So, Thursday was a big deal. Did you get that?
Markets rallied around the globe, especially European markets and U.S. markets.
But did you get what really happened?
I know you saw the rally, and I'm sure it lifted your spirits. It lifted mine for about a day – that is, until I lifted up the ECB's skirt to see if their provocative language would leave Europe's knickers in a twist or not.
If you're not the kind of person to look at such intimate things too closely, don't worry. I love all that stuff and am driven to know how all the bits and pieces come together or apart. So, I'll tell you what I saw up there.
Europe's knickers certainly are twisted. So much so that if an ill wind blows, everyone is going to see the naked truth.
Let me show you what I mean…
The ECB's head hemline determinator, Mario Draghi, announced that the cobbled-together central bank (it's cobbled together with spit and promises of the European nations that backstop its paper-lion balance sheet) would buy unlimited amounts of one- to three-year sovereign paper obligations (some of it eventually could prove to be toilet paper) of the poor nations in the Union. The same nations whose interest rates have been rising because real investors have been demanding a risk premium on their purchases of b-list government bonds.
And, of course, because the contemplated action is essentially illegal under the Maastricht Treaty that governs the Union of euro currency playmates, they're not going to buy the bonds in the primary market.
No, they're not going to buy them directly from issuing governments (that would be illegal, did I say that?). They're going to buy bonds (technically they're "notes," not bonds, because govies with less than a 10-year maturity are notes, and 10-year and longer paper are bonds) in the secondary market.
That's right. They are going to break their own laws by not really breaking them; it's "sanitized" you know.
Sanitize – that's also what they're telling the world they're going to do when they buy bonds (notes, did I say that?) in the secondary market from everyday investors, like the hedge funds that have been shorting the you-know-what out of them.
When they print money, euros, to buy the bonds (credit cards aren't allowed), which will increase the money supply and eventually trigger inflation (Achtung Baby), they're going to offset that fear by taking an equal amount of money out of the system on the back-end of the field. The idea being that it's going to be a zero-sum kind of equation.
How are they going to sanitize this scheme? They are going to pay banks a nice chunk of interest when they deposit money with the central bank, thus taking money out of circulation. Banks, of course, like collecting interest. So theoretically, they will rush to deposit all their unlent money into the ECB, and that money coming out of circulation will offset the printed paper the ECB will shell out of the front door to buy bonds in the secondary market.
Sanitize the purchases of bonds? That's a great idea. But it means nothing.
It won't happen that way.
You see, banks that deposit money at the ECB can still use those deposits as collateral for – you guessed it – loans from the ECB.
That's funny, right? We, meaning the Germans mostly, are supposed to believe that this new, illegal scheme (no, wait, it's not illegal if they buy in the secondary market, yeah, right) won't eventually become the engine of roaring inflation? That's ridiculous.
The amount of bonds to be purchased to keep beleaguered nations from having to pay unsustainable interest rates on the money they borrow from the investors who buy their promise paper will be staggering. As in, staggering the balance sheet of the ECB.
And who backs the ECB's balance sheet? The same countries, a lot of them beleaguered, that are slipping into continental recession.
Oh yeah, and the ECB's help will come with a price. The countries whose bonds are to be bought to help lower their costs will first have to agree to austerity measures that they aren't doing now because they can't afford the austerity.
The plan is see-through. The empire (European empire) has no clothes.
This plan will not work well enough or fast enough to fix what ails Europe.
Enjoy the rally, folks. It's got a ways to go. But remember, what goes up…
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
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