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Ultimately, all financial roads lead to Wall Street. The big investment banks and trading firms known as primary dealers all play in one worldwide money pool. When the ECB prints money, it's not just available to Europe, it is also instantly available to Wall Street. This isn't Vegas. What happens in Europe doesn't stay in Europe. That's why it's important to keep track of the performance of the European banking system.
Any decline in European liquidity will have a negative impact on Wall Street, the U.S. Treasury market, and U.S. stocks.
And any European skullduggery is likely to make 2018's bear market much worse.
Unfortunately, that's precisely what's going on now.
But don't worry - as always, we're set up for protection and even a bit of upside...
A Trick Program That Utterly Failed to Stimulate Growth
There's every indication that liquidity in the European system has not grown as a result of NIRP (negative-interest-rate policy) and QE (quantitative easing) and that it will only get worse now that the ECB has drastically cut its asset purchases.
In December the ECB announced that it would cut those purchases in half from 60 billion euros a month to 30 billion, beginning in January. Meanwhile the ECB continues to penalize bank deposits by imposing negative interest rates on banks that hold reserve deposits at the ECB.
ECB asset purchases along with NIRP has caused many bonds, particularly sovereign bonds, to have negative yields. Instead of earning interest, investors and banks holding those bonds get clipped every quarter. So they have an incentive to unload them especially once the stop appreciating. But cash deposits also get penalized, so big banks and institutional investors largely get rid of deposits by using them to pay off any debt that they hold.
The result is that bank assets and deposits don't grow, leaving the ECB flummoxed as to why their insane policy isn't working. So they just pretend that it's working, but begin to gradually dismantle it.
The ECB's trillions in asset purchases have done nothing to stimulate lending or growth. Most of the money the ECB printed to buy those assets has been vaporized as banks and investment institutions deleveraged their balance sheets by selling assets and using the proceeds to pay off debts that were other banks' loans.
Meanwhile, the ECB established a trick program called the targeted long-term lending operations (TLTRO) that gave the appearance that bank assets did grow now and then. But it's a sham. The idea was that the ECB would lend money to the banks and pay them a bonus if they increased their lending to customers.
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But there was no intrinsic loan demand in Europe. So what did the banks do? They lent the money to each other in a shell game, so that they could collect the interest bonus. Now it appears that they are beginning to unwind that scam.
European bank assets and deposits plunged in December just as the ECB announced that it would cut its asset buying program (QE) in half to 30 billion euros a month. The liquidation of assets was probably a preemptive move by investors and depositors. They wanted to reduce deposits to stop the bleeding from NIRP.
The drop in European bank assets is a likely sign of more to come as the ECB maintains the punitive NIRP policy but cuts QE, reducing the amount of new money it injects into the system. That in turn will cut the flow of European capital into the United States. The name of the game in Europe now is deleveraging.
Total European bank assets plunged in December back to the level of the 2014 lows, indicating that NIRP and QE have done nothing to stimulate borrowing or investment.
Household loans have been growing, but that has all been in mortgages. It's evidence of yet another housing bubble as central bankers the world over continue to address systemic rot by papering it over. They do it by promoting housing bubbles. Then they act surprised when their precious bubbles deflate.
All of the ECB's money printing and negative-interest-rate trickery have failed to stimulate growth. The evidence suggests that rather than borrowing more as a result of NIRP, as the ECB had hoped, many economic actors are pawning their assets off on the ECB and deleveraging in the process.
These Euro Bank Charts Paint a Dire Picture (Here's What to Do)
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A December plunge in European assets has been a regular seasonal happening throughout this decade, but this one was the worst since 2014. Bank assets in Europe made a new low for 2017 and dropped almost to the low of December 2014, which was in the early days of NIRP and the current round of QE.
Business borrowing is moribund, but interbank lending has gone crazy as banks play a shell game with each other to take advantage of the ECB's sham TLTRO bonus payments.
Business loans to nonfinancial corporations (NFCs) - similar to the commercial and industrial loans stat for U.S. banks - are dead in the water. They are up less than 0.2% year to year, and just 0.5% since the beginning of NIRP. This is what Mario Draghi calls progress. Total loans to NFCs are still in the range that they were in during the year before the ECB started NIRP in 2014. If NIRP and QE and TLTRO were meant to stimulate business borrowing... FAIL.
Interbank lending fell sharply in December after making a new high in November, almost equaling the 2008 peak. Need I remind you what happened in 2008? The annual growth rate in interbank loans is now 10.7%. Without these interbank games, total loan growth would have been virtually nil over the past year.
The banks resumed lending to each other in March 2017, collecting their LTRO bonus from the ECB in the process. The drop in December could be the unwinding of those loans.
Nonfinancial corporate deposits are growing rapidly, indicating either that business is growing or that European businesses are repatriating their cash from the U.S. and elsewhere.
But strong business revenue is no reason to be bullish. Strengthening European business will only encourage the ECB to finally pull the punchbowl and end QE altogether. It has already begun the process, and the ECB's media proxies have been floating the notion that QE will end in September. Once central banks put the word out via their banker cronies and media handmaidens, you can bet that the policy change is a done deal. The end of ECB asset purchases is coming. And that is unequivocally bearish.
Another trend that will encourage the ECB to end QE is that household borrowing is going parabolic. Household debt to banks is growing at an accelerating rate, now at a 3.4% annual rate. That's up from 2.9% in November and 1.9% a year ago. The fact that consumers are adding to debt while business and institutions are shedding debt is a sign that the dumb money is levering up, just when the smart money is deleveraging.
In fact, it is actually a sign of a housing bubble. Mortgage lending rose 167.7 billion euros (4.1%) in the past 12 months. That accounted for 90% of the rise in household borrowing. It was also nearly double the annual increase in December 2016. Housing bubble anyone?
Here's another interesting factoid. Mortgages outstanding rose by roughly 400 billion euros since 2014. Over the same period, European bank deposits, excluding TLTRO related balances, rose by approximately 800 billion euros. The rise in the proceeds of mortgage loans accounted for half of the increase in deposits. The rest came from the ECB's QE purchases. There was no intrinsic growth outside of the mortgage hustle and the housing inflation that it drove.
Meanwhile, Europe's weak sister banking systems are showing no sign of recovery. Spain is an example.
The crisis has been buried beneath optimistic financial and economic headlines, but it is still there, festering. Despite that, the ECB seems intent on finally ending QE. It has joined the Fed in the realization that QE has only caused asset bubbles and hasn't worked to stimulate real growth. As the ECB cuts QE and probably ends it later this year, liquidity will shrink, and so will the amount of European liquidity flowing into U.S. markets.
So I'll stick to my recommendation to substantially increase your cash holdings by systematically selling stocks. I would do so over the next four to eight weeks, if you have not already reached the original goal of 60% to 70% cash by the end of January. That percentage will vary based on your personal circumstances, but I think that a substantial cushion of cash will be essential as we head into a bear market in 2018. Meanwhile, here's a "set it and forget it" U.S. short sale trade to profit from a down market and rising interest rates.
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About the Author
Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.