There's a Fire? Go, Get the Gasoline!

The Bank of England hasn't disappointed. Clearly the Posen camp has won the day once again – there will be no 'policy defeatism' in the UK. Instead, more money will be printed to create a false sense of prosperity while the wealth accumulated over centuries quietly rots away underneath.

However, recent somewhat better economic data and the 'lessening of dangers from the euro area' have at least produced what looks like a vague commitment to leave things be after this latest £50 billion expansion of the BoE's 'QE' program (the euphemism 'quantitative easing' is a stand-in for the more mundane 'money printing'; this makes it sound more sophisticated and it is hoped that the hoi polloi won't so easily catch on to what is being done).

As the WSJ reports:


The Bank of England on Thursday said it will buy another £50 billion ($79.1 billion) of U.K. government bonds with freshly created money in an effort to shore up the fragile economy.

The central bank said its rate-setting Monetary Policy Committee voted to expand its program of quantitative easing to take the total scale of its stimulus efforts to £325 billion when the latest batch of purchases is complete.

In a statement, the BOE said it will keep the size of the stimulus program under review. But recent data and surveys suggest that the economy has begun to stabilize after a contraction in the final quarter of 2011, and the U.K. may avoid a recession that would justify another round of bond purchases in May.


Much will depend on the euro zone's fiscal crisis, however, and a further worsening of the economic outlook in the U.K.'s main export market, combined with added strains on bank funding, could trigger further action by the BOE.

The bank justified loosening policy further on the basis that its latest forecasts indicate inflation will slow sharply in 2012.

“The committee judged that the weak near-term growth outlook and associated downward pressure from economic slack meant that, without further monetary stimulus, it was more likely than not that inflation would undershoot the 2% target in the medium term," the BOE said in a statement. The committee left the central bank's key interest rate unchanged at a record low of 0.5%, where it has stayed since March 2009.”


The full BoE statement can be read here. It should be noted here that UK CPI recently fell to 4.2% and it is indeed likely that it will decline further as certain elements fall out of the 12 month comparison (e.g. the VAT increase). It is still amazing to see a central bank increase the pace of money printing with the price gauge that it is supposed to be targeting showing a rate of growth exceeding its 'target' by more than 100%. Mind, as we always point out, all the attempts to 'measure the general level of prices' are in any case in vain – it is simply not possible to arrive at a sensible number. Every housewife in Britain probably knows more about what is happening to final goods prices than the government's statisticians.

We have apparently arrived at the point where the Western central banks resort to money printing on a grand scale practically at the drop of hat. The BoE is actually the most consistent and worst offender as it were.

As we discussed in some detail yesterday, it is not possible to improve the health of the economy by printing money. Nothing a central bank does can add to the economy's stock of real resources; all that will be achieved is a distortion of relative prices and the consequent misallocation of scarce capital. Over the longer term, most prices are likely to rise as the effects of the inflation percolate through the economy.

The more monetary heroin is pumped into the patient, the sicker he is bound to become. He may seemingly revive for a short period of time, but eventually will fall prey to an even bigger denouement.

All of this has been known for at least 100 years – Ludwig von Mises work 'The Theory of Money and Credit' was published in 1912. However, even before monetary theory was fully worked out and systematized by Mises, economists already knew of the pernicious effects of money supply inflation. What Mises inter alia achieved in 1912 was to show that the – in principle sound – theory of the 'Currency School' that had brought forth the Peel Act of 1844 in the UK was deficient in a sole, but decisive point: the Currency School failed to consider that deposit money was part of the money supply in the broader sense. The reason why the Peel Act failed to keep boom and bust cycles in check was that it only forbade the issuance of unbacked banknotes. Meanwhile, fiduciary media – deposit money created from thin air – continued to proliferate. Hence the Peel Act did not present a serious obstacle to the economic evils commonly associated with credit expansion from thin air.

Anyone with a grasp of economic history could have told the BoE's MPC that 'solving' a credit and economic crisis by the creation of more credit is an ages old idea that has been tried in vain on many occasions. Not once was the ultimate outcome a good one.

For instance, in the late 18th century France's Revolutionary Assembly learned the hard way that inflation of the money supply only brings temporary relief to the economy and is soon revealed to have done even more damage, leaving the economy in worse shape than prior to the inflationary push. Similar to their modern-day colleagues, the revolutionaries simply could not stop: every renewed downturn was met with yet another injection of money. They continued until France's economy lay in complete ruins.

And even the revolutionaries would have only needed to look back to John Law's Mississippi bubble or even further back to the Roman emperor Diocletian's attempts to buy prosperity by means of inflation. They would have discovered that not only was the economy utterly destroyed in both instances, but that the inflationary policy made ever more draconian and tyrannical legislation necessary. 'Speculators', merchants, artisans, farmers and other producers all soon found themselves to be on the receiving end of ever greater State-sponsored violence and coercion. The revolutionaries themselves soon succumbed to employing the same methods. The 'liberators' became worse oppressors than the hated king they had deposed. As an example, in the end, anyone found in possession of gold faced a sentence of death.

In other words, we can not expect monetary pumping to 'fix the economy' – that is a complete pipe dream, refuted by economic theory a long time ago. However, we must mentally prepare that when the policy predictably fails and brings on ever more economic misery, it won't be the perpetrators who will get the blame. Speculators and wealth creators alike will become the favored scapegoats of the etatistes. Economic liberty, and with it liberty in general  will be trampled by the jackbooted enforcers of 'morally correct' and state-sanctioned economic behavior.

All economically productive people should seriously consider their options in the event that push comes to shove. Are you prepared, or will you meekly wait for the highway robbers to turn up at your door and take you for all you have?



Mervyn King and Adam Posen: pouring more gasoline on the fire.

(Photo via: PA/Rex Features)


A bunch of slightly over-optimistic UK CPI forecasts under different 'QE' scenarios from Merrill Lynch, relying on the BoE's internal forecasts – click chart for better resolution.



ECB Sets Up 'Cash Grab' For Bankers

In light of the above, a Reuters headline in the context of the ECB's rate decision yesterday is quite fitting: “ECB collateral expansion clears way for cash grab.

It is of course our precious and irreplaceable banks that will be enabled to partake in this 'cash grab' – and incidentally, the governments whom the 'independent' central bank serves will be able to sell more of their debt paper to said banks, continuing the Three Card Monte that is the major characteristic of the modern-day monetary system.

We recently came across a cartoon that illustrates this incestuous relationship between governments and banks quite nicely:



While this is perhaps not an entirely correct description, as the central bank should sit in boat number three, it gets the main point across.

(Cartoon by Singer)


Reuters reports on the most important decision announced by the ECB yesterday. New collateral eligibility rules are the main point:


An expansion of the assets eligible as collateral in the European Central Bank's financing operations clears the way for banks to grab more three-year cash at the end of the month and should further ease financing strains.

The ECB approved proposals from seven national central banks, including those of Spain, Italy and Portugal, temporarily to accept additional credit claims as collateral.

The new rules will apply at the ECB's second offering of three-year loans, on Feb. 29, when demand is expected to be similar to the near half trillion euros taken up at the first, in December.

The operations are aimed at easing a bank funding squeeze as debt repayments fall due, with bond markets all but closed to banks on fears over exposure to the sovereign debt crisis.

"If you can effectively pledge the kitchen sink you could see a fairly significant take-up," said Rabobank rate strategist Richard McGuire. "But while it allows for easy access it doesn't address the heart of the problem."

That, McGuire said, was not liquidity but that some banks were using the cash, either temporarily or longer-term, to buy their country's debt – the "carry trade", in which an investor borrows at a low interest rate to buy higher-yielding assets.

"That provides support to the peripheral issuers but sees those banks become more vulnerable to a possible turn in sentiment down the line," he said.”


(emphasis added)

As we have mentioned in several previous articles on the ECB's easing measures since the December 2011 meeting, one of the problems this creates is that it amounts to a creeping nationalization of the euro area's banking systems. The more bank collateral is tied up with the ECB or in the form of 'covered bonds', the fewer bank assets are left to satisfy the potential claims of unsecured creditors. This means that it will become ever more difficult for the banks to attract unsecured funding. There is in any case little chance of selling any subordinated bonds in the future: in reality, 'senior' bondholders have become the class of subordinated creditors. Moreover, in their attempt to shore up their capital, a great many European banks have begun to buy back their subordinated debt at vast discounts to par, leaving bondholders in the lurch. We imagine that many investors are forever swearing off this type of investment.

The fact that the ECB and the euro system central banks seem eager to go 'all in' in terms of the collateral they are willing to accept in the upcoming 'LTRO 2.01', is bound to worsen the status of unsecured bank creditors further – it also indicates that it is probably a complete illusion to believe that these measures will only be 'temporary' in nature. The money supply inflation resulting from these operations will never be taken back.

Meanwhile, we have already seen the effect of the 'carry trades' on the bond markets of Spain, Italy and others: as noted last week in 'Euro Area Crisis – Papered Over', specifically Spain's banks seem to have gone 'all in' as well.

It is of course only logical that if you give fractionally reserved banks access to oodles of practically free money that they will indeed 'do something' with it. We would also not be surprised if there was a bit of arm twisting behind the scenes. Obviously, once the sovereign debt crisis resumes, the banks will be in even more trouble than they are already in. The eventual capsizing of the Euro-Titanic promises to become quite a show.

Reuters continues:


“Much of the funding from the ECB's first three-year operation has been earmarked for repaying maturing debt but some banks are putting the funds to work in the meantime.

Initial signs are that while northern European banks are, for now, channelling the money into safer places such as German government bonds, repos and the ECB's vaults, southern European banks, especially in Spain, have dived back into their own countries' sovereign issuance, supporting the euro zone peripheral bond markets.

Expectations of a large take-up at the second such tender at the end of February have spiralled with market talk it could be as much as 1 trillion euros. However, many analysts take a more modest view and a Reuters poll published on Monday saw an allocation of 400 billion euros , higher than in a similar survey a week earlier.

Deutsche Bank said that if take-up was close to its own 500 billion euro estimate this would greatly help sentiment in financial markets. "It would still present a powerful tool for market sentiment as the new money which could be used for carry trades, providing a cushion for bank refinancing and to buy back own debt, could be almost double the December (operation)," the bank's analysts said in a recent note.”


(emphasis added)

Incidentally, Deutsche Bank was among the banks refusing to participate in the first round of the LTRO in late December. The reason was that the bank did now want to be seen to be in need of such funding. Of course this creates the perception that the banks accepting the LTRO funds in fact deserve to be stigmatized. For this very reason Mario Draghi castigated the hold-outs in the ECB press conference yesterday, accusing them of engaging in unwarranted displays of 'virility'.

As Bloomberg reports:


“European Central Bank President Mario Draghi lashed out at bankers who said tapping the ECB’s three-year-loan program carries a stigma, after executives including Deutsche Bank AG (DBK)’s Josef Ackermann said they shunned the loans.

“There is no stigma whatsoever on these facilities,” Draghi said at a press conference in Frankfurt yesterday. “Some have made some sort of statements that I would call statements of virility, namely it would be undignified for a bank, a serious bank, to access these facilities. Now let me say that the very same banks that made these statements access facilities of different kinds — but still government facilities.”

The statements by Draghi, who didn’t identify any banks by name, came a week after Deutsche Bank Chief Executive Officer Ackermann said Germany’s biggest lender didn’t tap the ECB in December because it could damage its reputation with customers. The ECB awarded 489 billion euros ($650 billion) in loans to 523 banks on Dec. 21 to keep credit flowing to the economy as Europe’s debt crisis drove up banks’ borrowing costs. The ECB will offer a second batch of the loans this month.

ING Groep NV CEO Jan Hommen told reporters on a conference call yesterday that the biggest Dutch financial-services company didn’t take the loans in December, partly because of reputational risk. It’s discussing internally whether to take loans in the second program, he said.


(emphasis added)

However, Deutsche Bank has a good point. As its soon retiring CEO Ackerman noted:


“Ackermann told analysts on Feb. 2 that Frankfurt-based Deutsche Bank may consider participating in the next round of ECB loans if it is “very attractive from an economic point of view.” The German lender has impressed customers by not requiring direct government aid during the financial crisis, Ackermann said.

“The fact that we have never taken any money from the government has made us from a reputational point of view so attractive to so many clients in the world that we would be very reluctant to give that up,” said Ackermann, 64.

Deutsche Bank’s decision to avoid the loans follows the disclosure of its borrowings from the U.S. Federal Reserve’s emergency-loan program during the credit crunch in 2008.

“We learned our lesson during the Fed activity, where we were encouraged to borrow money from the Fed on a confidential level and later on the list was disclosed, and we heard that we had to accept help from the government,” Ackermann said. “We just don’t want to do that, and that’s why we have not participated.”


(emphasis added)

Alas, one should keep in mind here that Deutsche is a highly leveraged institution. Readers may recall that Lehman was levered by approximately 35:1 when it went under. Deutsche's leverage is more like 50:1 or even higher (assets to tangible net worth). Obviously, a lot can go wrong with such excessive leverage and eventually probably will.

As the Telegraph reports, while governments have profited greatly from the ECB's generosity, the private sector was not so lucky: credit to private borrowers in the euro area contracted by € 90 billion in December. The new collateral eligibility rules are estimated to 'free up' an additional € 200 billion in liquidity – this is to say, that is the amount of bank reserves the ECB will provide in exchange for collateral consisting of commercial loans. As we noted previously, the total amount of money from thin air that could be created based on such collateral is in fact much larger – a table detailing the amounts can be seen here.

All in all, commercial loans in the euro area total € 7 trillion, so the scope for money supply expansion has increased a great deal. However, there is a fly in the inflationary ointment, so to speak. The haircuts applied to such collateral will be extremely steep. Evidently the central bank is worried about taking on a lot more risk. The haircuts range from 42% to 80%, depending on the maturity profile of the credit claims pledged. The details can be seen in this Alphaville report.


The ECB and Greece

During his press conference, Mario Draghi stressed that the ECB can not engage in anything that smacks of 'government financing' – which is the main obstacle standing in the way of the ECB contributing to the rescue of Greece. Moreover, he stressed the alleged 'uniqueness' of the Greek situation. Not surprisingly, in the wake of the discussions over the ECB's possible contribution to the Greek 'haircut', other countries have already come forward and demanded the same treatment, notably Ireland.

According to the Irish Independent however:


“EUROPEAN Central Bank President Mario Draghi yesterday insisted any"arrangement" the ECB might make to ease Greek government debt would not be extended to other bailed-out countries such as Ireland.

The comments came as the ECB was reportedly on the verge of agreeing to forgo full repayment of its Greek bonds as part of an eleventh-hour rescue deal for the stricken nation. Mr Draghi repeatedly insisted he could give no detail on the ECB's Greek plans.

Asked whether Ireland might benefit from similar treatment if the ECB made an "arrangement" for Athens, Mr Draghi replied: "Greece is unique for … for everything. We don't want to repeat any experience."

The ECB is believed to hold about €20bn of Ireland's government bonds. In private meetings Finance Minister Michael Noonan is understood to have repeatedly laboured the fact that Europe is making concession for Greece that it would not make to other countries such as Ireland.”


We happen to believe that the topic will come back up for discussion in connection with Portugal next. Meanwhile, although Draghi would not divulge any details about the ECB's plans with regards to its Greek bond holdings, some hints as to how it will be done did in fact emerge.

As Reuters reports:


“Asked whether the central bank could sell its bond holdings to the EU bailout fund at the same value as it paid for them, Draghi indicated it would have to pass on the profits to governments when they are realised.

"The EFSF is governments. So if the ECB gives money to governments, that's monetary financing. If the ECB distributes part of its profits to its member countries as part of the capital key, that's not monetary financing," Draghi told a news conference after keeping interest rates on hold at 1.0 percent.”


In other words, what we have here is a distinction without a difference. The ECB will release the difference between what it paid for Greek bonds and the par value, but it will do so in a manner that allows to keep up the pretense of 'no government financing'. As Irish finance minister Noonan has once said, it is all a question of 'clever legal tricks'.



We recently came across a chart of the rate of growth of vehicle registrations in Ireland. It illustrates the credit bubble and its aftermath quite nicely. The growth rate has dipped below the average that pertained prior to the bubble period.



Via 'Not Jim Cramer' – vehicle registrations in Ireland. The growth rate has fallen below its pre-credit bubble levels – click chart for better resolution.



Central economic planning by central banks is a pernicious variant of socialism. 



Charts by: Merrill Lynch, Bloomberg, OnS, BoE



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One Response to “BoE and ECB – More ‘QE’ and The ‘Cash Grab’”

  • SavvyGuy:

    Excellent analysis as usual, Pater! Now let’s seriously think about these key points mentioned above:

    “All economically productive people should seriously consider their options in the event that push comes to shove. Are you prepared, or will you meekly wait for the highway robbers to turn up at your door and take you for all you have?”

    Well, what are our options? All CBs worldwide are gaming their economies; that is abundantly clear. But how do we hedge against that? I understand that this forum is not for financial advice, but perhaps we could start exchanging ideas on smart ways to hedge against CB machinations.

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