"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Monday, August 8, 2011

Trichet's Got A Gun

And he just used it.  The gun reference, for those not familiar with it, is from former US Treasury Secretary Hank Paulson (under Bush II).  Paulson, seeing that the stock and bond markets were in full panic mode in 2008, said that he needed a large amount of money to be used to provide liquidity to the markets.  His view that this large and accessible amount of money, that gave him cart blanche, would be a bazooka.  That is, both a defensive and offensive weapon to ward of bond vigilantes and short sellers.  He even said that merely possessing this bazooka could be enough to stem the market carnage that was taking place in 2008.

Well,  ECB President Trichet just fired his own bazooka - he started "cranking up" the printing presses to buy Spanish and Italian bonds that the market started deeming to expensive due to increased risk of sovereign default.

This represents an interesting development for the EU.  The EU is far from a federation, and thus only the larger member countries have control over EU policy - France and Germany.  But even these two countries need to answer to their electorates, so arriving at a sensible (if it even exists anymore) EU monetary and financial policy, is extremely difficult.  Enter Trichet with his bazooka...

From Bloomberg this morning:
The ECB bought Italian and Spanish bonds this morning, according to five people with knowledge of the transactions, driving their 10-year yields down to 5.39 percent and 5.3 percent respectively from above 6 percent on Friday. Both reached euro-era records last week. Italy has 1.8 trillion euros ($2.6 trillion) in outstanding debt. 
European stocks erased losses, led by a rebound in banks, with the benchmark Stoxx Europe 600 Index up 0.5 percent to 240.04 at 8:25 a.m. in London. U.S. futures on the Standard & Poor’s 500 Index slid 0.8 percent after earlier being down as much as 3.1 percent.
Hyperinflationists will see this as excessive money printing, and they are right, to a degree. The reality is, that when central banks engage in such an action, they attempt to "sterilize" or as I like to put it "cancel out" the inflationary affects of such actions.  How do they do this? They increase the amount of term deposits banks have with the Central Bank.  It's a cancelling out of sorts of money in the economy.  It's parked.  It's basically a balance sheet exercise of shifting around numbers on a ledger.

But it also defies the laws of capitalism.  Without negative economic consequences, economies become distorted and malinvestments are not flushed out of the system.  Those that disagree with this point counter that to do nothing could collapse the system.  They are correct.  However, the same political influence that leads to debt monetization - banks that have an undue influence on governments and central banks - also controls the regulation of banks.  The banks that hold this poisonous debt are not tamed.  There is no governmental regulation strong enough to punish the banks, the type of punishment the darwinistic aspect of Capitalism dishes out to bad investors - banks included.

And so, yes, for today, a free lunch has been provided.  Pain has been avoided - today.  But the imbalances of trade between member EU countries still exist, there is no guarantee that the ECB can sterilize everything that may be needed in the future, and the Banks continue business as usual.

Yes, Trichet has successfully impacted Italian and Spanish bond yields - let's call it what it is - he successfuly manipulated the market.  But there is one asset that doesn't buy all this balance sheet/ledger shifting of poisonous debt.  You know what that asset is?


I have been saying for years now.  Watch gold, it is the barometer of the world economy and the current debt based fiat monetary system.  As more temporary band aids are applied to this systemic band aid, gold's value will only increase.

Furthermore, as banks are saved with liquidity and sovereigns are starved of liquidity, austerity will collapse economies, and thus collapse tax revenues, leading to very little change in deficit and debt to gdp targets.  The EU's goals for implementing austerity - to lower deficit and debt to gdp numbers will also fail.  It's been failing in Greece every few quarters.  I'm in Greece now, and it is full blown debt deflation.  When the economy shrinks, when salaries fall, tax revenues fall, and the debts?  They remain the same or even grow.  A country can only lower its debt to gdp if its economy grows and its debts get paid off.  None of that is happening under austerity.

There is no solution in my opinion.  As Michael Hudson has put it:  "debts that can't be paid, won't be paid."  Trichet may carry the game on a little longer, but eventually, one of two things will happen.  The currency collapses, or the economy collapses.  Or both.