Today, the European Central Bank (ECB) completed its second round – a total of 3 rounds are expected – of its “quantitative easing” program, referred to as the Long-Term Refinancing Operation (“LTRO”).  Over 800 banks in Europe took advantage of this LTRO by borrowing an additional 529.5 Billion Euro – $713.4 billion.  These are three year loans with a very low 1% interest rate.  The ECB is creating money and injecting it into the system in a fashion similar to what the Federal Reserve did with QE1 and QE2.  The banks need liquidity; however, they are not using the loan proceeds to provide loans to capital starved businesses.  Rather, they are buying the sovereign debt of weak European economies such as Italy and Portugal.  Why not?  They can borrow at 1% and buy a bond yielding 3-13%.  It is a simple game of interest rate spread.  It works as long as the sovereign nations don’t go bankrupt – like Greece did.

The operation of the ECB has changed dramatically in the last year.  It is now run by an Italian – Mario Draghi – and has lost its sound German philosophy on money.  Does anyone remember how well Italian central bankers did in preserving the value of the Lira?  If you don’t, we can sum it up in one word – “disastrous”.  Last year, two of the ECB’s top leaders from Germany resigned because of concerns about debasing the Euro’s value.  Germans have been, and continue to be, staunch inflation hawks since the Weimer Republic printed money after World War I that sparked hyper-inflation.  The two individuals that left the ECB were former Bundesbank President Axel Weber and ECB Chief Economist Juergen Stark.  Since the loss of these two hawks, the ECB has gone on a printing spree – see the chart below.  With today’s action, the ECB’s assets have exploded to over 35% of GDP compared to just 20% less than 6 months ago – hmmmmmm, is this a coincidence that it happened right after Juergen Stark left in early September?

The ECB is trying to print the Euro out of its debt crisis.  This does not bode well for the value of the Euro.

Sincerely,
Your THOR Team