Best of the Week
Most Popular
1.Stock Market in DANGER of Strangling the Bears to Death - Nadeem_Walayat
2. Germany Pivoting East, Exit US Dollar, Enter Gold Standard - Jim_Willie_CB
3.Flight MH17 – Kiev Flash Mob's Last False Flag? - Andrew_McKillop
4.Stock Market Crash Nightmare! - Nadeem_Walayat
5.Gold - The Million DOLLAR Question... - Rambus_Chartology
6.Gold And Silver – BRICS And Germany Will Pave The Way - Michael_Noonan
7.The Jewish Selfish Gene, People Chosen by God, Everyone Else is Goyim to Kill - Nadeem_Walayat
8.The Israeli Promised Land Dream - The Criminal Roadmap Towards “Greater Israel”? - Felicity Arbuthnot
9.Which Way is Inflation Blowing? Watch Commodities - Gary_Dorsch
10.U.S. Economy Quarterly Review and Implications for 2014-2015 - Lacy Hunt
Last 5 days
Tesco Supermarket Death Spiral Accelerates as Customers HATE the Mega Brand - 24th July 14
Ukraine MH17 Crisis - Best Remember Who Your Friends Are - 24th July 14
Three Reasons Why Gold Price and Gold Stocks Will Rise - 24th July 14
HUI Gold Bugs Fighting To Break Downtrend - 23rd July 14
What Putin Knows About Flight MH17 - 23rd July 14
Why Microsoft Will Continue to Rebound, Huge Upside Potential - 23rd July 14
Will Putin Survive? - 23rd July 14
MH17 Crash Next Phase Economic Warfare - 22nd July 14
The TRUTH about China’s Massive Gold Hoard - 22nd July 14
Forex Multi-week Consolidation in EUR/USD Ended - 22nd July 14
Bitcoin Price Medium-term Trend Being Tested - 22nd July 14
Beware Of The Flash Mob - 22nd July 14
Can Putin Survive? - 22nd July 14
Israel Assault on Gaza: A Historic Crime, Nazi Like Final Solution - 22nd July 14
Zionist Israel an International Pariah - 22nd July 14
Reflections on the Global Misery Index - 22nd July 14
GDP Economic Statistic : A Brief But Affectionate History - 22nd July 14
TransTech Digest: Super Battery Bio-Power vs. Dirty CleanTech - 21st July 14
How to Find Trading Opportunities in the Currency Markets - 21st July 14
Stock Market One More Pull Back - 21st July 14
The Conquest Of Real - Degenerate Philosophies of the Book - 21st July 14
A Clear Way to Profit from a Graying Population - 21st July 14
Last Chance Critical Financial Market Forecasts Special Total Access - 21st July 14
Stock Market Crash Nightmare! - 21st July 14
Why the Stock Market Is STILL Cheap - 21st July 14
From Gore-Bore To Gore-War - 21st July 14
Gold Price Looking Drab - 21st July 14
An In-Depth Look at Gold Chartology - 21st July 14
The Jewish Selfish Gene, People Chosen by God, Everyone Else is Goyim to Kill - 20th July 14
AUD NZD Taking The Forex Bull By The Horns - 20th July 14
US-backed Israeli Invasion of Gaza Unleashes Death and Destruction - 20th July 14
The Israeli Promised Land Dream - The Criminal Roadmap Towards “Greater Israel”? - 20th July 14
Stock Market in DANGER of Strangling the Bears to Death - 20th July 14
Sanctions and Airliners - What’s the U.S. Empire’s Agenda? - 19th July 14
Gold And Silver – BRICS And Germany Will Pave The Way - 19th July 14
Choppy Stock Market in Recent Weeks - 19th July 14
Is The Stocks Bull Market Over? - 19th July 14
Edward Snowden Towers Over His Enemies - 19th July 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Enjoy the Stock Market Rally While it Lasts, Super Mario Draghi’s Bazooka is a Dud

Stock-Markets / Eurozone Debt Crisis Sep 07, 2012 - 06:37 AM GMT

By: Money_Morning

Stock-Markets

Diamond Rated - Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: Not too long ago I mentioned that whatever European Central Bank President "Super Mario" Draghi delivers, it had better be big.

Because the only way he could hope to shore up the beleaguered e uro, wrest control of interest rates from the modern day financial pirates that dominate credit default swaps and break the impasse between skittish investors was with a monetary "bazooka."


We certainly got one yesterday when he announced an unlimited bond purchase program designed to do exactly this.

The S&P 500 shot up 26.13 points while the Dow and Nasdaq both tacked on 216.01 and 62.80 points respectively. European markets also moved sharply higher on the news as well while Spanish and Italian yields tumbled at maturities of every length suggesting traders relaxed their risk aversion stance considerably.

Under Draghi's plan, the ECB will be buying unlimited amounts of short-term sovereign debt while also sterilizing that debt-- ostensibly to stave off concerns about hyperinflation and further money printing.

Up to now, the ECB has only purchased troubled EU bank bonds as a buyer of last resort. So this is a big change now that Draghi is talking about stepping up as a sovereign debt buyer, albeit also of last resort.

Draghi noted interestingly that the ECB will retain exclusive decision making on when to engage in purchases, the amounts purchased and when to stop. This effectively puts the politicians on notice that further bickering will not be tolerated.

Further, Draghi did not rule out purchases of Greek, Portuguese and Irish bonds when those countries regain practical access to the bond markets.

There are a couple of things that stand out here...

A Cause for Fear-Not Celebration

First, things are so bad that insiders are using euphemisms to describe Draghi's plan which is officially referred to as a "blueprint" and called "Monetary Outright Transactions."

I don't know about you but if it smells like a duck, walks like a duck and quacks like one, too...odds are pretty good it's a duck.

It doesn't matter whether you are talking quantitative easing or bond purchasing. The fact that things are so bad that central banks - first the BOJ, then the Fed, now the ECB - have to wade in as lenders of last resort should be a cause for fear rather than celebration.

If not now, than a few years from now, when it all comes back to roost.

Here's why.

Under Draghi's blueprint, the ECB is going to be buying bonds from troubled sovereigns. The banks, meanwhile, "sterilize" their debt by investing with the ECB.

The only trouble is that the banks have been borrowing money from the sovereigns all along so the money they are "investing" to sterilize the ECB's purchases really came from the ECB in the first place.

The money is simply going around in circles - whether that's like a tornado or a toilet bowl depends on your perspective.

Figure 1: Fitz-Gerald Research AnalyticsThen there's the cash itself.

As I understand it, Draghi's plan presumes that European banks are going to invest it in the ECB as part of the sterilization process. Last time I checked, many European banks are functionally insolvent because they don't have enough cash to operate let alone invest the excess, especially when it comes to Spanish and Italian banks.

At the same time, banks are deleveraging in order to meet revised capital requirements. They are selling assets and scaling back lending. When you scale back lending you have less credit. And less credit means less growth.

The ECB itself forecasts the economy will expand by 0.5% in 2013 and a deeper economic contraction in 2012 that shows Eurozone GDP dropping 0.4% instead of 0.1%.

In other words, the numbers are already going in the wrong direction - and that's before any sort of austerity whatsoever. Imagine what happens when somebody actually starts getting serious about spending less.

Second, the plan targets sovereign government bonds with 1-3 year maturities while also including longer dated instruments that have residual maturities within the 1-3 year time frame.

That means there are huge swathes of the credit market that will not be stabilized nor sterilized. It also fails to address corporate and private debt both of which have also reached problematic levels in the EU just like they have here in the United States and Japan.

According to Eurostat long term sovereign debt accounts for between 74.6% and 98.9% of total debt in 23 EU member states. Shorter term levels of less than 5% were recorded in Estonia, Slovenia, Austria, Slovakia and Poland. Only Sweden and Romania presented a significant short term debt ratio which Eurostat defined as greater than 23% according to the latest data.

Figure 3: Eurostat

In other words, by addressing the short term debt (in purple), the ECB is potentially leaving the bulk of the long term market (in yellow) out of the picture.

(Admittedly, details are hard to come by on this point only hours after Draghi's announcement so I'll plan on an update for Money Morning readers in the weeks ahead as we learn more about the exact debt composition details.)

Third, Draghi's concept of "unlimited" really bothers me. It's been a common theme so far because policy wonks want to "send a signal" to the markets that they are serious about fixing this problem.

I don't know about you, but I am tired of signals.

What I would like to see is governments learning to live within their means and the derivatives traders who have fractured the credit markets, making Draghi's actions necessary, held accountable for having driven the rest of the world to the brink of financial oblivion.

Granted, Draghi did say that nations requesting purchases will have to apply to the ECB and maintain specific behavior to qualify on a periodic basis, but so what.

EU membership supposedly required strict adherence to the Maastricht criteria which formed the basis of the initial economic and monetary union and that's been effectively ignored or violated six ways to Sunday since it was signed in 1991.

So Now What?...
Draghi's plan is little more than a fresh shot of intoxicants for stimulus addicted markets. I have no doubt that it will create a "rush" that people enjoy.

How big and how long this "rush" lasts really doesn't matter - two weeks or two years - I don't know.

What's far more important is that investors think through what will happen next and take steps to help to protect their money once the high wears off.

I'm not trying to ruin your day but I think it's much more important in this instance to be a futurist than a nowist.

1.Buy what the ECB is going to be buying...that's short term EU debt. Just like you don't want to fight the Fed in the United States, Draghi showed Thursday you don't want to fight the ECB either.
2.Buy gold. Like that's a surprise. Gold is a hedge against further crisis. Whereas once it was reserved for the periphery, it's now a foundation investment. Further, because of its generally low historic correlation to other asset classes, adding gold - even now - can help dampen overall portfolio volatility.
3.Buy TIPS or variable rate bond instruments that have either an inflation escalator built in or the ability to adjust interest rates as they begin to move higher. No matter how Draghi or any other banker positions this, bond buying and sterilization merely delays the inevitable seeds of inflation that are being sown in the meantime.
4.Short the e uro. I've made no bones about it since this crisis began that the e uro's very existence is at stake here. That means shorting the e uro is the way to go if you agree. After a Draghi bounce I still expect it to hit parity with the US dollar before the dust settles.

At the end of the day, I'll take a rally. Right now the world's investors could use one psychologically and financially. But, get ready for reality.

Once traders and central bankers figure out what unlimited actually means and how expensive Draghi's bond bazooka will become I have no doubt we're going to experience the entire doom, gloom and boom cycle all over again.

Source :http://moneymorning.com/2012/09/07/enjoy-the-rally-while-it-lasts-super-mario-draghis-bazooka-is-a-dud/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2014 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014