Europe Money Flood

As a follow up to my recent comments about the sovereign debt crisis in Europe, I want to comment briefly about the flood of money that has just been released by the European Central Bank (ECB). Today, February 29, 2012, the ECB allowed any bank that is in a Common Market country to borrow unlimited funds at nearly zero interest rates for three years (see http://finance.yahoo.com/news/second-cheap-money-round-hard-171320240.html). The total taken was 529B euros ($710B, @ 1 euro = $0.7450). This is the second such offering. Last November, the ECB loaned about 479B euros ($650B). The grand total is now 1.02T euros. Someone suggested that there was some shorter-term debt owed ECB that the banks paid back and that the net new made-up money amount was close to 600B euros ($805B).

Much of the money from last February was just put back into accounts with the ECB. That’s right, when the banks had billions sitting around doing nothing, they took billions more. What the hell, the money was nearly free.

The justification for this exercise in Disney finance was that the banks were no longer willing to make loans to. The banks were not sufficiently confident to risk making loans to nearly anyone. Interest rates for the debt of many European governments was going up, loans to businesses, especially small businesses were declining, and loans to other banks had essentially stopped, even the overnight loans. That’s right. Overnight loans to other banks were deemed to be too risky.

So now, European banks have lots of money. Lots.

What have we seen since November?

Interest rates and the availability of money to governments, even to countries with severe problems like Italy, Spain, and Portugal, has vastly improved.

Commodity prices have begun moving up again. The spot price for copper has climbed over 15% in the last couple months (when it looks like the Greek bailout would go through the copper price would go up, when not, down).

The euro has fallen against the dollar. (The euro would fall against the yen, but the Japanese are doing all they can to make the yen fall. This is the called world competition.) We can count on prices in the euro zone to begin climbing.

These are the more obvious consequences of this flood of money. I am sure that more will surface as time go by.

One interesting thing to look forward to is the time when these loans need to be paid back. Some of the bonds that the banks are buying have a longer time to maturity than three years. How are they going to get their money out? If all the banks are selling bonds at the same time what will that do to the markets and interest rates? Do the banks think that the European economy is going to be robust enough for the banks to be making money or to acquire capital? I did see that one governor of the ECB was concerned with the bank’s ability to pay back these loans. He suggested that the governments be ready to bail out the banks in three years. Which would mean more made-up money or higher government debt.

The banks also have to improve their balance sheet to meet the ECB’s new equity to loan requirements of ten percent. Where is that capital going to come from?

The ECB is prohibited by charter from buying government bonds directly from the government auctions, i.e., financing the debt of the euro zone governments. But that is what they have done by giving the banks cash. In fact, before the first set of loans had been taken, the French President suggested that the banks should put the ECB money immediately into bad bonds. It is such a bad idea. Letting interest rates come down for the problem countries makes it seem as if there isn’t much urgency for them to spend less or engage in economic reforms that are necessary if people are going to find jobs and survive. This exercise is counter-productive. The Europeans have not learned anything.

There is such a fixation with the immediate short-terms that you wonder if people have been surgically altered. To solve problems that they created a little while ago (which they aren’t willing to admit to – except for the excessive government debt to a limited extent) they engage in actions that will create greater problems just a few months later. The process is a spiral, and it is becoming tighter.

It is amazing that they think that putting 600B euros into their economy will have only good consequences.

So, everyone:

Short the euro. Go long on commodities and European stocks, as there will most likely be an equity boom. But be careful. Who knows when that bubble will bust. And, if you plan to go to Europe, you can plan on not having to spend as much. The dollar will be able to buy lots of euros, at least as long as the money that the Fed tried to put into the economy, which is twice the amount the ECB created in Europe, still sits as deposits at the Fed.