The ECB is tacitly acknowledging the end of the euro

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by Hazel Lewry

The ECB is tacitly acknowledging the euro is on life support.

Last week a very strong statement by the European Central Bank [ECB], even if not made bluntly and directly, made it appear that it sees little hope for the euro, but it will prop it up until the bitter end.

In the short term it’s likely to have little impact in Scotland, but as Europe’s our largest trading partner it will alter dynamics substantially in the medium to longer term.

The immediate good news is that this effective quantitative easing [QE] in the EU puts Europe on a similar monetary devaluation slide as the UK. This helps to maintain equilibrium of sorts in relative monetary values and reduces the potential shock of either the cost of our imports becoming much greater adding to the deficit, or exports becoming more expensive.

The big loser is the average EU citizen, ourselves included, as rapid devaluation lowers the buying power of any resources we have, be it savings, salaries or benefits.

It has happened because this week the ECB effectively “caved” and announced QE in Europe.  Not directly, but by the back door through mid to long term banking loans.  250 billion euro worth of loans was expected.  These are loans with money its member states simply don’t have.  They had to print it and loan it to the ECB so the ECB can lend it to the banks that will, hopefully, buy sovereign debt and lend it back the nations that printed it in the first place.

The reaction in the financial world was surprising; the massive Societe Generale in France fundamentally blew off the announcement, stating “banks can’t save the sovereigns”.  In essence they are telling the ECB that the banks have issues and that borrowing from the EU is borrowing from an entity they no longer consider creditworthy.  Fundamentally, the banks and nations are both in a bind.

There is no guarantee the banks will do what the EU requires, even if they do decide to borrow the money made available.  No nation has the authority to force private banking to do this and that led to Societe Generale concluding its statement that even with 250 billion euro being “made available … the potential to repair the sovereign bond market is dubious”.

This will put 2011 down as the year that closed with the European snake eating its own tail.

Other banks and economies were also eyeing the total size of the loan package, too much indicated almost panic in the ECB, too little, pointless, the anticipated number was 250 billion, give or take the odd 50 billion.

In effect we in Europe are loaning fundamentally insolvent banks the money to re-finance or buy back our own debt, and to do so at a better interest rate, thereby paying us less for the privilege, while we ourselves are collectively broke and can only do so by mortgaging futures already so indebted as to be literally worthless.

In spite of this the Guardian quoted analysts reactions as “Given the ongoing stresses in the banking system, we expect there to be high demand for these loans”.  The interpretation is simple – the banks have such a crisis of liquidity that they have no choice except to take near worthless bond issues from over-mortgaged peoples.  They’re kicking the immediate need for a real solution somewhere past Christmas.

Jane Foley, senior currency strategist at Rabobank International held the view, “Eurozone governments will be hoping that a lot of the ECB’s cheap money will be used by banks to buy sovereign debt. This remains to be seen”.

“However, banks in the core are likely to be understandably reluctant to stock up on peripheral debt given fears that this could affect their reputations and their ability to fund themselves”.  In summing up she could only say, “The euro remains a very vulnerable currency”.

In simplistic terms this means that banks substantially rely on interbank lending, and much of these assets they obtain in this auction may not eventually be saleable or under writable. They’re buying a lemon, but they’ve no option.

If Ms. Foley’s was a lone voice this week it might be ignored or just put on note, it wasn’t, it was typical.  Michael Hewson at CMC Markets raises similar concerns on how much of the money will be used to buy sovereign debt:

“Nobody is able to predict how much of the funding will be utilised to buy up sovereign debt and there is a strong possibility that banks will for the most part take the cheap money as replacement for maturing existing funding.”

Mr. Hewson expects the banks will do the smart thing.  They’ll take the funds and use them to refinance what they already owe each other.  That will cause a rapid implosion of the euro as the nations of the euro will no longer be able to get loans to finance their ongoing deficits.

Mr. Hewson concluded “the main stickler is that the ‘solution’ is assuming a liquidity problem, while the real issue of solvency and the lack of growth remains unaddressed once again”.  Simply put, it’s a delaying tactic, and not likely to create a long delay.  The world’s economies need growth, growth takes energy, and global energy supplies are currently contracting.

The Royal Bank of Canada has also weighed in with an opinion, “our rates strategists point out the range around the €250bn median estimate is €50bn to €450bn.  Just where the “goldilocks” number is remains difficult to determine; a much larger than expected number in light of recent movements in short end peripheral yields would seemingly confirm that the carry in trade is in full flight (and that the European financial sector is taking on risk at a time when it is being guided to do the opposite).  Our rates strategists therefore think anything up to their €250bn estimate would be positive in that rollover concerns should abate somewhat whilst providing limited sign that no unreasonable risks have been taken”.

The final number was 500bn euro, in excess of RBC’s high end estimate.  It is a short term delay on a long term catastrophe in waiting, or in terms we all understand about £80,000 for every man, woman and child in Scotland, that’s what we have underwritten high finance in this week alone.

Any who think it’s just Europe should think twice, because we’re all interconnected and the UK is in worse shape than most of Europe, Westminster is simply a sick and tired old man that hasn’t made it to the hospice yet, the last rights are imminent with credit ratings anticipated to be lowered soon.

No nation will be immune from the tsunami that’s coming as a result of rampant unbridled capitalism, but those who can best implement damage control and limitation will be smaller agile nations that operate with a close to neutral or positive balance of payments.