Dan Amoss

The Euro crisis is not “solved.” Not by a long shot. Yet Bloomberg reports this morning (i,e, March 2nd) that European leaders “declared a turning point in the Greece-fueled debt crisis.” The next project for the busybodies: a commitment to a “pro-growth agenda.” This agenda, we can be sure, will involve the few remaining creditworthy EU governments borrowing even more money for stimulus plans.

But aren’t the problems in Europe rooted in spending more than incomes and tax revenues and having to borrow the difference? Yes. Europe has already run out of money — that is, money defined as having a certain amount of purchasing power today. But what about paper money that will buy less goods and services in the future? Isn’t there plenty of that? Sure, there is! In fact, [in order to finance its Long-Term Financing Operation (LTRO)] the European Central Bank printed about 1 trillion euros in just the last few months.

But this much-heralded LTRO isn’t fueling purchases of risky assets — at least not yet. If investors follow the money, they’ll discover that banks are depositing the three-year euro loans they borrowed from the ECB right back at the ECB! These banks are, obviously, not in a hurry to speculate with the cash proceeds from their three-year LTRO loans.

Here’s the part about EU bank behavior that should terrify anyone basing an investment strategy on the fact that the PIIGS governments will continue to enjoy lower and lower yields at sovereign bond auctions: The banks that borrowed three-year money from the ECB at a cost of 1% per year are willing to redeposit the cash at the ECB for a 0.25% per year return. In other words, banks are willing to suffer a “negative carry” of 75 basis points just to have cash available to satisfy depositors at a moment’s notice.

The most plausible explanation for this behavior: Banks will use this cash to satisfy their own lenders and depositors, many of whom will decide not to roll over their loans to these banks. EU banks are, in short, replacing private-sector funding with ECB funding.

Here is the consequence: the slow-motion nationalization of many European banks. When the LTRO loans mature in three years, many of them will not be able to go back to the private-sector funding model. This will ultimately force the ECB to indefinitely roll over the LTRO loans to insolvent banks. A better name for the “long-term refinancing operation” would have been “infinite refinancing operation” (for as long as the euro exists) — or, for the acronym fans, IRO until RIP EUR.

As European investors realize this LTRO cash will be used simply to satisfy maturing liabilities, we’ll probably go right back to the market environment we saw in July-September 2011. The situation in Europe is as fragile as ever. Political change in Greece has the potential to bring about a messy default, and the April election in France has the potential to spark the end of the euro by ending the Merkel/Sarkozy “bailouts at any cost” status quo.

The euro crisis is about as “solved” as the US financial crisis was solved after the March 2008 Bear Stearns rescue. I remember spring 2008 well, having spent hours identifying the next banking victims of the US mortgage crisis, while the consensus breathed a sigh of relief (as it is today), that the Fed rescue of Bear Stearns “solved” the mortgage crisis.

The only thing these central bank rescues accomplish is to impose the cost of bank bailouts onto the holders of paper currencies. That’s why the S&P 500 Index remains 50% below its 2008 peak in real (gold) terms, even though the index is only 12% below its all-time high in nominal terms.

All the cash the central banks are printing is dry tinder for a great explosion in consumer prices that should, unfortunately, more than offset any meager gains in the S&P 500 that have the talking heads in the financial press so excited.

Here’s the good news: By the end of this bear market, the S&P will be an even tinier fraction of gold prices. If you save heavily in the form of gold, your buying power when the next great stock buying opportunity arrives will be that much greater.

As central banks prop up bankrupt governments with newly created money, an ocean of paper money will be desperate to own gold, bidding it up in the process.

Over the next few years, I expect that as consumer prices rise, investors will greatly hike the rate at which they discount future corporate cash flows, which will result in much lower price-earnings ratios for most stocks.

The list of negative market catalysts is long and scary. The list of positive market catalysts is nothing to get excited about. The most-important positive catalyst to drive the market up from here is an old standby: “Stocks offer a better total return, including dividends, than 2% Treasury bonds and 0% bank CDs.” This meme is ready to celebrate its second or third birthday, by my calculations. It’s front-page news. It’s a talking point for financial advisers and Wall Street strategists. So it’s hard to argue that this well-worn debating point of the bulls is not already reflected in stock prices.

Regards,

Dan Amoss,
for The Daily Reckoning

Dan Amoss

Dan Amoss, CFA, is a student of the Austrian school of economics, a discipline that he uses to identify imbalances in specific sectors of the market. He tracks aggressive accounting and other red flags that the market typically misses. Amoss is a Maryland native, a graduate of Loyola University Maryland, and earned his CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts, advising readers to hold the position as the stock fell from $45 to $12. Amoss is managing editor of the Strategic Short Report.

  • Diego Torres

    If banks where lending the money borrowed at the ECB, and the borrowers then buys houses, cars, and other stuff, and the sellers buying other stuff, at the end the money would end up in a bank account and being deposited at the ECB, unless people are withdrawing money from their accounts and placing them under the bed. I think the author should learn a little bit more about what a fiduciary monetary system works. I suggest you can look at the velocity of M2 or the total level of credit by institutions to really see what´s going on. I agree that banks are using that money to repay debt, but obviously that cannot be seen by the amount of money banks deposit at the ECB. You cannot make stuff like this!! let´s be serious. Best regards.

  • http://www.bullionuk.com jrt

    Protect your wealth, research gold in europe at http://www.bullionuk.com/blog

  • gman

    “an ocean of paper money will be desperate to own gold”

    real gold or paper gold?

Recent Articles

5 Min. Forecast
How to Profit On the Back of an “Activist Investor”

Dave Gonigam

Since the invention of the "shareholder rights plan" (i.e. the "poison pill"), most companies are relatively immune to hostile takeovers. But according to Dave Gonigam that could all change thanks to one activist investor. And if you're savvy enough, you may just be able to follow his lead for big gains. Read on...


Extra!
Why Americans Shouldn’t Worry About Income Inequality

Jim Mosquera

As the markets have continued to rally over the last several years, more and more people have touted the problem of "income inequality" in the US. But as Jim Mosquera explains, this perceived problem will likely sort itself out with the arrival of one specific market event. Read on...


One ETF to Play Asymmetric Warfare

Addison Wiggin

Almost one year ago, substation telephone cables were maliciously cut in San Jose, CA. In 20 minutes, 17 transformers were knocked out. A year on, similar threats have cropped up. Today, Addison Wiggin explains why these threats are so serious for the safety of the global economy... and shows you one way to play it...


What Small-Caps are Saying About the Current “Bubble”

Greg Guenthner

The big problem with declaring bubbles is that it really does you no good. Unless you're attempting to measure and time market moves, you're also blowing hot air. But if you keep watch for negative divergences, you have a much better shot at figuring out big market moves than the latest bubble-busters. Greg Guenthner explains...


A Simple Strategy for Investing in the US Energy Boom

Byron King

Too often investments are made in a vacuum. But as Byron King demonstrates, the global economic crash... easy money... and technological advancements are all interdependent. In particular, that connection has changed the investment calculus in the resource market. Read on to learn how...


How Gold Will Respond to Declining Discovery

Henry Bonner

Oil isn't the only resource to experience "peaks." Due to a major contraction in gold exploration over the past few years, the mining sector is no longer mining gold at its replacement rate. In other words, the amount of gold above ground is running out. And according to Henry Bonner, it will get worse before it gets better...