The market is quite content with the all the Central Banks of the world uniting to provide seemingly infinite liquidity to the system. The ECB's latest proposal is to buy unlimited amounts of sovereign paper to aid those countries whose yields are moving towards their proper market-based level. The Fed is embarking on QE3, no doubt to infinity...and beyond.
Clearly, we wouldn't want the market actually deciding the appropriate risk and consequent interest rate required to invest in sovereign and agency debt, as the market's true perceived value of the risk of these instruments would be catastrophic to the global financial system. There is an undoubted irony to a market that is called free yet has a third party deciding appropriate asset level prices. Nonetheless, this is an exercise of risk transference of unprecedented magnitude.
In Europe, they are trying to transfer risk to the larger ECB and away from the smaller peripheral countries. The real key here, despite Germany's rampant opposition to printing more money, is that they are transferring debt to the entity that owns the printing press. The ECB has apparently committed to sterilizing the bond purchases (meaning not print new money to buy the bad debt) by issuing their own debt. I've written countless times over the years to my investors that a country can not sustainably issue debt in a currency for which they do not own the printing press. Many have tried. They have failed.
Now, it seems the European Union may actually be taking some steps to bootstrap together a legitimate union. If there is a means for all the countries to issue debt and have the whole print their way out of it, then the ability to run larger debt/GDP ratios becomes more prevalent, at least, less susceptible to liquidity shock risk. This system, no doubt, is also flawed, however much more capable of kicking cans down metaphoric roads.
The new problem, however, is that there are still a lot of inputs in the decision making process. Germany does not want to print more money, but you can obviously see the problem with an entity that is flogging its own balance sheet with lots of bad debt and then trying to go to the market to issue its own paper if it can't print its way to repaying principle. What is the credit worthiness of an entity that holds a bunch of bad debt and can't just freely generate cash? It's not very good. All of these new announcements have strengthened the euro and dramatically calmed the markets, but the overall balance sheet is still deplorable.
Germany does not have infinite funds to prop up all of the failing countries in Europe, especially when the appetite for entitlements is never ending. The balance sheets simply do not exist in order to support the level of spending that is occurring. The market must be assessing that they will be able to get a return of principle because Germany will ultimately roll over and allow money to be printed, and it seems that the return of principle that is devalued is far superior to no return of principle at all. In other words, we are still tied to the notion that the central banks will do everything they can do, and that means they must print their way out of this mess.
It's easy to fault the Central Banks, but they are really just reactionary and doing what they can to hold the system together. What we have is a global spending problem. Governments have expanded beyond their fiscal abilities. When households try this, they fail. There is a serious fault in logic when a government believes they can net together all of their households and be successful partaking on a strategy that fails for each individually. There is a failure in mathematics here.
Though well intended, most of the actions do not produce economic growth. As an aside, what is economic growth, really, if you also count the debt you now owe? Every government forgets about this side of the equation. It matters. The New Deal has already been tried. It was a great failure. Unemployment ended higher, and then there was just more debt. It's not obvious why we are doing this all over expecting different results, but this is what all the governments of the world are now finding out once again. You can spend all you want to try to prop up the asset side of the balance sheet, but it doesn't erase the liability. If you have no money in your pocket, you are not suddenly better off because you borrow a Benjamin Franklin. You may have the hundred dollars, but you owe it also. You are net the same.
To quote Henry Morganthau Jr., Secretary of the Treasury under FDR who oversaw the New Deal, "We have tried spending money. We are spending more than we ever have spent before and it does not work." "I say after eight years of this Administration we have just as much unemployment as when we started. And an enormous debt to boot."
Everyone knows this is the case, but it is clearly much more fun if a global equity put is put in place in the process to prop up all assets, then to come up with a bunch of cool acronyms for your programs, and pretend that the liability side will take care of itself. The tailwind still exists despite the structural flaws, and it should not be fought. Insanity is deep, and it devours all who stand in its way without regard for logic.