ECB money injection not a reason for optimism

Photo by M. Bartosch

Are you feeling optimistic yet? Are you confident that policy-makers have things under control? – If so, you must believe that we can solve any economic problem by throwing freshly printed money at it. Even problems that are evidently the result of previous periods of ‘easy money’- such as overstretched and weak banks.

The ECB this week allotted another EUR529.5 billion of new money to Europe’s banks. The banks get these funds for three years at 1 percent interest. That this is a gigantic subsidy for one specific industry does not require much explanation.

This operation, called long-term refinancing operation (LTRO) is only possible because the ECB has a printing press. The ECB can print unlimited amounts of euros and lend them to the banks at whatever rate it wants and against whatever collateral it deems appropriate. For this round of the LTRO collateral requirements have been eased again: the ECB gets ever more generous.

LTRO is nothing but the refinancing of struggling banks through money printing. This is one of the operations that the advocates of fiat money and opponents of a gold standard tell us we should all be grateful for. Such a ‘proactive’ policy of bailing out banks and ‘stimulating’ the economy would evidently be impossible in a system of hard and apolitical money. — True, but it would also be unnecessary. It is entirely inconceivable that the present mess, which is the result of a gigantic credit boom funded with a constantly expanding supply of fiat money, could have developed under a proper gold standard. The extent to which banks could over-lend, take risk, leverage their balance sheet and help blow various asset bubbles was only possible in a fiat money system with persistent expansion in bank reserves, with lender-of-last resort central banks, and repeated and lengthy periods of artificially low interest rates.

What we are seeing now is not the result of some unfortunate policy mistakes. The idea of the ‘policy mistake’ implies that the system itself is sound and would deliver the hoped-for results if only it was handled properly. “If only Greenspan had tightened earlier after the 2001 recession…”, “if only Greece had stayed out of the euro,…” — these deliberations are completely missing the point. Okay, maybe it would have taken longer for the system to reach its logical endpoint but it wouldn’t change the nature of that endpoint. Fiat money systems – systems of essentially fully elastic money – are fundamentally incompatible with capitalism.

The present crisis is therefore the crisis of our fiat money system. A system for cheapening credit artificially, systematically. A system in which the banks can grow, never shrink. A system in which prices always rise, never fall. A system in which we take on debt and never pay it back. A system in which the money supply always grows, never stalls and never shrinks. A system in which we only have booms, never busts. At least not big ones.

Never?–Well, until the system chokes on its own inevitable adiposity, its arteries clogged, its heart too weak. Or, in the parlance of economics, at the point at which the imbalances that a system of ‘elastic’ money constantly accumulates have reached system-threatening proportions. – That would be now.

“Wednesday’s loans were on top of the EUR489.2 billion of similar loans the ECB dispensed to 523 banks in late December. The ECB’s goal is to help struggling banks pay off maturing debts and to coax them to lend to strained governments and customers.” The Wall Street Journal reports.

We are almost 5 years into the financial crisis. This crisis started in the US subprime market in July 2007. In August 2007, Germany’s IKB had to be bailed out. In September, the UK’s Northern Rock experienced a bank run. Since then the numerous bailouts, the trillions of newly printed currency units and the zero interest rates in all major countries have avoided or arrested or postponed the total collapse of the system, and have generated the intermittent pseudo-recoveries. That the underlying problems are not solved is resoundingly confirmed by yesterday’s move by the ECB. The crisis started in 2007 and we are still in it.

A banking system that needs EUR1 trillion in long term zero cost loans from its central bank within 3 months is not a healthy one. Those who advocate this policy will say that without it we would have faced disaster. I agree, and I do not relish the thought of what that means. But how does the present policy solve anything?

With essentially unlimited funding at essentially no cost, no bank will fail. But ‘unlimited’ is a word that has no place in economics, which is always about the best use of limited resources. ‘Unlimited funds’ from the central bank is a scam, a deceit, a trick, a mirage. This is not the healing of the market economy. It is the complete abandonment of a market economy.

Failure – bankruptcy – is as indispensible to a functioning economy as death is to the concept of life.

This policy is no solution. It is a policy of perpetuating the crisis, of deep-freezing the imbalances, and of magnifying the accumulated aberrations.

Do we know which banks are in good shape and able to stand on their own two feet? No, and policy-makers do not want us to find out. – Do we know how big the banking sector should be and what shape it should have in a post-bubble economy? No, and policymakers do not want us to find out. – Do we know what the cost of funding the deficits of countries like Spain and Italy are? No, and policymakers do not want us to find out. They want us to believe that all banks are money good, that all countries are money good and that we are in a recovery. “Don’t worry, be happy!”

I guess LTRO is to our time what LSD was in the 1960s. As they used to say back then, “I don’t have a problem with drugs, I have a problem with reality.”

The reality is that financial markets are rigged. Prices are manipulated. Nobody can tell to what extent asset prices, interest rates and risk premiums reflect true available savings and real risk appetite, and to what extent they simply reflect the skillful manipulations of central bankers and the wall of money sweeping through the system. I believe you should stay away from rigged markets as much as possible. Keep your exposure to banks to a minimum, and stay away from government bond markets altogether.

The essential self-defence asset (photo by Swiss Banker)

This is why gold remains so attractive. If they stop printing money, the gold price will correct. But then banks and governments will be in serious trouble. So you still cannot put your money there. My guess is that they won’t stop printing money, and what the ECB did this week – although it was already anticipated – further confirmed this. Gold got a considerable beating yesterday, supposedly because Bernanke did not hint at additional easing measures. Well, we will see. Given the aggressive measures we have seen since October from the Fed (swap lines), Bank of England (2 rounds of QE), the ECB (2 rounds of LTRO), and the Bank of Japan ($129 billion in QE), we may see another manufactured rise in financial asset prices and in certain economic indicators over coming months. Maybe we can all enjoy a spring ‘recovery’. The hangover can wait — we just opened another bottle of the really strong stuff.

Let’s see how long it lasts.

In the meantime, the debasement of paper money continues.