Markets Rally On Central Bank Intervention

The Dow Jones Industrial average surged 490 points today on news that the Chinese government cut their commercial bank reserve ratio (RRR) by 50 basis points.

The announcement, made before US equity markets opened, sent US equity index futures soaring. When all was said and done, the Dow racked up the seventh largest up day in history.

The RRR ratio is the minimum amount of reserves that each Chinese commercial bank must hold in notes and deposits. The Chinese today decreased RRR reserves from 21.5% to 21.0%. When reserves are decreased, lending is made more readily available and the money supply increases in hopes of stimulating growth through higher inflation.

After the People's Bank of China (PBOC) announcement, through a coordinated effort, the Bank of Japan, US Federal Reserve, Bank of England, Bank of Canada, Swiss Bank, and the European Central Bank said that they would lower US dollar liquidity swap interest rates by 50 basis points. This operation will begin December 5, 2011 and end February 1, 2013.

US Dollar liquidity swaps are currency transactions between central banks. They involve a foreign central bank (FCB) exchanging their native currency for US dollars with the US Federal Reserve. Liquidity swaps have a maturity element ranging from an overnight hold to three months along with current market rate at the time of the swap, plus interest.

"We welcome and support the actions taken by Central Banks around the world today to help ease pressure on the European financial system and help foster the global economic recovery"

- U.S. Treasury Secretary Timothy Geithner

Essentially, the Fed is making available US dollars at a lower rate to foreign central banks - especially the European Union in times of financial stress at a lower rate (less 50 basis points as announced today).

Swap activities are publicly reported on the New York Federal Reserve website.

Since March 2010, the Fed has re-established liquidity swaps in lieu of the European Debt Crisis.

About Kerry Kobashi

Kerry is the founder of KerryOnWorld. He lives in Silicon Valley and has worked as an engineer and project manager. He owns Kobashi Computing a consulting company.