal Reserve, the Bank of England and the central banks of Canada, Japan and Switzerland made an announcement that would help prevent that from happening. How are they doing this? By giving out more free money via lending in US dollars:

The statement said the central banks have agreed to reduce the cost of temporary dollar loans to banks – called liquidity swaps – by a half percentage point. The new, lower rate will be applied to all central bank operations starting on Monday.

They are also taking steps to ensure banks can get ready money in any currency if market conditions warrant by establishing a temporary network of reciprocal swap lines.

So European banks can now borrow dollars to fund their day-to-day operations through a network of central banks, and they can get those dollars cheap. This should address part of the liquidity crisis.

Now, if the world were only worried about a liquidity crisis in Europe, we’d be all set. The problem is, As Karl Smith points out,  much more widespread than that:

I haven’t completely sorted this out yet but for a number of reasons I believe that the ECB has lost control of monetary policy in the Eurozone.

By that I mean the ECB is no longer controlling the marginal cost of funding and that indeed the cost of such funding is rising much higher than the official 1.25% rate, at least up to 2.25% and perhaps as high as 6 – 7% [...]

This malfunctioning appears to be down right mechanical with trades regularly not settling on time, collateral not being delivered, awkward interventions by local regulatory agencies and a host of other deep, deep problems.

I don’t have it all sorted out but its not clear that there is a fully functioning money market in Europe right now. Well informed opinion suggests that there is literally a shortage of know-how on the ground. That is to say, some large banks or brokers cannot trade in certain types of paper because they don’t have anyone on staff who knows all of the relevant institutional details.

The opening of temporary swap lines could mean that other central banks can step in with expertise, but from this is sounds like they would have to replace the staff of practically every European bank to fix things.

And then there’s that whole insolvency crisis. Eurozone ministers are still talking in vain about their precious bailout fund, the EFSF, now trying to get the IMF to invest in it. It’s a bit like someone rolling into town and asking you to invest in their magic bean factory. Unfortunately for the Eurozone, none of the entities they are courting are that stupid. The plan is still to leverage the EFSF as a kind of CDO, which is almost criminally insane. And they still won’t reach their goal number needed to cover potential bailouts of Spain and Italy.

The finance ministers approved the next bailout tranche for Greece, but with bond yields rising almost throughout the zone, that’s almost an afterthought at this point.

It could be that Germany is playing an elaborate staring match with the more troubled countries of the Eurozone, getting the maximum amount of mandated fiscal discipline before allowing the ECB to step in.

One way of looking at the sequence of events is to say that the ECB was willing to permit contagion in order to wring out inflation. I think a better way of looking at it is to say that the ECB was willing to threaten Italy with insolvency in order to give Germany more formal control over Italy’s finances.

That’s incredibly hard-ball politics, but if you are not accountable to anybody (which the ECB, basically, is not) then you can play really, really hard-ball politics.

But if this massive relinquishing of national sovereignty was expected to work, then you wouldn’t see companies actually preparing for the breakup of the euro, a previously unthinkable event. Will this be painful? Probably. It also may be unavoidable. And there’s no way the US can avoid the pain.

Indeed, it’s worth checking back on the OECD’s 2010 forecasts: the think tank greatly overestimated U.S. growth (it expected 2.6 percent; we got 1.7 percent) and underestimated euro zone growth (predicted 1.4 percent versus actual growth of 1.6 percent). In other words, the United States was expected to grow at twice the rate of Europe last year and the two economies ended up growing at about the same pace. That could be a sign that forecasting is just really tricky, or it could be a sign that the euro zone and U.S. economies have a tendency to converge.

Yikes. Convergence is scary in this case. That staring contest can end any time now…