Central Banks Pump Money to Prop Up Europe

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Exactly three years after Lehman Brothers filed for bankruptcy and almost brought down the global financial system, central banks in North America, Europe and Asia engaged in a coordinated money pumping operation to prevent the EU banking system from stalling. The move created a sharp stock market rally, especially in financial shares, just as was the case when similar actions took place during the 2008 Credit Crisis.

Involved in Thursday's action were the U.S. Federal Reserve, the ECB, the Bank of England, the Swiss National Bank and the Bank of Japan.  The purpose was to improve dollar liquidity among  European banks struggling because of the Greek debt crisis. The credit markets have frozen up, just as they did after the Lehman bankruptcy, and U.S. banks have been unwilling to lend dollars to European banks. The ECB will now be able to access dollars by swapping assets with the Federal Reserve. It wasn't stated in the announcement what assets were involved, but obviously they are substandard ones that wouldn't be accepted  in free market trading. This operation also increases exposure of the U.S. financial system to the new credit crisis in Europe.

Such coordinated money-pumping operations are a sign of desperation on the part of the authorities. They were commonplace after Lehman's bankruptcy on September 15, 2008. They created significant volatility in the stock market back then as they did yesterday. Both the German DAX and the French CAC-40 closed up more than 3%. Troubled banks had huge rallies, with Lloyd's Banking Group up over 7%. In 2008, even greater volatility took place, but the rallies proved time and again to be only temporary. The market ultimately nosedived.

The Friday before the Lehman bankruptcy, the S&P 500 closed at 1251.70. Lehman declared bankruptcy on Monday. At the end of the week, the S&P 500 closed at 1255.00. The day before however, the S&P rallied off of its intraday low of 1133.50 to a close of 1206.51 (that's a 6.4% intraday rally -- an enormous move for an index like the S&P). So, the first week after Lehman's bankruptcy it looked like the market wouldn't be impacted that much. It turned out that the actions of central banks provided investors with a false sense of security however.

By the end of September 2008, the S&P 500 closed at 1166.36. Then at the end of October it was down to 968.75. At the end of November, it had dropped to 896.24. It actually closed higher the last day of December at 903.25, before falling to 825.88 at the end of January. By the close of February, the S&P was trading at 735.08. It finally bottomed at 666.79 on March 6, 2009. All along the way, there were big moves up that coincided with the latest money injections of the central banks.

While mainstream media reports tend to portray the central bank actions and the big rallies they cause as good news for the market, they are actually an indication that more trouble is on the way. All investors have to do is remember what happened just three years ago. Yesterday's central bank action indicates that more volatility and lower stock prices are in our future. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

EU-Centered Credit Crisis Continues

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The 2011 Credit Crisis continued Tuesday with the Stoxx Europe 6000 index hitting a two-year low, the Swiss taking desperate measures to control the franc, more record high prices for credit default swaps (bond insurance) on British Banks and yields on 10-year U.S. treasuries hitting an all-time low. Despite the dramatic turn of events, stock losses were somewhat muted.

U.S. markets opened sharply lower, but the Nasdaq and S&P 500 recovered toward the close in a technical move that involved filling the gap down that took place on the open. The Dow however still had a 101 point loss at the close. In Europe, the German DAX was down 1.0% and the CAC-40 in Paris 1.13%. While these losses would have been considered significant only a few months ago, they are minor compared to what has taken place on a number of trading days since late July. The British FTSE up even up 1.06%, despite trouble in the UK banking sector.

The British banks most in trouble are the ones that were nationalized during the 2008 Credit Crisis -- Royal Bank of Scotland and Lloyd's Banking Group. Credit default swap (CDS) rates for these banks are higher than they have ever been. CDS rates for HSBC and Standard Chartered are at one-year highs. The problem with these banks seems to be toxic loans left over from earlier in the 2000s. It is not clear if they were included in a sweeping statement made Monday by Josef Ackermann, CEO of Deutsche Bank, that "numerous" European banks would collapse if they were forced to recognize all losses against their holdings of government debt.   

The most significant market event yesterday was the Swiss capping the value of the franc. The Swiss National Bank (SNB) said it would "no longer tolerate" a euro franc exchange rate below 1.20. The franc then had a significant drop against all major currencies. A similar approach was tried in 1978 and it did succeed in stabilizing the franc back then. Such currency intervention measures generally only work for a short time however. It remains to be seen how long it will take before the franc begins rising again.

The new Credit Crisis is also showing up in U.S. treasury rates just as the one in 2008 did.  The 10-year yield made another all-time low at 1.97%, taking out the 2008 low. Global money flows into U.S. government bonds during periods of financial system instability because they are still seen as safe havens. While the 10-year is only a little below its low in 2008, the two-year at 0.20% on Tuesday is well below its low point back then.

Credit Crises are not very short events. The previous one lasted six months. This one could last that long or even longer. The cause of the problem has to be gotten under control. In this case, it is the ongoing debt crisis in Greece and the emerging ones in Italy and Spain. While a default in Greece could happen this fall and create some finality there, the problems in Italy and Spain are only in their early stages. So, this could go on for some time.

Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.