European Central Bank

Just as Germany was warming its "Nein, Nein, Nein" machine, now that Merkel is solidly back from vacation and has caught up with all the desperation emails in the inbox, as reported yesterday, the ECB, in a furious attempt to preempt the unwind of every innuendo, speculation, "unsourced rumor", and everything else the ex-Goldman controlled printer of European currency (which however now and always is powerless without German support) has done in the past month to keep sovereign rates low, has just resorted to yet another deja vu preemption tactic: rate caps on sovereign bonds. Spiegel reports the based on unsourced data, "The European Central Bank (ECB) is considering to establish in its future bond purchases interest rate levels for each country. Thus, it would buy sovereign debt of the crisis countries whenever interest rates exceed a certain spread to German Bunds... At its next meeting in early September, the Governing Council will decide whether the interest rate target is actually installed." Which of course it won't for one simple reason: the same reason the ECB has done lots of talking in the past 3 months, and implemented absolutely nothing: the Bundesbank's Jens Weidmann, and the fact that as Danske (see below) and everyone else already explained when this idea was floated unsuccessfully the first few times, it would require an infinite balance sheet, something the ECB does not have, especially not when Germans are 'consulted.'

What do USD money markets have to do with gold? Money market funds invest in short-term highly rated securities, like US Treasury bills (sovereign risk) and commercial paper (corporate credit). But who supplies such securities to these funds? For the purpose of our discussion, participants in the futures markets, who look for secured funding. They sell their US Treasury bills, under repurchase agreements, to money market funds. These repurchase transactions, of course, take place in the so-called repo market. The repo market supplies money market funds with the securities they invest in. Now… what do participants in the futures markets do, with the cash obtained against T-bills? They, for instance, fund the margins to obtain leverage and invest in the commodity futures markets.  In summary: There are people (and companies) who exchange their cash for units in money market funds. These funds use that cash to buy – under repurchase agreements - US Treasury bills from players in the futures markets. And the players in the futures markets use that cash to fund the margins, obtain leverage, and buy positions. What if these positions (financed with the cash provided by the money market funds) are short positions in gold (or other commodities)? Now, we can see what USD money markets have to do with gold!  Let’s propose a few potential scenarios, to understand how USD money markets and gold are connected...

In Europe, the "no news" vacation for the past month was great news. The news is back... As is Merkel.

• "The Euro Crisis May Last 20 Years" - Welt
• German finmin: no new aid programme for Greece - Reuters
• Westerwelle Opposes Relaxing Greek Aid Terms: Tagesspiegel
• Euro Countries Plan Strategies to Prevent Break-Up: Sueddeutsche (via Bloomberg)
• Deutsche Bank Among Four Said to Be in U.S. Laundering Probe - Bloomberg
• Bundesbank Vice-Head Opposes Schaeuble’s Banking Proposal: WiWo (via Bloomberg)
• Westerwelle Opposes Relaxing Greek Aid Terms: Tagesspiegel
• German Industry Group Head says No Place In Greece For Eurozone: WiWo  (via Bloomberg)
• German Taxpayer Association Head Criticises ESM: Euro am Sonntag (via Bloomberg)
• Spain says there must be no limit set on ECB bond buying - RTRS
• France Favors Greece Rescue Package, Opposing Germany: Welt (via Bloomberg)

When financialization fails, the consumerist economy dies. This is what is happening in Greece, and is starting to happen in Spain and Italy. The central banks and Central States are attempting resuscitation by issuing credit that is freed from the constraints of collateral. The basic idea here is that if credit based on collateral has failed, then let's replace it with credit backed by phantom assets, i.e. illusory collateral. In essence, the financialization system has shifted to the realm of fantasy, where we (taxpayers, people who took out student loans, homeowners continuing to make payments on underwater mortgages, etc.) are paying very real interest on illusory debt backed by nothing. Once this flimsy con unravels, the credibility of all institutions that participated in the con will be irrevocably destroyed. This includes the European Central Bank (ECB), the Federal Reserve, the E.U., "too big to fail" banks, and so on down the financialization line of dominoes. Once credit ceases to expand, asset bubbles pop and consumerism grinds to a halt

Gold continued gains on Friday receiving a boost from Angela Merkel’s comments saying she supported ‘Super’ Mario Draghi’s pledge “to do whatever it takes” to save the euro. While this sentiment lifted markets and some investors hope ECB action is sooner rather than later - it is also creates the risk of currency debasement and could lead to further falls in the euro. At the beginning of August, the European Central Bank said that it might buy Spanish bonds if the government first applied for the European Financial Stability Facility (EFSF) support. The ECB has said that specific committees within the bank would design the appropriate mechanisms for the bond purchases in the coming weeks, suggesting a possible green light within a few weeks.

There are already three former European central bankers who criticize more or less openly the European Central Bank (ECB). All these older central bankers experienced the inflationary periods in the 1970s in detail, whereas the younger ones seem not to grasp what inflation means. Modern central bankers seem to think that monetary inflation will not lead to price inflation in the long-term. This might be true in countries where asset prices need to de-leverage after the bust of real-estate bubbles. But it is certainly not true in states like Germany, Finland or Switzerland, that did not have a real-estate bubble till 2008. With current low employment and the aging population, qualified personnel who speaks the local language  will get rare. PIMCO’s Bill Gross might be right saying that soon employees want to get a part of the cake and not only the stock holders. This essentially implies wage inflation, the enemy of the 1970s.

Can anyone seriously claim the European Union, the European Central Bank and its alphabet-soup programs still retain a shred of credibility? Every EU/ECB "save" is fictitious, every "fix" expedient, every promise empty, every face-saving summit a living lie. Ultimately, all the posturing, promises and saves come down to an impossibility: "rescuing" phantom assets purchased with astounding levels of debt by issuing even more astounding levels of debt. Does anyone truly believe this absurdity is anything more than a transparent fraud designed to extend the life of a failed, corrupt system constructed on fantasies and lies? Those with assets are fleeing for less fantastic and dangerous climes. The handful of French millionaires who are supposed to magically bail out a failed-state that absorbs 55% of GDP are busy transferring their assets out of France, a mass exodus of capital that is also playing out in China, where those who embraced the slogan "to get rich is glorious" are transferring their wealth, ill-gotten or well-earned, overseas. So vast is this outflow of wealth that for the first time the outflow of capital from China exceeds the inflow of investment capital. The smart money is exiting, and the last batch of credulous "China story" rubes are dumping their capital down a rathole.

It's not unheard of for stocks to rally when economic conditions are weak, particularly when corporate profits are doing well; Q2 marked a new all-time high run rate of S&P profits. As a result, the 13% gain in the S&P this year is not a complete anomaly. But, as Michael Cembalest of JPMorgan notes, in prior cycles, 'weak economy' stock market rallies were predicated more on the view that a private sector recovery was just around the corner, rather than the current view that more Central Bank stimulus is just around the corner. The other notable aspect of the rally is that it took place as earnings forecasts for 2012 and 2013 have been falling, and as Q2 revenue growth slowed. To paraphrase what’s going on, Cembalest believes "Bronze is the new Gold" as expectations are so low, that anything better than recessionary data can be well-received by markets. Of course, the other factor behind the recent rally is the prospect of unlimited bond purchases by the ECB to which the JPM CIO science-fictionally analogizes: "Swallowing an alien is one sure-fire way to get rid of it, but then you have to wonder what happens once it gets digested. Color me nervous how this all turns out."

Hold on tight boys and girls, cause Merkel is back from vacation, and she is not happy despite that healthy Santorini due diligence-inspired tan (as deputy-Chancellor Fuchs telegraphed earlier today, when he made it quite clear what his boss thinks about Greece, and about more printing). Per Bloomberg: "German Chancellor Angela Merkel returns to the front line of the European debt crisis this week as the bloc’s leaders squabble over measures including bond purchases to relieve concerns the single currency may fragment. Merkel ends her summer vacation and travels to Canada Aug. 15-16 for talks with Prime Minister Stephen Harper as a spiraling euro crisis threatens to constrain the global economy. With the region’s leaders awaiting a German high court decision on bailout funding next month, they’re struggling to smooth divisions over a European Central Bank plan to buy the bonds of indebted nations."

And suspicions arose immediately that the Troika was laying the publicity groundwork for something that bailout-leery Germans would oppose.

Lost in the complete and utter lack of newsflow yesterday (no pun intended) were some comments from Otmar Issing, former chief economist of the ECB. Also a German. Also an advisor for Goldman Sachs. In the absence of Angela Merkel and Schauble, both of whom are still conducting privatization due diligence on Santorini, he decided to present the German view to all the recent bluster and posturing by Europe choosing beggars. What he so conveniently explained is just why "European Union" is the biggest oxymoron imaginable, and why Germany will hardly smile quietly as the rest of the continent uses history as its only leverage to shame Germany into funding the bailout of its broke neighbors. In fact, what Issing confirms, is why any hope that a Federalist union in a continent in which deep seated hatred runs deep, and will promptly overtake any of the happiness associated with the recent 30 years of fake prosperity, is doomed. Art Cashin explains.

Who the heck turned off the spigot in the first place?

And so the fly in the ointment arrives as beggars are not only choosers but have completely lost their minds. As we explained very, very clearly over the weekend in "In Order To Be Saved, Spain And Italy Must First Be Destroyed", the market, courtesy of its primary function of discounting being completely and utter distorted and destroyed thanks to central planning, "priced in" the fact that Spain will be bailed out in the only possible way: by making a Spanish bailout next to impossible, sending its bonds so much higher that Rajoy could not possibly see any need in demanding a bailout (something which as Art Cashin explained further today will very much infuriate Obama). Well, as often happens, we may have been ahead of the market by a few days. And reality as well: because as of minutes ago Spain's PM confirmed precisely what we warned against - that by frontrunning Spain's destruction, and hence rescue, it has doomed Spain to a fate far worse. From France24:  Spain will not seek eurozone financial aid beyond an agreed rescue for its banks if more conditions than those already agreed for recapitalising lenders are attached, an EU source said Tuesday." The problem is that if and when the inevitable bailout demand comes, not only will there be more conditions, but Spain will effectively cede sovereignty to the Troika explicitly, and to Germany implicitly (for the full breakdown see here). Which again begs the question: which came first - the market frontruning the bailout or the government refusing to request a bailout on the market frontrunning the bailout and so ad inf.

Moments ago, members of the Greek government, which likely won't last long once the thorny issue of "math" returns and not even selling Bills to local banks (which promptly repo said Bills back to the Greek central bank) so the country can fund its payment to the ECB via an ECB guaranteed ELA payment from a Greek central Bank (confused yet) satisfies the New Normal ponzi math, made a strong statement: the country will not let any more public workers go:

• VENIZELOS SAYS STICKS TO PLEDGE NO LAYOFFS IN PUBLIC SECTOR
• KOUVELIS SAYS CAN'T ADD MORE UNEMPLOYED TO RANKS

The reason for this pledge is obvious: the last thing the country's new rulers need is more anger in the ranks as people demand a new government, which in turn will bring back Drachma redenomination risk. So what is the Greek solution instead? Simple: enter the labor pool, or the Greek version of the Permanent Paid Vacation, or akin to America's 99 weeks of unemployment benefits.

Market players are watching for any details on the ECB’s bond purchasing plans, after bank chief Mario Draghi said last week that the ECB would target short-term debt, fuelling optimism in the bond markets. A Reuter’s poll of economists on Friday highlighted that they expect the Fed to start QE3 in September, but a top Fed official said that a stimulus package so close to a presidential election would not be prudent. Since the ECB conditioned it would buy more government debt from Spain & Italy if they agreed to strict austerity packages, this has decreased pressure on either country to act quickly. The Financial Times interviewed Ken Wattret, a BNP Paribas economist who said: “If people think this will all be sorted in a matter of days, or weeks, then they will be disappointed. We could be in limbo for months.”