Today, about 490 billion euros ($637 billion) worth of ultra-low interest "loans" will be delivered to European banks. This cash has been provided courtesy of the ECB, which denies that it will ever engage in printing money, like the Americans, Britons and Japanese have now done for many years. The "loans" are for a 3-year period. In return for the cash, the ECB accepts various forms of "collateral," which includes the debt of insolvent southern European sovereigns. This is the largest uptake of cash in the history of the European Union, including the cash given out by the ECB after the collapse of Lehman Brothers.
This is merely the first of a series of so-called long-term refinancing operations (LTRO) the ECB is going to undertake. These are unlimited tenders of cash. The banks call the shots. Any amount they ask for will be given to them, subject only to the availability of collateral. The next tender is scheduled for February 28, 2012, and many are predicting that it will generate an equal or greater demand for cash among euro-banks. The stated intent is to provide liquidity to banks at a time of great stress for the eurozone. The unstated expectation is that part of the cash will be used to shore up balance sheets, and another to replace or buy more bonds from troubled sovereigns of the eurozone, including, particularly, Italy and Spain.
The maturity time for the "loans" is long enough to cover banks until the maturity of many of the sovereign bonds banks might purchase. A bank can now borrow from the ECB at 1% per year for 3 years, invest in a 3-year Italian bond paying 6% plus, and pocket 5% each year in pure profit. That is an enticing proposition. But, the end game is much more lucrative than that. Today's cash delivery is only the first of many 3-year LTRO events that will happen every two months this year. The next one is scheduled for February 28, 2012. The income achieved from buying sovereign debt can, therefore, be leveraged each time a new LTRO takes place, until it reaches an astronomical level of profit. Remember, sovereign debt collateral, at the ECB, is in so-called "category I," and is the subject of a tiny 1.5% haircut
The tiny haircut means that a eurozone bank can post $1 billion in Italian bonds with the ECB on December 21, 2011. On December 22, it can take back $985 million and use that cash to buy more Italian bonds. On February 28, 2012, it will be able to take the newly purchased bonds back to the ECB, take out another 3-year loan, and walk away with $970 million in euros the very next day. It can use that money to buy more Italian bond. Every two months, it will be able to do this again and again, until such time as the ECB decides to stop the LTRO offerings. It is unlikely that the ECB will stop doing LTROs until sovereigns have sold all the bonds they would have liked to sell directly to the ECB if that institution were not prohibited from buying them directly.
The LTROs, therefore, are a back-door method of quantitative easing. If Italian bonds continue to pay about 6%, after 1 year of participating in bimonthly LTROs, a euro bank can earn about 30% per year in spread interest. The longer the LTROs continue, the bigger bank earnings will be. Even if LTRO offers end after one year, in three years, an actively participating bank, taking a modest risk, will achieve a 90% return on investment, with the ECB taking all the risk. If the eurozone collapses, at the end of the 3-year period, and bank would likely collapse anyway. But, if it participates to the fullest extent possible, in the back door money printing, its executives will have collected fat bonus checks from big profits made on sovereign debt. That cash will, by that time, be safely invested in gold, silver, platinum and palladium.
Yet, in spite of this reality, many market pundits still claim that European banks won't buy the debt of troubled European sovereigns. This view is naive. While it is possible that this first LTRO may be used to bolster balance sheets, you can be sure that clever executives at the banks will quickly catch on, and, by February 28, plenty of banks will be taking hundreds of billions of euros for the sole purpose of buying sovereign bonds and earning the spread. But, being "clever" is not really necessary. Central bankers communicate heavily with commercial bankers before making decisions to flood financial markets with hundreds of billions, and, probably, trillions of euros or dollars.
If commercial bankers had not already agreed to buy sovereign bonds, this program would not exist. There is no doubt that before providing unlimited LTRO money, a quid pro quo has been reached. Even in the extremely unlikely event that banks do not buy much European sovereign debt, the money market in Europe is going to be very liquid over the next 3 years. The total amount of cash injected by the ECB may total several trillion dollars. That means the eurozone is not going to fall apart for a while. It will remain until at least the end of the 3 years, even though individual nations, like Greece, may end up dropping out or nations like Germany may introduce national currencies toward the end of that period. But, at the very least, the free availability of cash over the next 3 years will make commercial and personal loans, including loans to buy automobiles and capital equipment, very easy to come by. Production of cars, trucks, airplanes, etc. are not going to nosedive, but are likely to increase.
As usual, therefore, the Wall Street groupthink is wrong. Europe is going to see significantly better nominal growth levels than the assumptions gave it credit for. It is also going to see a lot of monetary inflation, at least over the next 3 years. Since withdrawal of trillions of dollars in liquidity, 3 years from now, would implode the eurozone, you can be sure that some EMU treaty modifications are going to be made, by that time, to make this soon-to-be bulging money supply permanent. The money supply in Europe is about to exponentially increase. This is money printing on a scale that exceeds that of even the master money printers of America and Britain. The end result, at least in the medium term, is going to be lower yields of European sovereign debt, and increased bond prices.
Gold prices will eventually respond directly to monetary liquidity increases, no matter how much central bank price suppression intervention there may be right now. With huge euro injections, alongside significant quantitative easing in the UK and the USA, gold will rise stronger than ever, at least over the next three years. Silver, which responds both to monetary liquidity and to commercial demand, is going to rise even faster, especially as commercial demand increases in Europe, and those that "feed" Europe, like China. Platinum responds to monetary liquidity, commercial demand, and, particularly, auto and truck sales. Of all the precious metals, platinum has been the most deeply abused by Wall Street groupthink, which assumed the complete death of European auto sales. It may, therefore, rise most quickly, once reality catches up, especially considering the 27% drop in S. African production in October.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PPLT over the next 72 hours.
