Thursday, September 6, 2012 - Free Money With Strings Attached

Free Money With Strings Attached

-by Sinclair Noe

DOW + 244 = 13,292
SPX + 28 = 1432
NAS + 66 = 3135
10 YR YLD +.08 = 1.67%
OIL - .67 = 95.82
GOLD + 7.90 = 1702.30
SILV +.44 = 32.81
PLAT + 10.00 = 1589.00

Pop Quiz.

Q: What does Wall Street love?

A: Free money.

The Standard & Poor’s 500-stock index jumped 2 percent by the close to its highest level since January 2008. The Dow Jones industrial average added about 244 points, or 1.9 percent. And the Nasdaq composite index gained 2.2 percent for its highest close since 2000. In Europe, stock market indexes closed with gains of more than 2 percent, with Spanish and Italian stocks up more than 4 percent. The DAX in Frankfurt added 2.9 percent. The FTSE 100 in London gained 2.1 percent.

Today, the European Central Bank announced they will launch a new and potentially unlimited bond buying program to lower borrowing costs for countries struggling with debt. The idea is to buy bonds with maturity of three years or less. ECB President Mario Draghi claims this is within the mandate of the ECB. Germany's Bundesbank reiterated its opposition to the plan. Draghi said the ECB would only help countries that signed up to and implemented strict policy conditions, with the euro zone's rescue fund also buying their bonds, and preferably with the IMF involved in designing and monitoring the conditions.

At a news conference, Draghi said: "Under appropriate conditions, we will have a fully effective backstop to prevent potentially destructive scenarios," and he indicated there are no limits on the size of the transactions. The bond buying program would not target specific bond yields. Spanish and Italian government bond yields have fallen significantly since Draghi said on August 2 that the ECB would buy bonds issued by Madrid and Rome. Again today, yields fell further after he announced the bond buying program.

Draghi also said the ECB was prepared to waive its senior creditor status on bonds it purchased - meaning it would be treated equally with private creditors in case of default. This was a little trick of the ECB during the Greek meltdown, where they basically jumped to the front of the line when it came time for payment. The central bank hopes that by removing private investors' concern about being paid back last in the event of a sovereign default, they will not be frightened by ECB intervention.

Draghi said all bond purchases would be "sterilized" by taking in an equivalent amount in deposits from banks to avoid any risk of inflation; think trash for bonds. The bond purchases have not started yet, and they might never get off the ground. Germany's constitutional court is scheduled to rule on the Euro Stabilization Mechanism rescue fund next week. Support for Mr. Draghi includes the German chancellor, Angela Merkel.

The German economy has already been dragged down by the downturn of the other euro-union countries. As much as Germans may complain about the less competitive indebted countries of the south, the costs to Germany of a euro collapse would be enormous. If Spain and Italy are shut out of the debt markets, the bailout funds are too small to bail them out. The cost of a bond buying program may be uncomfortable but the cost of a full fledged crisis and possible collapse of the euro-union is prohibitive.

Although the bond-buying program announced Thursday should reduce the pressure on Spain and Italy, if those countries choose to seek its protection, it will not solve the deep structural problems of the euro. The thinking is that it could buy time for the political leaders of the 17-nation euro zone to follow through on their past promises to back the currency with a more tightly integrated fiscal union and more disciplined oversight of national budgets.

And the bond buying plan is not guaranteed to succeed. The ECB deal is based on conditionality. Greece is the implied fate of anybody who dares to flout the rules. Greece hangs on the edge of being tossed from the euro-union while the country is increasingly being placed in an untenable position, which will almost certainly set it up for future failure. Part of the problem is whether Greece can be allowed to fail without destroying the union.

Marshall Auerback reports:

The eurozone creditors are now saying the Greek government must tighten the universal neoliberal screws even further by imposing a six day work week and perhaps reducing wages as well, as a condition for the Greeks getting another “bailout.” Of course, unemployment and underemployment in Greece are rising rapidly, so it is hard to see how extending the work week for the already employed can be the kind of “tough love” that will create an increase in the total number of jobs or improve the economy. In the creditor’s eyes, however, that is unimportant; the real problem is Greece’s dysfunctional culture of work and profligacy.

So the neoliberal policy solution for turning around the Greek economy is to improve the culture of work is to introduce a kind of debt peonage by taking the Greeks back to the 19th Century. And what happens when the six-day work week and wage reductions do not work, as they inevitably won’t? What comes next? Charles Dickens knew the answer — improve the culture of work by relaxing child labor laws to reduce wages further and/or privatize the Aegean islands, Delphi, and the Acropolis. No problem.

Greece, to be sure, has its share of self-inflicted economic problems, but austerity economics is pushing Greece into a death spiral. Europe is cutting its nose to spite its face as it converts one Eurozone economy after another into a barter state. The problem is that the renewed bond buying will be tied to the conditionality of yet more fiscal austerity, and Greece is being held up as the poster boy of what happens when you don’t comply with the conditions laid out by the ECB, or the Troika. In addressing the solvency issue, the ECB’s conditionality ironically will make the very “problem” of fiscal profligacy and higher government deficits much worse, as demand gets crushed by yet more austerity.

In other economic news, the Institute for Supply Management said its services index jumped to 53.7 last month from 52.6 in July. That beat economists' forecasts for a 52.5 reading. A reading above 50 indicates expansion in the sector. This follows a less than robust ISM manufacturing report on Tuesday.

Also today, we had a possible preview of tomorrow's jobs report. Initial claims for unemployment dropped by 12,000 last week to 365,000. ADP, the payroll processing company estimates nonfarm private businesses added 201,000 new jobs from July to August. The forecast for tomorrow's official jobs report is calling for an increase of about 150,000 jobs. The ADP report is not very good at actually predicting the official BLS report, but it suggests the number might be a little better than current guesses.

The data will also set the tone for monetary policy, ahead of the September 12-13 meeting of the Federal Reserve's policy board, the Federal Open Market Committee. Last week Fed chief Ben Bernanke laid out his case for the FOMC to take more action to boost the economy, citing the lack of progress this year on jobs and the rise in long-term joblessness.

Today the markets jumped higher on the prospect of the ECB passing out free money and the hope the Federal Reserve will pass out even more free money next week. Of course the buzz on the street from the central bank handouts is kind of like the buzz a little kid gets from eating too much sugar; it is fun for the moment but it wears off quickly. With respect to equity market levels, it doesn’t matter anymore. This isn’t the market we learned about in the past or what is described in the texts. Earnings don’t matter anymore, except for random stock picking, and then probably not very much after a few days or weeks of reduced stock prices. Structurally, the market only responds to liquidity and algo enthusiasm. What will sustain the markets moving forward? What will sustain the economy moving forward. Central bankers may be good at averting crashes; they may even be good at creating crashes, but what can they do to build sustainable economic growth?