Europe, I am sorry, as long your banks must use channels, and credit cannot flow freely, you will not get out of the hole.

Sir, I refer to Martin Sandbu’s “Forget the Fed – it’s the ECB that should worry investors” June 21. In it Sandbu writes that in order for the “ECB to scale its operations down private cross-border credit must resume” and that “While pre-crisis credit was often wasted, richer savers lending to borrowers (who must deploy borrowed funds better) is what economic efficiency requires”. 

Indeed, the problem though is that the reason for why so much pre-crisis credit was wasted was that bank credit was not allowed to flow freely, but had to use an irrigation system designed by regulators. In that system, the depth of the channels, the capital requirements, varied dependent on the perceived risk. For instance bank credit could flow to the Greek government in a 62.5 to 1 leverage deep channel, while if lending to an unrated Greek business it had to use an only 12.5 to 1 deep channel.

And since these capital requirements based on perceived risk are still the most prominent feature of Basel III, there is no reason whatsoever to believe the allocation of bank credit will achieve the efficiency required to take Europe out of their hole. Europe, I am so sorry, but that is how it is.