Today, an ECB "rate setting" meeting is scheduled. This comes at a time when the common European currency is under more stress than ever. Everyone is waiting with baited breath to find out what they'll do. The consensus opinion is that the central bank will cut by 25 basis points. I think they'll do more.
Keep in mind that no fiat currency, including the euro, has any inherent worth. They are all irredeemable against anything of real value. Fiat currency has value solely on the basis of faith. People trust that other people will continue to exchange little slips of paper and electronic representations of that paper, for real goods and services. For all intents and purposes, maintaining the value of a fiat currency is a confidence game.
Sometimes, in confidence games, the perpetrators need to put on a show. There is a strong need for drama, right now, in the eurozone. People need to be reassured that the central bank will stand behind its currency. Central bankers seem to think they can "kick-start" things with dramatic acts. I am convinced that the ECB is going to try to be dramatic. They'll cut by 50 basis points, not 25.
This brings us to the question of what they'll do to the deposit rate. The ECB, like the Fed and a number of other central banks, pays interest to banks which leave money in reserve deposits. The rates vary a lot between central banks. For example, the Federal Reserve paid a zero rate of interest on reserve deposit for many years because it wasn't allowed to pay any more. The ECB currently pays 0.25% per annum. In normal times, banks keep very little money in the form of reserve deposits, because the rates are so low.
These are not normal times. This week, 772.86 billion euros, just shy of about $1 trillion dollars, sit in storage, at the ECB's depositary facility. The money has been put there by various eurozone member banks who have more cash than they need right now. The banks are willing to earn very low interest rates in exchange for a high level of safety. Some advocate cutting the interest rate on reserve deposits to zero, because many economists think that banks will be forced to start lending out the cash. The ECB may want to try, but suddenly cutting to zero (or a negative rate) could cause unanticipated inflationary consequences, if these economists are right, but the reaction is too strong. The ECB is likely to take it slow, cutting 12.5 basis points so that the deposit rate falls to 0.125%.
For purposes of this discussion, the deposit rate is much more important than the lending rate. Cutting the deposit rate dramatically will force banks to think very deeply about the idea of removing the cash. A pool of up to $1 trillion dollars could be released. Banks don't like to sit on completely "dead" money.
Cutting the rate by 12.5 basis points is likely to have less of an effect than cutting to zero, but it would cause some money to move out. The real question is where will it go? The eurozone is in recession, demand for loans by credit-worthy borrowers is said to be low, and many economists question whether or not the euro will even survive. That won't give banks that have a cash surplus much confidence in making new loans.
Commercial loans are dangerous at a time the economy is contracting. Real estate lending is out of the question, given that values are stagnant in most parts of Europe, and collapsing in others. Peripheral sovereign bonds continue to come with a high probability of default. German, Dutch, Japanese and Finnish bonds pay almost no interest. Japan has a 200% government debt to GDP ratio. British and/or American bonds also pay almost nothing, and will collapse as soon as the market recognizes that the debt situation in the UK and USA is much worse than in Europe.
In spite of the danger, I expect that some ECB deposit money, once released will be reflexively be put into sovereign bonds and commercial/personal loans. Auto loans, for example, are likely to become cheaper and easier to get. But, commercial banks are not keeping money at the ECB because they want it to "go to work for them". They are doing it because they are afraid.
If European banks wanted non-cash assets, they'd buy them. They'd be making loans with the money, which they aren't. European stock markets would not be crashing because banks would be using the cash to buy stocks. They aren't. Banks with excess funds clearly want to stay in "cash" or its equivalent. Deposits with the ECB are viewed as a risk-free "store of value". If storing wealth at the ECB happens to become undesirable, they will store it in another form.
The key, again, is that banks with excess cash would be lending it if they wanted to. That isn't going to change simply because they're forced to redirect cash into another form. When and if the ECB deposit rate falls, the larger part of reserve deposits will continue not to circulate, until business conditions improve. Part of the excess cash will flow into investments, like precious metals, which are another form of cash.
Gold (GLD) (IAU) (PHYS) is the most monetary of the metals, but silver and platinum also have monetary properties. All are traded in terms of dollars, and will retain a majority of their value after the prospective implosion of the euro currency. All are free of counter-party risk when owned in physical form. Banks know this.
Gold, silver and platinum are about to become massive beneficiaries of eurozone monetary easing. If the ECB does what I think it will do, all three metals are likely to take off over the next few months, starting with a very large short squeeze. The velocity of price increase may well progress at a rate never seen before, over such a short period of time. Given market tightness and the fact that central banks have a hard time supplying the physical commodity, silver is likely to rise fastest, at least in the short term (before the end of August).
If, on the other hand, the ECB disappoints, the metals are likely to see a continuing lack of direction. They may rise anyway, but the rocket propulsion will need another spark to ignite the fuel. This may eventually come in the form of a bank charter for the ESM bailout fund, an announcement of QE3 by the Federal Reserve, a western attack on Iran, and/or a number of other important geopolitical events.