Europe's Unprecedented Rate-Slashing Gives Us a Classic Profit Play

Peter Krauth

European Central Bank President Mario Draghi is desperate.

The European Union has been plagued with years of falling inflation and stubbornly high unemployment.

And now its central bank is attempting to employ "unconventional" policies to kick-start the economy.

Using tactics never tried before, the ECB has just entered uncharted waters.

But if we look at the history, we'll see the perfect opportunity to profit…

Europe's Next Great Experiment Begins…

Last Thursday, after months of thinly veiled hints, the ECB took drastic measures.
Some of the central bank's key moves included:

• Interest on main refinancing operations (MROs) was lowered by 10 basis points to 0.15%. These are loans to banks secured by sovereign debt.

• 400 billion euros were made available in loans to banks with a limit of up to 7% of existing loans to the nonfinancial private sector (excluding home lending).

• Marginal lending facility (overnight credit from ECB) was lowered from 0.75% to 0.4%

But the real kicker…

• Deposit rates (interest paid to banks on deposits at the ECB) were lowered from zero to negative 0.1%. Banks will now have to pay the ECB to leave funds on deposit. This is exactly what I highlighted back in mid-April.

It's a move no other major central bank, not the Fed, not the Bank of England, not even the Bank of Japan, has yet tried.

So what's the goal, and will it work? As it turns out, we can gather clues from some precedents.

The Velocity of Money Is a Problem

The ECB is similar to the U.S. Federal Reserve in that it issues the official currency, the euro. It also sets interest rates to help guide the economy, and it supervises commercial banks. But its top job is to keep inflation under control. The Fed has similar goals, yet has a "dual mandate" that includes seeking low inflation and high employment.

So let's look at the problems the ECB faces.

Europe's been mired in a "low-flation" state since 2011, with inflation actually decreasing over the past two and a half years to 0.5% in May, considerably under the 2% target.

This can be a problem in that, if it goes on for an extended period, markets will begin to expect falling prices, or deflation. Those expectations can drive consumers to delay spending as they assume they can buy things for less in the future, thereby retarding consumption.

Europe's other big problem is unemployment.

Though it's been declining (albeit very slowly), right now it's still high at 11.7%, but youth unemployment is astronomical at 23.5%. In Greece and Spain? Forget it. There, youth unemployment sits at 56.9% and 53.5% respectively.

These are big problems, so the ECB has begun pulling out the big guns.

Their hope is that these across-the-board rate cuts are going to stimulate activity and boost the economy through increased lending, as well as by accelerating the velocity of money. In turn, higher economic activity levels should also lead to higher employment.

And while there may not be precedent for negative rates on such a grand scale, it's actually been attempted in Denmark and Sweden recently.

As I mentioned in my article "Get Your Share of an Extra Trillion Euros," Denmark has had negative interest rates since 2012. Thanks to that genius policy, Danes have become the most debt-ridden people in the world. No more bragging rights for us.

Denmark's neighbor Sweden tried negative rates during the financial crisis. But their central bank saw no benefits, and that policy was soon reversed.

So now Europe is going to try this questionable plan on a grand scale.

Will it work?

Peter Krauth

About the Author

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Peter Krauth is the Resource Specialist for Money Map Press and has contributed some of the most popular and highly regarded investing articles on Money Morning. Peter is headquartered in resource-rich Canada, but he travels around the world to dig up the very best profit opportunity, whether it's in gold, silver, oil, coal, or even potash.

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