Europhoria

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–Yesterday was the day the world’s capital markets turned into a giant fiat money casino. Consider yourself warned. You can trade your way to profits this in this market on the tide of easy money being printed now by the Federal Reserve and the European Central Bank. But the financial markets are now setting up for the mother of all collapses.

–Up until yesterday, we’ve seen the end of the super cycle in fiat money as a process that could take years to unfold. The piecemeal nationalisation of certain industries…the assumption of private sector liabilities on the public sector balance sheet…the abrogation of contract in the form of defaulted mortgages that are not foreclosed on…and higher-and-higher public debt-to-GDP ratios were all signs that the government everywhere was sucking the life out of the economy to preserve the status quo, and turning dozens of firms and institutions into zombies with no real productive economic future.

–But yesterday is a day that sent a bit of a chill down your editor’s spine. And it’s not because the €750 billion bailout package by the ECB caused a frisson here in St. Kilda. Granted, it did wonders everywhere else. The S&P 500 was up 4.4% in New York. Local stocks rallied. And most impressively, the spread between 10-year Greek debt and equivalent German bunds shrunk by a massive 570 basis points.

–And if you’re a speculator – and especially a high-yield bond hunter – why not get on the gravy train? If the ECB is going to print money to buy public and private sector debts to “ensure depth and liquidity” in certain markets, it’s not a trend you want to fight. If the central banks are going to splurge on assets to support debt markets, bond yields will fall and asset prices will rise. For now.

–But we reckon it is not for long. This really is Act V of the fiscal welfare state, in which monetary policy becomes the shameless handmaiden of fiscal policy in order to sustain an unsustainable kind of riskless society with massive benefits for everyone paid for by a few. That is an unaffordable illusion, the shattering of which leads to lower standards of living – a fact many in Europe find politically unacceptable (even if the fiscal facts speak for themselves).

–To delay the day of reckoning, the ECB is offering European banks nearly unlimited amounts of cash for three and six month borrowing periods. You can imagine those banks – proud owners of heaps of sovereign debt from Greece, Spain, Italy, Ireland, and Portugal – are happy to sell that stuff to the ECB and borrow some short-term cash to lever up into an equity rebound. More privatised profits and socialised losses that favour the financial industry.

–And why wouldn’t you play that game if you were playing with other people’s money? We’ll get to WHOSE money in just a moment.

–The immediate question you might have is, “Will this work?” It depends on what you mean by “work”. By throwing wads of cash at stressed banks, the ECB alleviates the immediate threat in the market that bond yields spike and a liquidity crisis sets in. But enabling debt-laded countries to take on more debt hardly seems like a long term solution to the problem of living above your national means.

–“You cannot make any nation that is unable to service its accumulated debts more creditworthy by extending more credit!” said Jeremy Batstone-Carr, analyst at Charles Stanley in today’s Wall Street Journal. “If the EU lends Greece money, the loan will increase that country’s public sector debt. The interest on the additional loan, whatever it eventually proves to be, will increase the public sector deficit. Total debt-servicing costs will rise, raising the burden on public sector cash flows. At some point in the future, the loan will have to be paid back.”

–EU policy makers hope that by extending more credit now to sovereign governments, bond investors will just, you know, back off! It’s amazing to read how officials blame derivatives and a “wolf pack” of speculators for the crisis. As if it was the speculators who ran up huge debt-to-GDP ratios. As if the solution was to ban credit default swaps and remove the one market pricing mechanism which alerts investors to rising sovereign credit risk.

–Incidentally, this is a minor trading point…but worth thinking about…who is on the other side of all the credit default swaps underwritten on European debt? Remember it was AIG that collected premia by writing default insurance against sub-prime mortgage backed securities and collateraised debt obligations. Goldman, among others, bought that insurance.

–If you were a handy speculator right now, you’d find out who sold default insurance on Greek and Spanish debt. And then you might consider shorting the daylights out of them.

–Of course maybe the ECB really has solved the problem by throwing a wall of fake money at it. But we reckon yesterday’s action gives you fair warning about what’s ahead and a bit of time to do something about it. A massive monetisation of debt and an increase in public sector liabilities has now been set in motion. The euro itself will soon, again, become a target of speculators once the next major tranche of sovereign debt must be rolled over and there’s no one but the ECB there to buy it.

–How long can Europe pay its bills and creditors with money that doesn’t exist?

–But the buried item in yesterday’s news reveals that the U.S. dollar might be on the hook too. The Fed re-opened its swap lines with major banks around the world. This means the Fed will be expanding its balance sheet again…and sending a flood of dollars out into the world to shore up banks that need them. The Fed had closed the swap line with the ECB in February, when everything was just fine.

–To the barricades, dollar standard! But this really could be a kind of lass stand for the dollar as the world’s reserve currency. Unbeknownst to the American taxpayer, the Bernanke Fed has now thrown the dollar once more into the breach of a liquidity and solvency crisis. It may not survive.

–That’s what you should watch for, then: the expansion of the Fed’s balance sheet. It will be hard to keep your eyes on that target with so many green numbers on so many shares and indices. The ECB has invited the entire financial world to speculate on the house. The ECB’s monetisation – with the Fed’s cash – is going to lead to a quick reflation of some markets; that’s for sure.

–The biggest inflation, though, could come in precious metals. In fact, as a hedge against the central bank monetisation strategy, precious metals are about the only sensible speculation in a market which has essentially been reduced to total speculation by the distortion of values from the flood of money.

–Things that can’t be printed by a central bank and aren’t anybody else’s obligation to pay might be the best investments for the rest of this year. And beyond?

–The Welfare State has met its great funding crisis with a fraud. And the fraud is going to cost a lot of people a lot of money. If you’re in markets now, be aware that markets no longer bear any relation to underlying risk or reality. It’s never been more dangerous. And given the last few years, that’s saying something. More tomorrow on when the U.S. debt shock may hit.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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17 Comments on "Europhoria"

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Realist
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I know this topic has got a lot of attention from Dan but is it really inevitable that the markets will be held to account? Or will this perpetual need to rescue nations that are faltering see these grossly mismanagement economies go unaccounted for. To me this behavior sends a signal to all individuals and nations who can borrow, be that $100 or $100,000,000, to do so at their own discretion. There will be NO accountability for financial promiscuity, take the risk we will bail you out. I have spruiked heavily about the Australian housing market being at least 50%… Read more »
Ross
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Ah Dan, the idea of fair and rational bets is an anachronism. USD leverage can take market prices and the cost of debt any which way toward crony profit. And overall their best opposing player is always going to be the taxpayer. So that means the EU bailout will fail and Goldman will profit. The banksters think that control of unchecked debt can create anything endlessly no matter the corner they fight from … as long as they can beat those on the other side. Getting the opponent to play on their home currency means game over …. so they… Read more »
watcher7
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“If you’re in markets now, be aware that markets no longer bear any relation to underlying risk or reality” – what ever if this means, don’t let it get in the way of a good-buying opportunity. “It’s never been more dangerous” – time to buy, or don’t give up on the stock market just yet? “Investors in oil shares are more bullish on the U.S. economy than any time in the last eight years, convinced the biggest decline in equities since the bull market began will prove a buying opportunity. “The 39 energy producers and equipment makers in the Standard… Read more »
Stillgotshoeson
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Gold Maintains Solid Gains, Close to All-Time High By Jim Wyckoff 11 May 2010, 10:41 a.m. Comex gold futures came within a couple dollars an ounce of scoring a fresh all-time record high Tuesday morning. June Comex gold hit a high of $1,225.20 Tuesday, which is just shy of the record high of $1,227.50, basis nearby futures, hit in December of 2009. June gold last traded up $17.70 at $1,218.50. Gold continues to benefit from safe-haven buying interest amid the European Union’s sovereign debt crisis that just will not fade into the background. Looks like it is not being taken… Read more »
Lachlan
Guest

12/05/2010 6am ……gold @1233.. parabolic mode. Crumbs this last rally went from 1184 to here in 36hours. Gettin scary…think I might start building a bunker :(

Lachlan
Guest

The rescue packages get incrementally larger as the gold rallies get larger.

John
Guest

“If Moses and Irving Fisher were alive today they would shake their heads.”

If Mary and Joseph were alive today, they’d shake their heads and guffaw:
“Jesus, what was _that_ all about?!~”

Biker Pete
Guest

When Nostradamus wrote his treatise ‘Cash in the Shrubbery’ on 10th July 1543, noting convergence of the heavens “…when the moon is in its seventh house and Jupiter aligns with Mars…” was he simply referring to hegemony?

Ross
Guest
Reading watcher7 is always a pleasure. Watcher hasn’t explained the Dow flat lining through the norties. I was onboard equities in May 08 and he only got on later in 09. I think his wave is out of synch and the market had hit his Dec10-Nov 11 already. He thinks liquidity has hit the streets, many others do too. In Australia I agree somewhat & in China I agree but in the US where consumers are post-maxed out and in an EU where each person is more fearfull of their liabilities I don’t see it. Upper income borrowers in Australia… Read more »
Biker Pete
Guest

Yes, the references to America football teams’ performances affecting global economies are as instructive as his prediction that Australian property will fall by 60%. Our local big girls’ netball team has had seven straight wins, which probably means an out-of-synch tsunami will wipe east coast cities off the map, bringing about mass migration to the West, where values will rise.

As Lachlan suggests: “…think I might start building a bunker :( “

John
Guest

You’re not de-bunking the relationship of the Pittsburgh Steelers winning streak to the DOW Jones Industrial Average, I hope, BP? You really don’t understand the principles of alchemy, do you, you godless fool?!~

Biker Pete
Guest
“You really don’t understand the principles of alchemy, do you, you godless fool?!~ ” Well, it appears I can turn beach sand into gold, son. This morning’s ‘West Australian’ (p. 12) reports that the beach suburb in which we have most of our property appreciated 26.4% in the last twelve months. By contrast, the beach area we quit only appreciated 10%. Must be doing something right. :) OK, if it makes you happy I’ll concede Watcher7’s claim that an American football team’s success does, in fact, drive the DOW Jones Industrial Average. Will that help me pass through the Pearly… Read more »
John
Guest

Ah, but Nostrildamus nose all, Biker Fool. Was it not written that he shall descend from the great Virgin (Richard Branson) to breathe upon your lands a hot fiery breath… and lo, the stargivers shall smite thee a great smote and shall turn their first finger to point lo? Look, granddad, anything I decree earns me the five-pointed blessing… and thyself the cheese.
It is written.

watcher7
Guest
Ross wrote: “Watcher hasn’t explained the Dow flat lining through the norties”. A little background first – in viewing the future, I employ the Anglo-American Hegemonic Cycle (AAHC). This cycle takes as its starting-point the ‘Kondratiev Wave’: “In the early 1920s a Russian economist N.D. Kondratiev, later an early victim of Stalin, discerned a pattern of economic development since the late eighteenth century through a series of “long waves” of from fifty to sixty years, though neither he nor anyone else could give a satisfactory explanation of these movements, and indeed sceptical statisticians have even denied their existence. They have… Read more »
Stillgotshoeson
Guest

“This time round I expect to see inflation, raised interest rates and then massive deflation.”

Me too.. Have said as much in previous posts on the topic of inflation/deflation..

John
Guest

“This time round I expect to see inflation, raised interest rates and then massive deflation.”

Hindsight helps of course.

Based on your AAHC instrument, the estimated timeframe for these three periods would be…. ?

Inflation: 2010 –

Raised Interest Rates: 2010 –

Massive Deflation: –

Ross
Guest
Watcher, I missed this post and shoes reply for some reason. I was going off memory of your earlier long wave posts, apologies if I misinterpreted your cycle. I was value picking mid 08 and you have exposed my dim market recall. Memory works but recall has issues. Am always looking forwards but I do pay regard to your thoughts. Shoes, I see velocity as a real rather than an imagined issue in inflation. There is enough stimulus out there for velocity but for mine it hasn’t escaped the bottomless holes of fed and bank balance sheets in the US.… Read more »
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