An op-ed appeared in the Wall Street Journal today stating that “central banks are designed to stand up when markets fail to function.” It seems as if the markets are functioning just fine shunning the debt of countries with runaway spending habits and eye-popping entitlements. Markets are not “failing to function” when they pass on investing in or lending to banks with no respect for risk management. Why would a government or bank need to worry about risk management when the central banks were designed to bail them out? Central banks print money, which ultimately reduces the purchasing power of ordinary citizens via rising prices for goods and services. Citizens are hit with an indirect money-printing induced tax while government and banking leaders continue to lead and cash fat bonus checks. What happened to no more bailouts?
Moving on the next “final” solution in Europe, the entire concept of a new fiscal union, budget constraints, and penalties addressing the pressing issues in is somewhat misguided. The problem was summed up by Michael Derks, chief strategist at FxPro in the Guardian:
On some level, this last debate is rendered superfluous because most eurozone members will not get anywhere near satisfying the fiscal rules for some considerable time and so the imposition of financial penalties in the interim would make their plight even more tenuous. Merkel is apparently in Paris on Monday to thrash this issue out with Sarkozy, just four days ahead of the next EU Summit but Merkel is extremely unlikely to relent. For Sarkozy, there are huge political hurdles to accepting Merkel’s vision. The outcome of Monday’s meeting will tell us a great deal about the single currency’s near-term future.
Markets want nothing less than the ECB to declare they are willing to either (a) cap rates, (b) cap rate spreads, (c) “do whatever it takes”, or (d) buy bonds in unlimited quantities. If that fails to materialize, the markets could drop far and fast. From the Guardian:
The changes, if agreed to by member nations, would impose real fiscal discipline over nations, with the goal of giving Brussels the power to prevent countries from falling into fiscal trouble.
The approach is a risky one. It asks countries to sacrifice national sovereignty in the name of economic stability, but in recent years citizens have signaled an unwillingness to forfeit more control to Brussels. But an even bigger problem is that it’s a long term approach to an urgent problem. If successful, it may prevent countries like Greece and Italy from amassing huge debt burdens in the future. But it won’t solve the continent’s current crisis.
European nations need huge loans, and they need them fast or they risk defaulting. With the debt conflagration now blazing across borders, Merkel and Sarkozy are essentially gazing off at the horizon as the world urges Europe to deploy its most powerful option: unleashing its central bank to act as a lender of last resort.
Germany has continued to show opposition to the Hank Paulson “bazooka” approach to problem solving. Again from the Guardian:
The problem: Germany is resolutely opposed to using the ECB in this way. Merkel, appeared to reiterate her objections today (12/2/11), stating that “The European crisis will not be solved in one fell swoop.”
The stakes could hardly be higher. Forget about tiny Greece, Portugal and Ireland. Italy, the zone’s third largest economy, owes $2.55 trillion. It will have to refinance a staggering $530 billion in 2012 alone, and investors have been demanding unsustainable rates, in excess of 7 percent. Meanwhile, France’s interest rates are rising, and ratings agencies are threatening its AAA status. Even Germany itself — the continent’s economic powerhouse — may not be immune from investor’s aversion, as a recent weak bond auction showed.
Altering Europe’s treaties won’t change this. Instead, fear is mounting that Europe’s debt crisis is raging out of control, and could ultimately cause the breakup of the currency union or worse.
The most surefire solution would be for the ECB to step in, expanding its balance sheet to cover loans that private investors shun. That option would require a change in the bank’s charter, but it wouldn’t even demand taxpayer cash, given that the central bank can simply print money.
Even if the ECB relents and cranks up the printing presses, does anyone really believe creating money out of thin air to finance governments is sound policy? If money printing was the answer, we could all stop working and simply have the Fed and ECB hand out freshly printed greenbacks and euros. At some point, the markets are going to say enough with the money printing. Investors will simply leave markets and shun countries/currencies with a propensity to print. Printing money can “work” in the short-term, but history shows us it always ends badly.
Investors betting on a permanent fix in Europe may be very disappointed over the next six weeks. Forbes reported this week a major European bank was on the verge of failure before the Fed decided to…you guessed it…print more money. It was also widely reported this week EU leaders were told Italy was on the verge of insolvency. There are fundamental reasons the intermediate-term and longer-term charts continue to favor bearish outcomes. While it is almost comical, the U.S. Dollar (UUP) may attract “safe haven” capital in the intermediate-term. Put options, shorts (PSQ), and inverse ETFs (SH) may also come back into favor in a serious manner.
Could the Fed and ECB, armed with freshly printed dollars and euros, forestall the day of reckoning? Sure they could, but the fundamental clock continues to tick and investors are becoming more and more aware of the fragility of the global financial system. It seems the solution to all the world’s problems can be found at your friendly neighborhood central bank. Sounds too good to be true.
