Tuesday, June 21, 2011
Just as in 2010 the Europeans turned to the US for policy guidance and were offered Little Timmy's post crash STFU policy, 2011 sees them turn once again to the US for help with the same reoccurring problem. Now despite what might have been imagined before the implementation of the US QE2 program about 9 months ago, it hasn't been a complete disaster. In fact, if you were a European observer noticing that their stock market goes up, faith and the price of their bonds goes up, their currency starts to drift off making their exports more competitive and they hardly see much of a rise in domestically led inflation, then you might just rub your chin and say. "Hmm, I wonder".
To TMM it looks mightily like the Europeans are dreaming up a cunning new plan. Not as cunning as trimming their toenails with a scythe as the German's tried last year with their banking regulations, but pretty close. For it would appear that just as US QE is coming to an end, the Europeans are going to be embarking on a second attempt of their own version. Far from EVER calling it QE (or even Qu'Est) it will be deftly disguised as European Himalayan pink salt - a fantastic exotic remedy for the Euro woes. Which of course to TMM means a set of generic structures wrapped and presented to the unsuspecting bond holders as a "cure all".
Sharp observers have pointed out at various times over the past 18 months or so that the ECB's LTROs, SMP and balance sheet expansion in general are essentially just an indirect implementation of QE. Banks merely bought their respective governments' paper and promptly delivered it to the ECB's window in exchange for newly-printed Euros. Of course, that only worked until the ECB realised that they essentially had become Europe's "Bad Bank" and were going to take a bath if and when the Club Med eventually restructures. Naturally, the A-Team panicked and embarked upon brinkmanship with the Eurocrats, in the form of threatening to hike rates to force them into action.
And so it seems that the latest offering from the Eurostriches is to increase the EFSF to 780 Gigaeuros from 440 Gigaeuros. But just as Pink Salt is only salt with some pink, expanding the EFSF is just turd with but more turd added. As we know, the EFSF is capitalised such that the bonds it issues are rated AAA, with the proceeds then used to throw good money after bad lending to the iPIGS. Of course, it's not just the Chinese that are buying the EFSF paper, it's also the European banks themselves, because the risk weighting on these bonds is obviously far lower than that of the Greek government. So the banks then deliver the paper to the ECB window in exchange for newly printed paper... which isn't really that different from the ECB's first "no, it's not QE really" QE attempt. Except this time they've tried to get the Eurocrats on the hook for the eventual payout. Now, the thing is, the ECB's balance sheet is about 1.9 Teraeuros, to which TMM reckon we should add the EFSF's size given it all looks like smoke and mirrors to us, meaning that they just magically increased the money supply by about 15%.
And of course, the longer this goes on, the more privately held debt gets paid down, and the bigger proportion of the remaining debt ends up in the hands of EU institutions. The debt may get larger and larger but the scheme can run on happily until:
- The guarantor countries can no longer maintain their own credit ratings due to the guarantees they are making to support an AAA vehicle.
- The populations of the guarantor nations realise how much they are in hock for and insist on no more.
- Someone stops buying the EFSF issues.
- EFSF holdings are marked to market and someone realises that the EFSF haircut isn't enough.
- The ECB resigns itself to the money supply increase being permanent (Google "Zimbabwe").
- Embarking on expanding the EFSF is like mainlining financial smack while snorting woonga and smoking crack. Hooked until an early death. There is no escape unless the debt you own turns good and becomes profitable again. Mr Madoff tried exactly the same thing but apparently borrowing new money to repay existing shareholders whilst hoping those Russian railway bonds that paper your downstairs toilet become redeemable for face is called a Ponzi scheme and is illegal.
- Mucking around arbitraging credit ratings has only led to two things in the past. Fat bonuses for the inventors and massive suffering for everyone else. TMM await the calls to "mark EFSF paper to market".
Even if the Europeans do get away with pulling off this issuance trick shouldn't the FSA, SEC and other non-European governance bodies ban the purchase of such obviously dangerous products? And if they were too, would then the only money the Europeans could rely on be the Grey funds that arrive in suitcases whose owners expect their money back in full or else horrible things happen?
But of course the really cunning part of all this is that there is no government or central country running this thing. The ECB is still a quasi-governmental body reporting solely to an unelected parliament in Brussels. Who do you actually go to when the poop hits the prop to get your money back?
Now as for that QE. We have already covered how we think this is indirect QE, but in TMM's eyes, it wouldn't be unimaginable for somewhere down this financial maze of collective (i.e - no-one's) responsibility, someone may notice that just buying Greek bonds for the EFSF with money that has electronically been created will be damn site easier than all this AAA issuance guarantee stuff. No-one would either notice or mind really. We mean hey, Qu'Est the harm it did to the USA?