Monday, 10 May 2010

The 750 billion Euros Poker hand: All in !

The G20 and the ECB finally caved in to the Markets and the Nuclear option plan, Quantitative Easing. Central bank have been instructed to buy Government bonds (Greek debt as well...) on the secondary market.

Again, we are pointing towards the same road, deflation then inflation.

As I said it before, the game is to debase the currency and generate inflation down the line, the EU follows the path of the US and the UK, as Japan did previously, and failed.

This is why Gold has not retraced significantly.

Gold is now a one way market, the only way is up, as Yazz sung back in 1988:

"We been broken down
the lowest turn
and been on the bottom line
sure ain't no fun
but if we should be evicted from our homes
we'll just move somewere else
and still carry on
Hold on, Hold on, Hold on

The only way is up, baby
For you and me, baby
The only way is up
For you and me"

The G20 governments are basically postponing the day of reckoning and delaying the bond vigilantes. The structural issues have not been adressed yet. Also who is going ultimately to pay for this?

For the time being the bond vigilantes have been kept at bay, but should financial and fiscal discipline not materialise in the near future, you can expect them to be back with a vengeance.

The massive rally we have seen from CDS indices moving dramatically tighter to bank shares massive double digits equity moves, it really points to short covering, particularly in respect to the EUR/USD.

The big challenge is still very real. Following the financial crisis, banks have been busy repairing their balance sheets, credit has not flown dramatically back into the economy and banks have been net buyers of treasuries, borrowing at zero and locking a nice spread in the process.
Now countries are facing a similar music. Most European countries need to repair their public finances. For some, like the UK it will be easier as the UK control its currency.

In relation to the latest bail out:

David Goldman in his excellent blog Inner Workings sum it up nicely:

"The banking system really was about to come down. The reason is that sovereign debt is a bigger problem than subprime mortgages ever were. We know from available data that two-thirds of the US deficit, according to available numbers, has been financed by domestic as well as foreign banks during the last quarter of 2009 and the first quarter of 2010. This is clear from the Treasury’s data on international capital flows, which shows $50 to $60 billion a month worth of purchases of US Treasury securities from abroad, almost all of it from London or the Caribbean, that is, offshore banking centers. US banks meanwhile are adding Treasuries to their portfolios as fast as they shed commercial and industrial loans. Detailed data is not available on international banks’ holdings of Greek, Spanish, Portuguese or Italian bonds, but we know from anecdotal evidence that the weak sisters of southern Europe have been financed by bank treasuries just as the United States has.

It’s all been done by smoke and mirrors. The governments bailed out the banks in September 2008, and again in various increments through the Spring of 2009. The great Keynesian stimulus that was supposed to guarantee recovery left most industrial countries with government deficits in excess of 10% of GDP. How does the US finance a deficit equal to 12% of GDP with a savings rate of 2.5%? By bank leverage. The banks, once bailed out by the governments, in turn bail the governments out. And when the weaker governments threaten to go belly up, the banking system freezes up."

This is why a decisive action had to be taken, the system was freezing up again, the signs were very clear in the credit markets, looking at the TED spread as well as the OIS-Libor rate. The interbank market was drifting towards a Lehman style freeze.

Since the near collapse of the financial system, the patient who already had one cardiac arrest had to be resuscitated. Following TARP, this is the second defibrillator attempt.

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