The Euro Has Very Real Problems - And Nobody Really Stands Behind It

Thursday, October 16, 2008

Sorry for missing out on such first-in-a-lifetime-headlines like "Eurozone Throws €2.3 TRILLION At Banking Debacle and It Will Not Be Enough" or "Politicians Still Not Realizing What Kind Of Financial Tsunami Is Right Ahead Of Us" due to a stubborn flu.
But I think a lot of the political talk that fills airwaves and newswires as a recession is engulfing Europe will never have been more than hot air.
Reasoning that we are at the point of no return on the way into a drawn out recession if not depression because politicians are only demonstrating helplessness while the global margin call would have required action since 2006, I stand by my opinion that Euroland is destined for surging monetary inflation in the near future.
The latest datapoint is a very remarkable one. While EU politicians keep on talking about a unitary solution to the banking debacle, the ECB quietly rumps up its money creation to Weimar style.
While TV would have offered me Madonna's divorce settlement and all details around, the more interesting information is to be found on the ECB's website
Just watch the chronological order and discover that the ECB will flood the market with any amount of new debt until a political situation will be found. The latter may take a lot longer due to the varying size of the EU banking debacle in its member states.
ECB president Jean-Claude was on tour de calm on Monday with a speech titled "The financial turbulence: Where do we stand?" At that stage he suggested more and more fresh Euros to come until politicians would find a solution to the crisis that begins to hurt the real economy almost overnight.
Trichet also suggested there will be more government intervention.
This plan has six dimensions: ensuring appropriate liquidity; facilitating the funding of banks through various means (guarantee, insurance or similar arrangements for new medium-term – up to five years – bank senior debt issuance); providing additional capital resources to financial institutions; recapitalisation of distressed banks; ensuring appropriate implementation of accounting rules; and enhancing cooperation among European countries.
Tuesday was filled with various governments reassuring savers that their money would be safe in the bank. That day European taxpayers were taking on a risk of potentially €2.3 TRILLION. Prove me wrong for €500 million up or down from that figure.

More Shots In The Back Of The Euro 
It does not matter anymore as the ECB will continue to print Euros without any shyness. They did not lunch for long. According to a press release the ECB announced more limitless funding, this time with the Swiss National Bank (SNB),
Each Monday, starting on 20 October 2008, the Eurosystem and the SNB will conduct EUR/CHF foreign exchange swaps providing Swiss francs against euro with a term of 7 days at a fixed price. The fixed price and the maximum amounts allotted by ECB and SNB will be announced before the operation.
Still the same day the ECB came out with more shots in the back of the Euro. Check the release for much more detail than the 3 main points of action:
  • The list of assets eligible as collateral in Eurosystem credit operations will be expanded as set out below, with this expansion remaining into force until the end of 2009.
  • As from the operation settling on 30 October 2008 and until the end of the first quarter in 2009, the provision of longer-term refinancing by the Eurosystem will be enhanced as set out below.
  • The Eurosystem will start offering US dollar liquidity also through foreign exchange swaps.
The details offer the expected: As long as you have any crap to offer as collateral, we will take it and give you unbacked Euros. As much as you want.
The threshold is very low and so are the haircuts to the securities the ECB will accept as collateral.
The Eurosystem will add the following instruments to the list of assets eligible as collateral in its credit operations:
  • Marketable debt instruments denominated in other currencies than the euro, namely the US dollar, the British pound and the Japanese yen, and issued in the euro area. These instruments will be subject to a uniform haircut add-on of 8%.
  • Euro-denominated syndicated credit claims governed by UK law.
  • Debt instruments issued by credit institutions, which are traded on the accepted non-regulated markets that are mentioned on the ECB website; this measure implies inter alia that certificates of deposits (CDs) will also be eligible when traded on one of these accepted non-regulated markets. All debt instruments issued by credit institutions, which are traded on the accepted non-regulated markets, will be subject to a 5% haircut add-on.
  • Subordinated debt instruments when they are protected by an acceptable guarantee as specified in section 6.3.2 of the General Documentation on Eurosystem monetary policy instruments and procedures. These instruments will be subject to a haircut add-on of 10%, with a further 5% valuation markdown in case of theoretical valuation.
  • Furthermore, the Eurosystem will lower the credit threshold for marketable and non-marketable assets from A- to BBB-, with the exception of asset-backed securities (ABS), and impose a haircut add-on of 5% on all assets rated BBB-.
All these measures spell I-n-f-l-a-t-i-o-n to me.

Desperate ECB Expands Liquidity By €310 Billion In 7-Day-Repo
The numbers back up the fear gripping credit markets. In order to keep the Eurozone banking system afloat, the ECB accepted all offers with a volume of €310 billion at its latest 7-day tender at the fixed rate of 3.75%.
Okay, in these days where TRILLIONS swarm in the thin air, a paltry €310 billion, basically a tad more €1,000 in future tax payments for every Euroland inhabitant, wont really make one scratch his head. 
But this figure certainly turns into a zombie robbing my sleep. The ECB has lent out "only" €445 billion toxic liquidity since the beginning of the crisis in August 2007.
While this may still sound tame in the face of a looming derivatives default, potentially worth almost $600 TRILLION, the ECB keeps the spigots wide open. Only on Thursday we saw a $170 billion 7-day repo while politicians were still talking about a common solution to the crisis.

Key Structural Deficit Of the Euro
These ongoing fixes may buy some time, but politicians run the imminent risk of skyrocketing monetary inflation if no plausible solution is brought forward in a few days. Markets partially expect this too, but what is a 5 basis point change in the LIBOR these days?
The Euro weakness also reflects the key structural deficit of the common currency. It has no treasury standing behind it. (And I would raise to arms if the EU would propose such a thing.) It is a fiat currency par excellence, backed by nothing than the diminishing belief that today €100 would buy you the same amount of services or goods in the future.
Eurozone inflation will probably bachtrack in October due to the crash in crude prices.
The spiral of fear is pre-programmed anyway already. Merchants are unwilling to lower prices in expectation of a resurge in commodity prices and employees are demanding wage raises in the high single digits.
Always eager to helicopter Euros around the world the ECB also entered into a "cooperation" with the Hungarian Central bank which is no Euro member.
I am confident we will see the ECB lending explode in the unknown world of TRILLIONS of new debt within a few months that may be everything but not the salvation before the sad end of capitalism that has gone bonkers in this millennium.
The next step will be surging government intervention.
After a wave of state guarantees that are anyway coming out of the pockets of taxpayers EU countries will hammer down new sets of regulation of the banking sector. This will come hand in hand with more nationalizations. Tiny Austria may even go so far as to expropriate bank share holders without the possibility of an appeal, the Austrian daily "Der Standard" reported on Wednesday.
Karl Marx must be having a good drink in heaven these days and I will soon come up with another post on the doubtful future of the Euro.

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