Please, click here to read this article in pdf format: november-10-2011 The events triggered during the last 24 hours warrant a short update on our last letter. As we noted then, we could either assume that (a) the ECB (i.e. European Central Bank) holds the line with sovereign bond purchases or (b) on the contrary, [...]
Please, click here to read this article in pdf format: november-10-2011
The events triggered during the last 24 hours warrant a short update on our last letter. As we noted then, we could either assume that (a) the ECB (i.e. European Central Bank) holds the line with sovereign bond purchases or (b) on the contrary, it accelerates them.
Please, please, pay attention to the following: When you think about (a) or (b), you further assume that there exists indeed an entity named “ECB” or European Central Bank. This should be rather obvious except that yesterday, “…EU sources told Reuters that German and French officials had discussed plans for a radical overhaul of the European Union that would involve establishing a more integrated and potentially smaller euro zone…” (refer: http://www.reuters.com/article/2011/11/10/us-eurozone-idUSTRE7A831520111110 ).
Now…this changes everything! This, if it is not seriously denied, will trigger a run against banks in the Euro periphery. This is in our view the most unfortunate move any policymaker should have made. They made it because they wrongly think they are still in control. They are not, so there is no upside in telling the market that they consider a break up. The market will tell them when and how!
Until yesterday, policymakers could have still managed to “do something”, even if that something was nothing else but to monetize sovereign debt. With this news, which we think was released in the European afternoon, we expect deposits not to be renewed in the EU periphery banks and an exponential increase in withdrawals from chequing accounts.
One thing is to have the options (a) or (b) above, with regards to the speed at which sovereign debt is monetized. An entirely different one is to be forced to act as lender of last resort for banks which face a run, precisely because the notion of the ECB as lender of last resort is challenged.
If you are a Spanish depositor, would you not withdraw your savings, in Euros, from a local bank? Why would you transfer them to, say a German bank, if you don’t even know what currency Germany will have? Yes, you can assume it will be a stronger currency, but still…why take chances? Why not buy certainty? Why not buy an existing currency, outside the Euro zone? At the same time, if that Spanish bank seeks a liquidity line from the ECB, what incentive would Germany or France have to support it and inherit their share of this headache, when they actually intend to break up? None, we suspect, which brings us to our most important point: If the Euro zone breaks and the ECB is liquidated… How can Ben Bernanke justify rolling over the existing currency swaps to provide USD funding to the ECB, a central bank in the process of being liquidated? He can’t!!!! He has the whole opposition spectrum, from Ron Paul to Mitt Romney, every night on TV shows explaining how they plan to audit the Fed if they get to power. The Fed can only keep its currency swaps outstanding as long as there is an institution called European Central Bank. Otherwise, the swaps will have to be called.
This is very serious. On September 5th, we wrote: “…AS LONG AS THESE FX SWAPS (USD BACKSTOP) REMAIN IN PLACE, WE WILL BE LONG GOLD. THE TOP FOR THE GOLD MARKET WILL BE REACHED THE DAY THIS BACKSTOP IS ELIMINATED EITHER VOLUNTARILY OR FORCED UPON THE FED BY THE MARKET AND NOT ONE MINUTE EARLIER…”
Well, the market is in control now, folks. The game is over and policymakers have lost it. Whether the break up is disorderly or not, remains to be seen. Personally, we prefer to watch from the sidelines.