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The historically hawkish European Central Bank (ECB) has the single mandate of ensuring price stability in the European Union. In the face of the rapidly unfolding debt deflation collapse of the European banking system in December 2011, the ECB shocked global financial markets with the December surprise of $645 billion in long-term refinancing operations (LTRO). The program provided three-year loans to strapped banks. The ECB on a lending binge to over 500 banks qualifies as interesting times by any standard.

To make matters even more interesting, the ECB is stepping up with a second round of LTRO this week. There are calls for as much as one trillion euro in new LTRO lending by the ECB. Such calls are no doubt from those with vested interests in preventing debt deflation. In short, banks owing more to creditors than they can pay without ECB help. The ECB appears to be more than willing to oblige those with an interest in inflating the system and privatizing profits, while socializing losses.

The creditors repaid by the banks are now deciding what to do with the proceeds of the loans that were going bust. They appear to be buying stock and gold with the return of their capital funded by the LTRO. The ECB is also hoping that in addition to paying off their creditors, the banks will have funds left over to buy sovereign bonds and bring rates down.

Before you get too excited about the prospects of the over-the-top LTRO lending you need to realize that the Chinese proverb, "May you live in interesting times," is intended as a curse and not a blessing. In addition, it is just the opening act of a three-part Chinese curse heaped upon their enemies. The second part is, "May you come to the attention of the authorities", and the third and final part of the curse is "May you find what you are looking for." The progression of this curse contains some deep Confucian philosophy and irony that may be more than most care to ponder, since the global banking system may shortly find what it was looking for.

If you grasp crisis unfolding on the world stage, you will recognize that the progression of this three-part Chinese curse in the global financial system is growing more disconcerting by the day. Putting the situation in the context of this Chinese proverb, the ECB loaning out a trillion euro qualifies as interesting times, even if there are those that would have you believe it is already standard operating procedure. Obviously, the banks have come to the attention of the authorities. They are borrowing trillions from them. The world may now be getting closer to understanding the third tranche of the curse. The global banking system appears to be looking for a release from the consequences of decades of financial folly through inflation. If they get what they are looking for, it will prove to be tragic.

Trying to stop global debt deflation is really an attempt to stop the business cycle. History has proven that this is not a good idea. Business cycles are natural forces that serve a purpose, just like the seasons of the year. We all know that it is not smart to fool with Mother Nature. Business and entrepreneurs need failure to get them headed in the right direction. If they do not get the feedback loop of failure, they get confused and start to think that bad ideas are good ideas. If this occurs often enough and long enough you end up with a global economy built on bad ideas leading to problems much larger than a business cycle, welcome to 2012.

The global economy is a complex system and business cycles, smaller cycles and even larger cycles serve to send signals to banks, businesses and entrepreneurs on what is working and what is not. It is how individuals and businesses find their fulfilling and rewarding purpose. Trillions in deficit spending by governments, QE, backdoor QE ECB loans, and various artificial injections into a system where businesses and individuals are pursing their purpose, produce far more disastrous results than just rewarding failure and punishing good decisions, it denies the fulfillment of individual and collective purpose.

Aggressive fiscal and monetary policy simply expands the cycles and makes the bust bigger and more painful when it comes. It also takes the pain away from those that deserve it and puts it on the backs of those who do not, including future generations. With an understanding of long wave and market cycle dynamics, you can actually observe the results of the fiscal and monetary stimulus on the cycles.

A quick review of the cycles is in order. The cycles are running long due to monetary and fiscal intervention. The most important cycle for investors and traders is the Wall cycle. The Wall cycle is a miniature long wave cycle, i.e., a long wave divided by 144 produces the next whole level of cycle that are the result of fields of human action and interaction. The ECB's LTRO program in December has produced an impressive Quarter Wall cycle. They have significantly lengthened the cycle, but it will end. The point of tracking Wall cycles is to use them as a formula timing plan to buy value when markets are oversold and sell when they are overbought.

The chart below of the German DAX demonstrates what happens when the central banks mess with Mother Nature. The ideal "natural" Wall cycle is 141.9-days. The ideal "natural" Quarter Wall cycle is 35.5-days. There is a chance that the August lows started Wall cycle #6. The chart below is set up to use the September lows in the DAX. Wall cycles tend to run long by Fibonacci ratios of their ideal lengths. Notice the Quarter Wall (QW) action with the first round of the LTRO in late December. The ECB has created a QW monster, but even this monster will end. The cycle looks like it hit resistance of the Fibonacci Level 2 golden ratio target price. The MACD is now a sell.

DAX
(Click to enlarge)

No doubt, some of the creditors never thought they would be repaid by the banks before the LTRO was launched. They are taking the proceeds of the ECB funded loan repayments and are fleeing debt and moving into equities. There is likely some wisdom in equities over debt when the central banks of the world are trying to inflate, but debt deflation still poses great risk to the global financial system.

The Swiss SMI is clearly benefiting from ECB provided liquidity. One reason for this rally is that investors are in pursuit of dividends in Swiss francs from Swiss large caps with strong global franchises in a world the central banks are trying to inflate. However, the current Wall cycle will correct and likely more severely than expected.

SMI
(Click to enlarge)

The liquidity produced by concerted central bank actions around the globe and the continued fiscal deficits by government are driving the rally in the U.S. S&P 500. Banks and markets have the attention of the authorities. They appear to be getting what they were looking for, but this is not the end of the story.

Wall cycle #6 was rolling over into a debt deflation late last year, but trillions in monetary and fiscal intervention have likely bought a higher high and a higher low in this cycle. In the S&P 500 the Wall #6 start was either the August or October lows, both starts have Fibonacci extension time cycle low targets in March. The liquidity in the system will drive Wall cycle #7 in the U.S. election year, but the ECB gone wild party with complicity and participation from other central banks is now going late into the business cycle and into the wee hours of the morning of the long wave cycle winter. This will not end well.

Wall 6 March Targets
(Click to enlarge)

The Chinese are typically a few steps ahead of their proverbs. They are the largest holders of developed world sovereign bonds. They know the inflation goals of central banks will eventually destroy the real value of these bonds. The Chinese are looking ahead of the central banks getting what they are looking for. The Chinese clearly recognize what the developed world is up to, and that the central banks of the developed world are intent on stopping the debt deflation with inflation.

In a debt deflation, debt gets more expensive and difficult to repay. The Chinese realize that central banks and bankers of the developed world could unfortunately get what they are looking for. The Chinese are keenly aware that something new is coming beyond the unfolding global debt crisis.

The Chinese are mining more gold than any other country in the world, but they are not selling any of it. They are also typically the largest buyers of gold on world markets these days. The Chinese appear to be betting on the rise of gold as an alternate world reserve currency. The late December correction in gold back to the golden ratio just above $1500 of the most active Fibonacci projection grid may have been the last call on the way to the next projection target of $2300. That was a nice gap up over the latest Level 2 Fibonacci grid target at 1771 last week, but is now bumping up against the Gann 3X1 off the 1999 lows, so watch that resistance.

GOLD
(Click to enlarge)

Central banks intend to destroy the value of the debt through inflation, but the crisis will likely get ahead of them for a time and produce deflation. The U.S. Fed has even provided the target rate at which it intends to destroy the value of the debt with the two percent inflation target. It is interesting to note that a two percent annual inflation rate becomes a 100% inflation rate over 50 years. It is starting to look like a central bank sponsored 50-year Jubilee of debt forgiveness program. Even in light of full throttle at the central banks, inflationist should keep an eye on prices. Debt deflation will still likely get the upper hand briefly in 2012 and into 2013, but the central banks will likely double down, slowing down the long wave spring season.

In summary, these are indeed interesting times as the ECB goes wild. The banks have come to the attention of the authorities, and the banks just might get what they are looking for. However, the new world reserve currency of gold is rising in its ascendancy. So enjoy the ECB's LTRO party this week, but keep an eye on gold, and do not forget that for thousands of years the Chinese have been refining their proverbs, and their curses.

Source: The ECB Gone Wild: Living In Interesting Times