The World Bank has just turned up to the party, telling everyone to go home and sober up. But with the music blaring and the booze flowing, no one is listening. Besides, the party only just started. 2012 is a new year. The 'January effect' - which says stocks usually enjoy a rally at the start of the year based on nothing more than blind optimism - is in full swing.
The front page of the Australian reports...:
The World Bank warned that the crisis in Europe could trigger a credit freeze that threatened to be worse than the 2008 crash that sent Wall Street investment bank Lehman Brothers bankrupt and ushered in the worse economic shock since the Great Depression.
We appreciate the insight. But everyone has known this for ages.
That's not to say it's wrong though. It's just nobody cares. With the European Central Bank (ECB) joining the Fed in their own special version of quantitative easing - and the prospect of much more to come - the stock market wants to party.
The 'credit freeze' the World Bank mentioned is off the table for the time being. Mario Draghi, new ECB boss who completed his monetary apprenticeship at Goldman Sachs, has conjured up a sneaky way to print money while giving the impression he's doing nothing of the sort.
As soon as Draghi took the helm in November last year he began talking out of the corner of his mouth. Like all good central bankers, he believes words speak just as loud as actions. Here's a snippet of what he had to say at his first public appearance as ECB head:
Gaining credibility is a long and laborious process. Maintaining it is a permanent challenge. But losing credibility can happen quickly - and history shows that regaining it has huge economic and social costs.
Six weeks later he opens the ECB's balance sheet up for all of the European banking sector to dump their toxic debt into. And he handed out nearly €500 billion euros in return. As Dan wrote yesterday, rumour has it the next 'long term refinancing operation' will see the ECB's balance sheet take on another €1 trillion of garbage debt.
No wonder the market is in rally mode.
Given Draghi talks about credibility, but acts in an incredible manner, it's no wonder the euro continues to sink. Look at the performance of the euro against the Aussie dollar...
A croissant and a café noir are as cheap as ever.
Which brings us to a question we received from a Daily Reckoning reader last week. He and 'the missus' are off to Italy in April and are a tad concerned. If they load up on euros, what would happen if Italy went back to the lira?
With Greece's return to the drachma still a very real likelihood it's a good question. But maybe Greece and its fellow uncompetitive peripheral nations will stick with the euro. Maybe the 'Northern League' nations, headed by Germany, will exit and form their own currency.
Here's our rationale. Forget for the moment Draghi's bank bonanza scheme. It's a time-buying exercise that does nothing to solve long-term imbalances. What it does do though is weaken the euro. This is good for the peripheral nations' exports.
Germany might complain about money printing by the ECB. But as an export powerhouse it benefits from the weaker euro even more so than its austerity (which is just a euphemism for living within one's means) drenched neighbours.
While a weaker euro will help the Eurozone gain international competitiveness, it does nothing for intra-Eurozone competitiveness. This is the crux of the problem in Europe. The southern European nations are, by some reports, 30 per cent less competitive than their northern trading partners. The policy of austerity is meant to correct this imbalance. But try cutting a nations cost base (wages etc.) by 30 per cent without inciting a social revolution.
All the talk about cutting Greek debt and getting voluntary write-offs of much more than 50 per cent is pointless. Even if it happens, the most optimistic scenario has Greece with a debt-to-GDP ratio of 120 per cent by 2020. That's where Italy is now!
With handpicked EU puppet governments running Greece and Italy, expect them to stay with the euro until an angry populace hauls them out of office. That could be some time away.
But Germany is no doubt watching Draghi closely and wondering how long they want to hang around with this wolf in sheep's clothing running the show.
It might not happen this year. But we can see a future where the euro survives, managed by an ECB channelling Greenspan and Bernanke on steroids.
Short of reversing thousands of years of cultural evolution, this is the only way to restore the imbalances within the Eurozone.
Regards,
Greg Canavan
for The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
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- Why Europe’s Plan to End the Debt Crisis Can’t and Won’t Work
About the Author
Greg Canavan is the editor of Sound Money, Sound Investments, a financial report devoted to unearthing great value investments amid today's "money illusion" of fiat currency. For a free trial of Greg's service, go to Sound Money, Sound Investments.
Comment by Joe on 23 January 2012:
So Private investors are being asked to voluntarily accept a 70% haircut on their investment in Greek Government Bonds even though they have insurance against loss. Now why on Earth would they agree to this, unless, they are being compensated in other ways. If, having been burnt to the tune of 70% of your investment why would you consider Greece to be a future investment option? You'd have to be mad wouldn't you? Of course, unless you were being compensated in some other way.
So how are these Private investors being compensated?
Very simple really, the ECB is taking on the risk by loaning to these Private Investors (read European Banks) money at 1% interest under the fixed agreement that they invest this in Euro nation Government debt at rates of 3-4%. A nice little guaranteed earner for them.
This is why (and the only reason why) Spanish and Italian bond auctions have actually taken off recently, and at rates way below the previous natural return mark for the risk of these nations which is at the dangerous 7% mark.
So, Greece will get its' 70% reduction on its Privately Owned Debt, and those self same investors will buy in again for longer term maturing debt at affordable rates, because, they will be using ECB QE money to do this, there by circumventing a hard and fast rule in the Euro legislation that prevents the ECB doing this itself.
Again, the Euro nations have demonstrated that rules are meant to be broken just as the 3% deficit limit was 'designed' to be broken.
And here is the real gem of a proposition. How on Earth do they think that they will stabilize the Euro and breath new confidence into it so that it works properly and for the benefit of the tax paying public, when they have no rules. Welcome to the World of UFC economics where anything goes.