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The Easy Fix? Can Europe Print Its Way Out of Trouble?

Nov 30, 2011
Simon Maierhofer

Central banks just provided easier access to U.S. dollars, but Europe needs euros more than dollars. Can the European Central Bank (ECB) print Europe out of trouble?

Today the central banks of Europe, Britain, Canada, Japan, Switzerland and of course the U.S. have reduced their borrowing rates to provide easier access to dollars. This is good news, unless of course you look at the big picture and realize that this was necessary to prevent (or extend to pretend) defaults of entire countries and a 2008 Lehman-like meltdown.

We know that the Federal Reserve is very generous when it comes to providing extra dollars. But the problem isn't just extra dollars, it's extra euros.

Why doesn’t the European Central Bank (ECB) just print Greece, Italy, Spain and all the others out of trouble?

Believe it or not, in theory, the idea of printing new Euros and handing them to Greece and others makes sense.

Here’s how it would work. PIGGS countries are having difficulties refinancing their debt. The way governments refinance their debt is by selling new government bonds. To find buyers of its bonds, Italy now has to pay about 7% for a 10-year bond. Such high interest rates only compound the problem for Italy (and other countries in the same position).

The ECB could step in and buy PIGGS bonds and thereby reduce interest rates and infuse much needed confidence into the European bond market. If it’s so simple, why doesn’t the ECB just do it?

Too Simple?

According to the treaties governing the ECB, the ECB is not supposed to buy sovereign bonds or do anything that’s not in furtherance of its mandate.  The ECB’s sole mandate is inflation and Euro currency price stability.

Printing Euros that are used to scoop up near-defaulting bonds would be inflationary and decrease the value of the Euro. Germany’s Chancellor Merkel and Finance Minister Schauble are scared by the inflationary spiral that ravaged Germany in the early 1920s and don’t mince words about their opposition to printing Euros.

That doesn’t mean that the ECB totally abstains from buying bonds. As part of its regular operations (without creating new Euros) the ECB has bought about $300 billion worth of government bonds (about $75 billion of Greek debt and $120 billion of Italian debt).  As the chart below shows, the assets on the ECB’s balance sheet have already grown 80% since 2008.


Would it Work?

Another question is whether a European version of QE would fix the problem. Over the short-term, it would impart a measure of confidence for bond buyers and, at least temporarily, reduce interest rates.

However, the problem is not a crisis of confidence, it’s a structural crisis that requires structural changes. As long as certain countries live above their means, they won’t be able to pay off their debt.

To illustrate: If you have a monthly income of $5,000 and monthly expenses of $7,000, it doesn’t matter how you restructure your credit card debt, you just don’t have extra cash to pay off the balance.

The only way to return to financial stability is to reduce expenses and increase income. Unfortunately, any attempt by a government to reduce expenses will inevitably result in lower income (i.e. laying off government workers decreases payroll but also decreases tax income).

Did it Work?

The Federal Reserve (our equivalent to the ECB) tried the QE approach by printing money and generously showering it upon American banks (NYSEArca: KBE) and financial institutions (NYSEArca: XLF). What was the result?

The Dow (DJI: ^DJI), S&P (SNP: ^GSPC), Nasdaq (Nasdaq: ^IXIC), Russell (Chicago Options: ^RUT) and pretty much every other tradable security rallied, but the economy did not improve. Instead of the stock market lifting up the economy, the economy eventually dragged down the stock market.

The April ETF Profit Strategy Newsletter predicted the outcome in no uncertain terms: “The Fed is fueling a bubble to combat the damage left behind by the previous one. Once punctured, bubbles tend to deflate quickly.”

Shortly thereafter, the S&P lost over 20% within a matter of weeks. The market never moves in a straight line and the rally from the October 4 lows simply retraced some of the previous losses.

Concerning this rally, the October 2 ETF Profit Strategy update stated that: “We are expecting new lows followed by a tradable bottom. We define a tradable bottom as a low that lasts for a few months and leads to a bounce that should propel the markets around 20%. The ideal market bottom would see the S&P dip below 1,088 intraday followed by a strong recovery and a close above 1,088.”

The S&P got catapulted from its intraday low at 1,075 and rallied 20% without looking back. Since reaching its target, the S&P did fall more than 100 points before recovering this week.

The Alternatives

There are none. It’s either print or bust. The notion of leveraging the European Financial Stability Fund (EFSF) has failed. There will also be no additional money from the International Monetary Fund (IMF) without US approval.
Using the Fed’s QE1 and QE2 as benchmark, the problem is that even printing Euros will only extend and pretend and eventually equal bust. The choice is between bust now or bust later.

Stair Stepping into Oblivion

Few things are more exciting for a market forecaster than seeing things fall into place. The Euro debacle harmonized well with my long-term outlook of a persistent bear market.

The chart below shows the S&P stair stepping lower. This process is gradual and doesn’t happen from one day to the next. But the chart points out more vital nuances.


The red trend lines mark the boundaries of a giant M-pattern (similar to head-and shoulders) top. The March 2009 bottom came right in time. A couple of trading days before the March 6 low, the ETF Profit Strategy Newsletter sent out a Trend Change Alert with the recommendation to buy, buy, buy and a target of roughly Dow 10,000.

Obviously Dow 10,000 was understated. Thanks to QE2 stocks rallied longer and higher than expected. The S&P nearly retraced a Fibonacci 78.6% of the points lost from October 2007 – March 2009.

This 78.6% Fibonacci resistance at S&P 1,382 coincided with the upper red trend line and made for a perfect stopping point. The April 2, 2011 ETF Profit Strategy updated warned that: “In terms of resistance levels, the 1,369 – 1,382 range is a strong candidate for a reversal of potentially historic proportions.”

This “reversal of historic proportions” occurred on May 2 and reduced the S&P by nearly 300 points before the October rally pushed the S&P back to 1,293. Again, the S&P retraced almost 78.6% of the previous decline before reversing.

The only thing stocks have going for them is bullish post-Thanksgiving and December/early January seasonality (combined with Band Aid approach news from Europe).

This may keep stocks afloat temporarily, but regardless of this glimmer of hope, the long-term outlook is as dark as night inside the Grand Canyon.

The ETF Profit Strategy Newsletter monitors the key parameters necessary for high probability market forecasting and provides short, mid and long-term outlooks along with common sense, easy to follow ETF profit strategies. Updates are provided at least twice a week to help navigate short-term fluctuations. 

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