European Banks Stress Tests and Other Bad Jokes

We like a good joke. Here’s a cute one:

What’s invisible and smells like carrots?
Answer: Bunny farts.

Here’s another one…

Two fish swim into a wall. The one turns to the other and says, “Dam!”

But we don’t like bad jokes very much. Here’s one:

What did the fisherman say to the card magician?
Answer: Pick a cod, any cod!

Here’s another one…

Many large European banks are solvent.

The recent stress tests of European banks were “a joke,” according to Jim Chanos, the famous short seller who laughed all the way to the bank when betting against fatally flawed companies like Enron, Conseco and Boston Chicken.

“The [stress] tests are a joke,” Chanos declared during an interview yesterday on Bloomberg TV. “The accounting is a joke and the markets are beginning to say, ‘No More!’” Chanos said he would be short these banks right now if European regulators had not outlawed the practice last month.

The stress test “joke” is only one small sliver of the European game of make-believe. Central bankers and politicians throughout Europe are continuing to pretend that various insolvent banks and insolvent governments are in fine shape…as long as they get a little bit of help form the ECB.

But the financial markets are providing ample evidence to the contrary. The share prices of many European banks are plummeting, while the yields of many European government bonds are skyrocketing. The now-infamous Greek two-year government bond yields a whopping 134%!

In other words, even if European banks can pass a contrived stress test with flying colors, they are flunking the “normalcy test.” Many European banks, like many European governments, have erected such a fragile and precarious financial structure that bankruptcy seems inevitable, even without any additional stress.

A deepening crisis of some kind is certain, especially because the US economy is still reeling from the credit crisis of 2008. Fearing a repeat of ’08, the US Federal Reserve is springing into action, which pretty much guarantees a repeat. Earlier today, the Fed christened the launch of “Operation Twist” — a scheme to buy up a bunch of the long-term Treasury bonds.


Don’t be. Operation Twist is simply a new form of Quantitative Easing, which was simply a new form of printing money out of thin air. (The Fed says it will pay for its new purchases with proceeds from the sale of the short-dated Treasuries it already owns. We don’t believe it. By hook or by crook, the Fed’s balance sheet will probably grow over the next few months. We will be watching). Op Twist, therefore, is merely the next illogical step in a regrettable progression toward dollar debasement. After Op Twist, look for Operation Contort, Operation Zig-Zag, Operation Bait-and-Switch, Operation Capital Control and ultimately, Operation Devalue.

The longer the Federal Reserve continues its misguided operations, the bleaker the prospects for the US dollar. But the greenback is not the only paper currency at risk these days. The formerly stodgy, conservative Europeans are beginning to call plays from the American Central Banking Playbook.

The European Central Bank (ECB), in response to the sovereign debt crisis unfolding around the periphery of the euro zone, has embarked on a quantitative easing program of its own — buying billions of euros worth of Greek, Spanish and Italian government bonds in the open market. At the same time, the ECB is also part of a central banking cabal that is providing undisclosed quantities of short-term credit to European banks. And to judge from recent headlines, the ECB is just getting warmed up.

The European Systemic Risk Board (ESRB) announced earlier today that systemic risks within the Europe Union’s financial system “have increased considerably” over the last three months. According to the ESRB’s grim diagnosis, “Key risks stem from potential further adverse feedback effects between sovereign risks, funding vulnerabilities within the EU banking sector, and a weakening of growth outlooks both at global and EU levels…Signs of stress are evident in many European government bond markets, while the high volatility in equity markets indicates that tensions have spread across capital markets around the world. The situation has been aggravated by the progressive drying-up of bank term funding markets, and availability of US dollar funding to EU banks had also decreased significantly…

“The high interconnectedness in the EU financial system has led to a rapidly rising risk of significant contagion,” the ESRB concludes. “This threatens financial stability in the EU as a whole and adversely impacts the real economy in Europe and beyond.”

The ESRB’s prescribed cure: More of everything that hasn’t worked. The ESRB — sounding a bit like Broderick Crawford in the old Highway Patrol TV series, yelling into his police radio, “Calling all cars! Calling all cars!” — called on “all authorities” to band together and do something.

“Decisive and swift action is required from all authorities,” the ESRB warned. “Authorities must act in unison with a total commitment to safeguard financial stability. Supervisors should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities…[And if necessary] lend to governments in order to recapitalise banks, including in non-programme countries.”

In other words, print euros, dollars, Swiss francs or anything else you can print and throw it in the direction of failing financial institutions and/or bankrupt sovereigns.

Your California editor will not judge the merits or shortcomings of the ESRB’s directive; but he will hail it as yet one more undeniable “buy” signal for gold and silver.

The surging bull market in central bank hyperactivity is all-but-certain to deliver a robust and long-lasting bull market in precious metals. Thus, for the fourth time in the last six editions of The Daily Reckoning, we turn our attention to the gold stock sector.

As if following The Daily Reckoning’s script, gold mining stocks aroused from their slumber last Thursday — immediately after we highlighted their months-long underperformance, relative to gold itself, and remarked, “Gold stocks are very lowly priced, relative to gold. This looks like a buying opportunity, not simply because gold stocks are cheap relative to gold, but also because gold stocks are cheap from almost every fundamental perspective.”

Since those words appeared, the prices of gold and silver are both down about one percent. But curiously, most gold stocks have gained ground. Some have gained a lot of ground.

The HUI “Gold Bugs” Index is up more than 4% since last Wednesday. A short list of standouts would include:

  • Newmont Mining (NEM) — Up 8.5%
  • Silver Wheaton (SLW) — Up 9.0%
  • Anglogold (AU) — Up 7.2%
  • Goldfields (GFI) — Up 9.1%
  • IAM Gold (IAG) — Up 8.1%

This recent past might not be prologue, but why wouldn’t it be? In a world of increasingly suspect paper currencies, what’s to stop gold from continuing to rally? And in a world of hyperactive central banking — when money-printing is the go-to cure for whatever ails a sickly economy — what’s to stop gold stocks from soaring?

Gold is not a “Sell,” and neither are gold stocks.

Eric Fry
for The Daily Reckoning

The Daily Reckoning