THE ECB SLOWLY BUT SURELY BECOMING A TWIN BROTHER OF THE FED: POSITIVE IMPLICATIONS FOR THE SHORT-TERM?
"We are in danger of being overwhelmed with irredeemable paper, mere paper, representing not gold nor silver; no sir, representing nothing but broken promises, bad faith, bankrupt corporations, cheated creditors and a ruined people." − Daniel Webster, speech in the American Senate, 1833
Increasingly, Mario Draghi, the European Central Bank President, is showing his true colors. He is clearly on the road to becoming Europe´s clone of Ben Bernanke. That said, Draghi is pushing hard against Germany´s (Merkel´s) resistance of running full-speed down the Keynesian road of monetary inflation.
In this context, our regular Mountain Vision contributor, Fredrik Boe-Hanssen, as you'll see following my introduction today, has written another insightful article on Europe's fiscal and monetary conundrum: "How The ECB Became Intertwined in Politics and Fiscal Bailout Facilities."
Reminder: US$ 5 Million Tax Exemption Ending at the End of the Year!
Before I add a few comments on Europe and its currency, I'd like to remind our readers with a US taxpayer status (residents and ex-pats!) one more time of their unique estate planning opportunity that will most probably run out at the end of this year.
As we approach September, US taxpayers should remember that the US unified estate and gift tax exemption, currently set at USD 5 Million per person, will expire at the end of this year. As of January 2013, it is scheduled to most probably be reduced to USD 1 Million. Furthermore, the estate and gift tax rates are also scheduled to go back to their prior 55% level, from the current 35%.
US persons who can benefit from this exceptional window of opportunity and have not made use of it yet should evaluate their options while there is still time to secure significant savings on future transfer taxes.
For more details on the current exemption, please refer to our Mountain Vision Update of February 2, 2011.
The ECB Wants to 'Ease'
On speculation that central banks from the US to China − and Europe − will act to spur economic growth with more monetary expansion, stock markets around the world have been generally moving up over the past few weeks. Equally, gold and silver rose to four-month highs. Meanwhile, hedge funds have raised bullish bets on oil and money managers have increased net-long positions.
Indeed, financial markets and their pundits consider the latest "decisively positive" action (or talk) a sign of improving times. In particular, the fact that the ECB is now pushing hard has been interpreted as a very positive sign.
For instance, it is considered "a saving grace" (as one Swiss banker put it) that the European Central Bank is "finally" pushing global banking regulators to relax rules on their credit liabilities. In other words, they want to be able to include ABS (asset-backed securities) as collateral under more relaxed terms in order to create a buffer against a possible credit squeeze. The ECB, with blessings from the Bank of France, feels that a current draft version of the liquidity coverage ratio, or LCR, may hamper efforts to combat the euro-area debt crisis by curtailing lending and making it harder for central banks to implement their monetary policies.
In other words, the ECB is seeking to relax the rule − designed to force banks to hold enough easy-to-sell assets to survive a 30-day credit squeeze − by expanding the range of eligible securities, aligning the standard more closely with its own collateral arrangements.
Notably, the ECB is already accepting almost any collateral from banks. This attitude is quite logical as banks do not have enough good-quality collateral against which they can borrow. It now looks as though the central bank is asking regulators to bend the rules yet a little more and accept ABS as a proxy for liquidity, with the aim of promoting loans to the real economy. In view of the overall context of uncertainty, I have strong doubts whether the ECB's attempt will in any way bend the banks' willingness to lend any more. However, the ECB is active on many fronts and is exploring all possible means to ease the credit crunch.
European Problems Solved? Risk in Decline?
Regardless of what I think, in a world addicted to central bank easing, financial markets appear to expect an improvement in the global economy and financial markets as a result of the ECB's "improved policies." The question is: Will the positive development in financial markets continue into the Fall?
Conservative investors may currently be tempted to sell after the recent rally. However, there is indeed a chance of a continued "recovery," which could justify additional exposure, particularly with regard to the Euro and European stock markets. Currently, some European stocks are available at a very good value. And the expected reflationary boost may, in fact, have a positive impact in the Eurozone economy, which is currently so weak that resistance to more easing is indeed crumbling.
I think this gamble may be worthwhile. However, if you take this route, I strongly recommend that you, or your mandated portfolio manager, have solid risk management mechanisms in place to protect you on the downside. At BFI, we continue to consider current markets and the global economy firmly planted in our Big Picture Scenario 2: The Reflationary Debt Trap. This continues to be a treacherous, highly uncertain and largely politically driven market.
None of the fundamental problems have been solved, nor can they be solved by papering debt over with more debt. This is another "quasi-recovery." It will be temporary and short-lived at best. However, for the more speculative portion of your portfolio, I would not argue against increased exposure to European stocks, energy and precious metals.
[See also "How the ECB Became Intertwined in Politics and Fiscal Bailout Facilities," by Hans Fredrik Boe-Hanssen.]
Frank Suess is CEO and Chairman of BFI Capital Group. To subscribe to BFI's weekly Mountain Vision Update, in which this column appeared, click here.