Money Printing by Any Other Name

European banksThis week, the European Central Bank (ECB) offered its second long-term refinancing operation (LTRO) to European banks to the tune of a staggering $712.2 billion.

First, let’s make one thing clear, dear reader. When the Federal Reserve here in the U.S. instituted QE1 and QE2, the Fed printed money, used this money to buy bonds from U.S. banks, and then took those bonds and placed them on its own (the Fed’s) balance sheet.

Money printing is a hot political issue in Europe, especially for Germany. Therefore, what the ECB did (instead of printing money to buy government bonds directly) was to loan European banks money at one-percent interest.

The European banks take this money and buy the bonds of the European countries like Portugal and Italy. The bonds are then placed on the balance sheets of the European banks, but the bonds are guaranteed by the ECB.


The ECB, therefore, is no different from the Fed. Oh, and where is the ECB getting this money that it loans out to European banks so they can buy the bonds? Well, since no one carries 529.5 billion ($712.2 billion) with them, I believe the ECB is printing money.

Now that that has been established, let’s look closer at this latest development out of the ECB. In December of 2011, when Europe was in extreme duress and European sovereign bonds needed to be purchased, the ECB began the first LTRO operation. It was in the amount of 489 billion, and the money was handed out to 523 European banks.

Once the European banks went out and bought the bonds, things calmed down in Europe, but the question still remained. Are the European banks in a healthy state? Do the European banks have enough money to cover their debts?

The answer looks to be “no” by the latest LTRO. The ECB was forced to print even more money: 529.5 billion this second go-around versus 489 billion the first time around.

What is more startling is that 523 European banks participated in the first round in December. For this latest money-printing handout, 800 European banks are banging on the ECB’s door.

There are now more European banks that need money to cover their debts. This means that more European banks need to earn more profit to cover the costs of their debts, and are using the LTRO to obtain those profits.

This does not solve the problem of too much debt on the balance sheets of the European banks. This simply buys the European banks time, by providing them with cheap money to get by.

So now that the loans have been instituted by the ECB to the European banks, the ECB joins the ranks of Japan and the U.K. in printing money in the last month alone.

Historically, in an environment of money printing, precious metals (gold bullion and those undervalued gold stocks) are an investor’s best protection. (See: Gold Stocks: There’s Value in Them There Hills.)

Michael’s Personal Notes:

At the height of the crisis four years ago, American consumer confidence was high and the average household’s debt-to-personal income was 114.76%. This means that for every dollar the household earned, it held $1.1476 of debt.

Clearly, this was not sustainable and dragged down consumer confidence. Since the crisis four years ago, the average debt-to-personal income has come down from 114.76% to the most recent reading at the end of 2011 of 101.1% (source: New York Federal Reserve).

This shows that the average American, with less consumer confidence, is at least paying down his/her debt somewhat. But with the average household still holding slightly more debt than money coming in, the average American still has some work to do in order to restore consumer confidence.

Unlike most economists, I don’t subscribe to the notion that 90% (one dollar earned for $0.90 of debt) is where the average debt-to-personal income level should be.

The real headwinds working against consumer confidence is a decrease in real wages, which I’ve been highlighting recently. If the average wage cannot keep up with inflation, then the average American must dip into savings to make up the difference in order to maintain his/her standard of living. Consumer confidence cannot improve under these circumstances.

Speaking of savings, if interest rates are close to zero, then the average American earns little in interest income, which he/she needs to help pay down debt. Consumer confidence can’t grow if debt is not paid down.

When we take all the above together, it means that GDP growth will be nonexistent in 2012. Since 70% of GDP is made-up of consumer spending, GDP growth cannot pick up any momentum when consumer confidence is faced with the above scenario.

This is not because I want to see the U.S. in a recession or that I’m against consumer spending and growth. It is actually just the opposite.

If the consumer earned higher wages to offset inflation and had some money left over to pay off some debt, combined with earning higher interest on savings so that the interest income can be used to pay down debt, then consumer confidence would strengthen.

If the average household’s debt-to-personal income was, say, 50% ($0.50 of debt for every dollar earned), then the average American consumer would not have a high debt burden to stress him/her out, which would increase consumer confidence. Under these circumstances, consumer spending and growth can resume!

The White House is fighting a natural process. Households must be encouraged to save so they can pay down debt and reach a point where the debt is manageable, so that consumer confidence can grow and consumer spending can resume. The government should not only be helping people save, but also encouraging it—how’s that for a change?

Where the Market Stands; Where it’s Headed:

We are in a bear market rally in stocks that started in March of 2009. Since then, the Dow Jones Industrial Average has rallied 101%.

The purpose of a bear market rally, as I have written many times before, is to get investors back into the stock market. Then the bear takes the investors’ chips away again.

Dear reader, the Fed had fueled the stock market rally of the past three years by aggressively expanding the money supply—an action which has simply extended the bear market rally. (See: The Next Step for the Stock Market.)

What He Said:

“What group of stocks is next to fall in light of the softening U.S. housing market? The stocks of companies that sell retail products to the American consumer, I believe, are next on the hit list. Many retail stocks are already reporting soft sales. In my opinion, they haven’t seen anything yet in respect to weaker sales.” Michael Lombardi in PROFIT CONFIDENTIAL, August 30, 2006. According to the Dow Jones Retail Index, retail stocks fell 42% from the fall of 2006 through March 2009.