December 23, 2011

A Bailout By Any Other Name

Not-So-Stealthy QE

As we happily head into the Holidays, I believe there are important things to keep our eyes on.  One of them is, as I see it, that increased money printing/quantitative easing (QE) continues – and has accelerated to new levels.

Specifically, recently ECB (European Central Bank) President Mario Draghi lowered the key benchmark interest rate by 0.25% to 1.00%, cut in half the reserve requirement ratios for European banks, lowered the lending credit rating threshold for acceptable bank collateral to “single-A,” while also offering Euro-banks large-scale three-year loans.[1]  On December 21, it was announced that the ECB had awarded 523 European banks 489 billion euros/$645 billion in cheap (1% interest rate) loans.[2] Per Bloomberg, this is the largest amount ever in a single undertaking, and was far greater than economists’ average estimate of 293 billion euros.[3]  Traders polled by Reuters had expected the amount to be 310 billion Euros[4] – another gross under-estimation.

The large numbers don’t surprise me.  Due to the bad shape of the global banking system, massively indebted governments, resulting shaky sovereign debt, and an uncertain at best world economy – this is a trend I expect to continue – and to increase.  In my opinion, as central bankers continue in their attempts to obfuscate what they are really doing — I’ll call it what I see it as – money printing.  Like the Federal Reserve Bank has in its rounds of QE, the ECB came up with the dough for these massive loans via newly created money out of thin air.

Thanks But

I believe ECB (along with Federal Reserve and other central bank) money printing will accelerate.  After this new capital infusion, Draghi may be hoping European Banks will now step up their purchases of Euro country sovereign debt, but I believe that’s highly unlikely.  Why would European banks repeat perhaps the major mistake which has gotten them into the mess they are currently in?  On the contrary, I believe just as in the United States during the post Lehman bailouts where large banks were recapitalized (i.e. got to off-load $trillions of bad sub-prime mortgage/student loan/credit card backed debt onto the Federal Reserve’s balance sheet in exchange for $trillions of Treasuries the Fed purchased with money created out of thin air) — European banks will not go on a lending/buying spree.  Instead, I think Euro-banks will avoid the sovereign debt of countries in the worst shape.  The same countries that need their debt financed/purchased the most desperately.

So while large European banks may have been granted a little breathing room for now, I don’t see the crisis resolved at all.  Risk of sovereign default still looms large.  I believe the day is approaching when either the ECB, IMF, the Fed, or all three will be forced to step up their printing (in amounts which could be stupefying) and buying, to continue to attempt to bail out large banks and countries which have managed their finances poorly.

As Ernharth Group clients know, I believe there is a right side to that trade.  It’s my opinion you don’t want to be on the wrong side of it.  As always, we remain vigilant and plan accordingly.  Keep an eye on my year-end commentary next week.

As always, I maintain my positive outlook.  That outlook is based on my belief a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – I believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances.  Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.