Market to Rally as ECB Rides to the Rescue – Should You Trust It?

by Sean Brodrick on May 10, 2010

Over the weekend, the European Union led an alliance to put up $957 billion to buy government and private debt (€750 billion) to keep debt markets working and lower borrowing costs. This has put a bid back not only in European debt, but the euro, and the American stock markets.  The Dow is up about 400 points in pre-market as I write this.  Gold is off about $16 an ounce.

So should you trust this rally?  It sounds like a continuation of the Ponzi scheme to me.  The program consists of €440 billion of loans from eurozone nations, €60 billion from an EU emergency fund, and €250 billion from the IMF.  So let’s look at the money from eurozone nations – that means Portugal, Spain and Italy – all troubled debtors – are now throwing in more money to buy the debt.  That really defines a Ponzi scheme.

The European Union is creating debt to buy debt.  At some point, gravity kicks in, and Wile E. Coyote realizes he’s about to fall into an abyss.

There are really two ways that I can see this can work out. Either the austerity measures will take place, not only in Greece but across Europe, and unemployment will go to Depression-era levels. Or, countries will start to unhook from the euro and devalue their individual currencies to pay off debts and make them more competitive with industrial juggernaut Germany.  That is the road to inflation and perhaps hyperinflation.

As for the U.S. market?  I’d look for a bounce for a week or two, then it will probably nose over again.  Meanwhile, this pullback in gold is likely a buying opportunity.

I said there are two ways I can see this working out, but I don’t have a crystal ball, and there may be other ways.  If you can think of some, feel free to leave your ideas in the comments.

UPDATE:  Peter Boone and Simon Johnson come up with a third option

It could be that in two years time Europe’s deficits are much lower, the ECB has hardly bought any bonds, and they have successfully managed a Greek debt restructuring while Spain is out of trouble, and Portugal and Ireland are scraping by in limbo but now isolated problems.  With the US likely to still be running near 10% GDP budget deficits – who will seem more risky then?  This immediate confidence in the US dollar that has come out of this European crisis could very quickly evaporate.

XX Sean’s note — I don’t see how the ECB could end up buying very few European bonds, but Boone and Johnson may probably know more about this than I do.

{ 3 comments… read them below or add one }

Nick May 10, 2010 at 10:30 am

Basically what the ECB has done is to consolidate the debts of the individual High Risk countries and replace them with ECB Debt which carries a higher credit rating – for now. In doing so they have effectively kicked the can down the road for a year or so – maybe less – which is a political decision. It seems that there is no politician anywhere with the guts to tell things as they are and take the necessary steps before the Markets force them to do it – as is happening now in Greece.

The problem is that the longer they leave it the worse will be the correction – when it eventually does come.

My question is this:

If central banks keep printing money – and most of that money goes to large commercial Banks – how does that become inflationary if all the commercial Banks do is to use that money to rebuild their balance sheets. They will not lend it out if they know what is coming (ie massive deflation and unemployment) – and that makes what is coming a self fulfilling prophecy.

Surely that is very bearish for Gold – because unless the money that is printed gets into the hands of those who will spend it (like my wife) – surely there will be no inflation?

So the problem becomes – you can lead Banks to customers, but you can’t make them lend. Or can you? And if so, how?

Reply

Van May 10, 2010 at 3:19 pm

957 Billion, not trillion. .
Also, in current post,Larry is saying that “$5,000 in 1913 is only worth 4.5 cents”
Should be “$1.00 in 1913 is now worth 4.5 cents”
And this should read $957 billion

Reply

Sean Brodrick May 10, 2010 at 3:33 pm

Thanks for the correction, Van. Where were you when I needed a proofreader? :-)

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