The Federal Reserve's Unauthorized Massive Bailout of Europe (and Possibly Japan)

On Monday of this week, I posted a commentary by Ron Paul calling for the halt of a coming  Federal Reserve bailout out of Europe (The Coming Fed Bailout of Europe Must Be Stopped!)

Now, beltarian insider Gerald O'Driscoll (former vice president at the Federal Reserve Bank of Dallas and later at Citigroup and now a senior fellow at the Cato Institute) warns, in WSJ, that the bailout that Ron Paul warned about has started, when one examines the latest Fed reports.

O'Drsicoll writes:

This Byzantine financial arrangement could hardly be better designed to confuse observers, and it has largely succeeded on this side of the Atlantic, where press coverage has been light.

Perhaps MSM is spending time on what Dr. Paul didn't write 20 plus years ago versus what he is actually writing now.

Here's O'Driscoll warning about what Dr. Paul spotted:

America's central bank, the Federal Reserve, is engaged in a bailout of European banks. Surprisingly, its operation is largely unnoticed here. [Except for Ron Paul-rw]

The Fed is using what is termed a "temporary U.S. dollar liquidity swap arrangement" with the European Central Bank (ECB). There are similar arrangements with the central banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades or "swaps" dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.

Why are the Fed and the ECB doing this? The Fed could, after all, lend directly to U.S. branches of foreign banks. It did a great deal of lending to foreign banks under various special credit facilities in the aftermath of Lehman's collapse in the fall of 2008. Or, the ECB could lend euros to banks and they could purchase dollars in foreign-exchange markets. The world is, after all, awash in dollars.

The two central banks are engaging in this roundabout procedure because each needs a fig leaf. The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.

O'Driscoll then goes on to detail a bit of bailout history and report on how the bailout is cranking up again:

The Fed had more than $600 billion of currency swaps on its books in the fall of 2008. Those draws were largely paid down by January 2010. As recently as a few weeks ago, the amount under the swap renewal agreement announced last summer was $2.4 billion. For the week ending Dec. 14, however, the amount jumped to $54 billion. For the week ending Dec. 21, the total went up by a little more than $8 billion. The aforementioned $33 billion three-month loan was not picked up because it was only booked by the ECB on Dec. 22, falling outside the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion in the most recent week. Could a bailout of Japanese banks be afoot? (All data come from the Federal Reserve Board H.4.1. release, the New York Fed's Swap Operations report, and the ECB website.)

Aside from the obvious inflationary consequences of printing more dollars via swaps (even though they start off in Europe those dollars could easily hit these shores) O'Driscoll lists a number of other problems with the swaps, including the fact that they are illegal:

First, the Fed has no authority for a bailout of Europe. My source for that judgment? Fed Chairman Ben Bernanke met with Republican senators on Dec. 14 to brief them on the European situation. After the meeting, Sen. Lindsey Graham told reporters that Mr. Bernanke himself said the Fed did not have "the intention or the authority" to bail out Europe. The week Mr. Bernanke promised no bailout, however, the size of the swap lines to the ECB ballooned by around $52 billion.

Second, these Federal Reserve swap arrangements foster the moral hazards and distortions that government credit allocation entails. Allowing the ECB to do the initial credit allocation—to favored banks and then, some hope, through further lending to spendthrift EU governments—does not make the problem better.

Third, the nontransparency of the swap arrangements is troublesome in a democracy. To his credit, Mr. Bernanke has promised more openness and better communication of the Fed's monetary policy goals. The swap arrangements are at odds with his promise. It is time for the Fed chairman to provide an honest accounting to Congress of what is going on.

The Coming Fed Bailout of Europe Must Be Stopped!

By Ron Paul


The economic establishment in this country has come to the conclusion that it is not a matter of "if" the United States must intervene in the bailout of the euro, but simply a question of "when" and "how". Newspaper articles and editorials are full of assertions that the breakup of the euro would result in a worldwide depression, and that economic assistance to Europe is the only way to stave off this calamity. These assertions are yet again more scare-mongering, just as we witnessed during the depths of the 2008 financial crisis. After just a decade of the euro, people have forgotten that Europe functioned for centuries without a common currency.

The real cause of economic depression is loose monetary policy: the creation of money and credit out of thin air and the monetization of government debt by a central bank. This inflationary monetary policy is the cause of every boom and bust, yet it is precisely what political and economic elites both in Europe and the United States are prescribing as a resolution for the present crisis. The drastic next step being discussed is a multi-trillion dollar bailout of Europe by the European Central Bank, aided by the IMF and the Federal Reserve

.

The euro was built on an unstable foundation. Its creators attempted to establish a dollar-like currency for Europe, while forgetting that it took nearly two centuries for the dollar to devolve from a defined unit of silver to a completely unbacked fiat currency note. The euro had no such history and from the outset was a purely fiat system, thus it is not surprising to followers of Austrian economics that it barely survived a decade and is now completely collapsing. Europe's economic depression is the result of the euro's very structure, a fiat money system that allowed member governments to spend themselves into oblivion and expect that someone else would pick up the tab.

A bailout of European banks by the European Central Bank and the Federal Reserve will exacerbate the crisis rather than alleviate it. What is needed is for bad debts to be liquidated. Banks that invested in sovereign debt need to take their losses rather than socializing those losses and prolonging the process of adjusting their balance sheets to reflect reality. If this was done, the correction would be painful, but quick, like tearing off a large band-aid, but this is necessary to get back on solid economic footing. Until the correction takes place there can be no recovery. Bailing out profligate European governments will only ensure that no correction will take place.


A multi-trillion dollar European aid package cannot be undertaken by Europe alone, and will require IMF and Federal Reserve involvement. The Federal Reserve already has pumped trillions of dollars into the US economy with nothing to show for it. Just considering Fed involvement in Europe is ludicrous. The US economy is in horrible shape precisely because of too much government debt and too much money creation and the European economy is destined to flounder for the same reasons. We have an unsustainable amount of debt here at home; it is hardly fair to US taxpayers to take on Europe's debt as well. That will only ensure an accelerated erosion of the dollar and a lower standard of living for all Americans.


(ViaLewRockwell)

Krugman Admits He Was Wrong

Well, he is subtle about it, but it's there.


An NYT colleague of his, Floyd Norris, has forced Paul Krugman into admitting he missed what the ECB is up to. Norris writes:

In recent weeks, the new president publicly insisted the central bank would never do any of the things that Germany opposed. The bank would not drastically step up its purchases of Spanish and Italian government bonds. It would not directly finance European governments. It would not backstop European rescue funds or print money that the International Monetary Fund could use to bail out governments.


It would do only what central banks normally do. It would lend to banks.


It turns out that may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process.


That fact only became clear on Wednesday, although Mr. Draghi announced his intentions on Dec. 8, when the central bank said it would offer to lend money to banks for three-year terms, in unlimited amounts, at a very low rate.


In reality, it was an offer banks could not refuse. They will initially pay the central bank’s official rate of 1 percent. But if the bank lowers the rate in coming months — as it is widely expected to do — the rate on these loans will drop as well.


There is no limit on what the banks can do with the money. But there is an obvious, virtually risk-free, option. A bank can buy short-term securities of its own government and pocket the difference — up to four or five percentage points — for the life of the securities.

So how does this nail Krugman? Because he didn't see what was coming when Draghi, Bernanke, and even the Chinese, rolled a boulder down the financial mountain. This is what I wrote on November 30:

The world's central banks have just announced a program to print huge amounts of money via dollar swaps and Paul Krugman doesn't understand why it is a big deal. He writes: 

So this looks to me like a non-event. Yet markets went wild. Are they taking this as a signal that substantive actions — like the ECB finally doing what has to be done — are just around the corner? Are they misunderstanding the policy? Was this cheap talk that nonetheless moved us to the good equilibrium? (If so, not enough: Italian bonds still at more than 7 percent).
A very strange day. 

It usually takes months to prove Krugman clueless. This time it will take just a little more than a week. The swap announcement is the first step in a major money printing plan. Or do you think Geithner and the President had European Council President Herman Van Rompuy over to the White House on Monday, along with European Commission President José Manuel Barroso, and High Representative Catherine Ashton, because they are great conversationalists over tea?

December 9 is the day the European Central Bank will announce its new money printing plan. You heard it here first. Krugman is clueless or mystified, whatever. I guess in this context it's pretty much the same thing.

I am, I have to say, somewhat mystified. Of course the Fed will make dollar liquidity available to other central banks as needed; that was never in question, because Bernanke doesn’t want to be the man who destroyed the world to save a few pennies. And reducing the interest rate on those loans seems to me to make virtually no difference; it was a trivial charge anyway.

Eh, so I was off by 12 hours, but this is what I wrote on December 8 in the EPJ Daily Alert:

Reuters is running with a leaked ECB story that the ECB may loosen collateral criteria to give banks greater access to cheap cash and offer longer-term loans. Reuters said the leak comes from "three euro-area officials" with knowledge of the deliberations.
This looks to me like the bazooka being put in place and that it is going to be used. 

The next day in the Alert, I wrote:

the ECB appears willing to back up EZ debt via the back door, as it has agreed to accept more types of debt securities from banks in discount operations. This could prove to be a very profitable arbitrage for banks, as they could buy high yielding paper off the market and have it financed by the ECB at low rates.

Floyd Norris has finally figured all this out (wait let me look at my calendar) 23 days after my first post advising that a printing plan was in place. On the same day that Krugman said he the November 30 news was a  "a non-event."  Let me spell this out: C-L-U-E-L-E-S-S.


But it's his NYT colleague's piece that has forced Krugman (subtly) to admit he was wrong. He writes:

A number of people have asked me for my reaction to Floyd Norris’s piece today on Europe. It’s a good summary of the argument many people are making about why the European situation looks less dire right now than it seemed a few weeks ago.


Regular readers may recall that I and others were adamant that it was essential for the ECB to step in and buy the debt of troubled governments, to head off what looked very much like self-fulfilling panic. The ECB refused to do that, and many of us took that refusal at face value — but the argument is that in reality it did the functional equivalent, lending very large sums to banks with sovereign debt as collateral, so that it was in effect doing the purchases we wanted, but laundering those purchases through banks...


The bottom line seems to be that Mario Draghi is a consummate eurocrat. I’ve always kind of enjoyed talking to eurocrats, who always seem to be implying something they aren’t saying; in this case he may have managed to say one thing while doing something else, and the thing he actually did was just what people like me have been urging.


So they’re subtle, these Europeans are...

Hey, Paulie, I don't think they are the only subtle ones.


(Thanks to Bob Murphy for tipping me off to Krugman's post)

Even Nouriel Roubini Gets What the ECB is Up To

He tweets:

ECB starts effective QE and stealth debt monetization: a backdoor SMP

Of course, EPJ had it figured out weeks ago, when it was announced.

Only Krugman remains mystified.

Just to Make This a Real Miserable Day for Krugman

Not only were jobless numbers and housing signalling a turnaround, but the stock market was up BIG,

The Dow Industrial Average was up 2.87%, the more broader based Nasadaq was up 3.19%, and the real dagger for "Deflation" Paul:

Oil was up 3.68%.

What's fueling the rally? Traders have finally woken up to the fact that the US economy is turning around (thanks to money printing manipulation by Bernanke) and traders are now realizing that what Krugman thought was no big deal, was really the start of the ECB going backdoor to prop up sovereign debt.

Economist Magazine Finally Figures Out What the ECB is Up To ( and Proves Krugman Even More Clueless)

Economist writes today:

AT THE European Central Bank's last meeting, Mario Draghi did not announce any plans to scale up purchases of sovereign debt and, indeed, he indicated that previous statements interpreted as a promise to do so were in fact no such thing. He did, on the other hand, announce new measures to boost liquidity across euro-zone banking systems, including a facility through which banks can borrow unlimited amounts from the ECB, very cheaply, for up to three years. It quickly dawned on observers that banks might just use this borrowing to fund purchases of government debt, thereby addressing the crunch in sovereign debt markets. And I see that some writers are now arguing that this step actually amounts to the critical turning point in the crisis.

I wrote, a week ago, on December 9, in the EPJ Daily Alert:

 This looks to me like the bazooka being put in place and that it is going to be used. All that junk paper the EZ banks have on their books will be allowed to be traded in for newly printed euros....the ECB appears willing to back up EZ debt via the back door, as it has agreed to accept more types of debt securities from banks in discount operations. This could prove to be a very profitable arbitrage for banks, as they could buy high yielding paper off the market and have it financed by the ECB at low rates.

Oh, by the way, notice the date: December 9, I wrote this on November 30 about Krugman cluelessness:

The world's central banks have just announced a program to print huge amounts of money via dollar swaps and Paul Krugman doesn't understand why it is a big deal....
 He writes:

I am, I have to say, somewhat mystified...It looks like a non-event to me. 

It usually takes months to prove Krugman clueless. This time it will take just a little more than a week. The swap announcement is the first step in a major money printing plan. Or do you think Geithner and the President had European Council President Herman Van Rompuy over to the White House on Monday, along with European Commission President José Manuel Barroso, and High Representative Catherine Ashton, because they are great conversationalists over tea?

December 9 is the day the European Central Bank will announce its new money printing plan. You heard it here first. Krugman is clueless or mystified, whatever. I guess in this context it's pretty much the same thing.

The State of the PIIGS

Here's the one chart that explains the eurozone crisis. Market participants are requiring higher and higher interest rates to hold debt issued by the PIIGS. The higher interest rates make it more and more difficult for the PIIGS governments to bring their budgets under control.

The only sound solution is for the PIIGS to go bankrupt and stick the hurt on those who were willing to hold the PIIGS paper in the first place---mostly the banksters. Instead, the PIIGS, with the banksters in the shadows, are imposing austerity (read: higher taxes) which smothers the PIIGS economies even more. Thus, the European Central Bank will eventually step in to prop up the sovereign debt by money printing, which will result in huge price inflation in the EZ.

Click on chart for larger view,

ECB Reserves Related to Margin Calls

FT has a very useful chart showing the alarming use by banks to use the European Central Bank as a source of funds for margin calls. Of key significance, most of this financing has been sterilized, meaning that money going out to bailout banks was balanced off by the ECB by money being drained by other sectors of the economy---thus distorting the eurozone economy in favor of European banksters.

Click for larger view.

More on the Stealth ECB Bailout

I have already suggested that that  the European Central Bank may be providing a backdoor by which European  banks can finance eurozone sovereign debt.

Ed Yardeni appears in the clip below to be thinking the same way about recent ECB financing changes. I hasten to add that while I agree with Yardeni's take on the stealth bailout method being employed by the ECB, I am not as convinced as Yardeni that the Chinese central bank is conducting anywhere near the money supply easing necessary for the bank to reverse the developing massive economic downturn in China. And while Yardeni may be correct in the short-term about the Fed being a "pretty powerful force" in keeping rates near zero, let's see how that works for the Fed when intensifying inflationary pressure starts to put upward pressure on rates.

German Minister "Certain" Summit has Solved Crisis

German Finance Minister Wolfgang Schaeuble said agreements reached at an EU summit this week will solve the euro zone's debt crisis and that Germany needs a strong Europe, reports Reuters.

"I am certain that we will be able to handle the debt crisis in Europe with the agreed, far-reaching measures on institutional reform of the European currency union," Schaeuble wrote in a guest contribution for Focus magazine.

The only way the current structure is maintained is if the European Central Bank prints money to support PIIGS sovereign debt. Does this mean the ECB has really set up a back-door method of financing the EZ debt or is Schaeuble blowing hot air?

Is the ECB Backing Up the EuroZone via the Backdoor?

Yesterday in the EPJ Daily Alert, I wrote:

Reuters is reporting that that overnight emergency borrowing by commercial banks in the EZ jumped to over 9 billion euros ($12 billion). translation: EZ banks are still scared to loan to each other.

The big guns need to be moved into position, or at least that's the way the banksters see it. And indeed that is what appears to be developing. Reuters is running with a leaked ECB story that the ECB may loosen collateral criteria to give banks greater access to cheap cash and offer longer-term loans. Reuters said the leak comes from "three euro-area officials" with knowledge of the deliberations.

This looks to me like the bazooka being put in place and that it is going to be used. All that junk paper the EZ banks have on their books will be allowed to be traded in for newly printed euros. The one caveat is that it must be newly printed euros and not just another sterilization program by the ECB, to get the economy going (in manipulated fashion). It sounds like it will be newly printed money,but we won't really know for sure until a few weeks down the road when the ECB balance sheet is examined to see if it has expanded.

This morning, in the Alert, I wrote:

... reports indicate the ECB has capped the maximum purchase of euro zone sovereign bonds at 20 billion euros a week for now and is not considering bigger action in response to the EZ plus 6 agreement.

That said, the ECB appears willing to back up EZ debt via the back door, as it has agreed to accept more types of debt securities from banks in discount operations. This could prove to be a very profitable arbitrage for banks, as they could buy high yielding paper off the market and have it financed by the ECB at low rates. The key will be to monitor the ECB balance sheet to see if this is going on. ECB direct sovereign bond purchases are not enough to hold the EZ together, especially given the fact that the ECB is sterilizing its purchases by draining from other sectors of the economy.

A report fro the Telegraph's Ambrose Evans-Pritchard suggests that Tim Congdon from International Monetary Research is thinking along the same line that I am. Pritchard writes:

Mario Draghi, the ECB’s president, said the bank had not agreed to any sort of “Grand Bargain” with EU leaders to act as lender of last resort for sovereign states, insisting that it does not have a legal mandate to rescue sovereign states in trouble.

“We have a treaty and Article 123 prohibits financing of governments. It embodies the best tradition of the Bundesbank. We shouldn’t try to circumvent the spirit of the treaty,” he added, warning against the use of “legal tricks” to bend the bank’s mandate.

The comments caused consternation on trading floors, where expectations for a “shock and awe” action by the ECB have been running ahead of reality. Mr Draghi had earlier hinted that the ECB might be willing to do more if politicians deliver on a “fiscal compact” to anchor budgetary discipline at today’s summit in Brussels.

“This is big, he’s basically pulled the rug out from under the market,” said Brian Dolan at forex.com. “There’s a sense of shock right now because he previously suggested that if EU leaders got things together, the ECB would step up bond purchases.”...

Almost lost in the drama, the ECB cut interest rates by a quarter of a percentage point to 1pc and offered sweeping measures to shore up the eurozone’s €23 trillion (£19.6 trillion) banking system and avert a dangerous credit crunch.

It extended its unlimited credit to banks (LTRO’s) from one year to three years, and halved the reserve ratio to 1pc to free up more than €200bn in extra liquidity. It will relax collateral rules to allow wider use of asset-backed securities, a life-saver for distressed banks that were running out of eligible “kit” for the lending window.

Mr Draghi said banks were facing “serious funding pressures”, compounded by the rush to raise core Tier 1 capital ratios to 9pc. The measures to shore up lenders are intended to avoid acute “deleveraging” as banks shrink their loan books and prepare to roll over €230bn in bonds in the first quarter of next year...

Tim Congdon from International Monetary Research said the ECB bank’s support is highly significant and could prove a transforming moment in this crisis. The steps help to shore up the whole interlocking edifice of bank debt and sovereign debt, giving back-door support for governments.

“ECB lending to commercial banks can act as an important safety valve for the single currency project. It could gain valuable breathing space,” he said.

“The ECB is bending over backwards to help banks, reversing the crazy withdrawal of special credit facilities early last year. The banks can now borrow for three years at 1pc or so, and use the money to buy bonds at yields at 5pc, with gearing. It encourages them to purchase the bonds because returns could be fabulous provided the euro holds together.

As I said in the EPJ Daily Alert, let's see by how much the ECB balance sheet expands in coming weeks. If Congdon and my suspicions are correct, Draghi has opened the door for European banksters to make some EZ money, which will at the same time, through backdoor money printing, prop up the sovereign debt of the PIIGS. All very inflationary and dangerous, of course.

Mario Draghi’s Speech in One Chart

Market traders are clearly concerned about the eurozone crisis. The market started to breakdown after European Central Bank president Mario Draghi spoke to the press after the ECB cut rates by 25 basis points to 1%. During the press conference, Draghi failed to inspire confidence that the ECB would step in to prop up debt of EZ governments.

It still remains hazy as to what Draghi is up to, traders might be over-reacting and misinterpreting the situation, since the ECB press release accompanying the rate cut stated that EZ banks could discount lower quality paper to the ECB. This may mean sovereign junk debt and thus a possible backdoor method to propping up EZ government debt. But if this isn't the case, or Draghi fails to make this case clear to traders, the EZ could collapse at any minute.

The below chart via Ezra Klein, clearly shows what traders think of Draghi's press conference performance.

European Central Bank Cuts Rate

The European Central Bank has cut its main interest rate by 25 basis points to 1.0 percent.

The rate cut was voted on at a regularly scheduled meeting of the ECB policy committee.


The ECB also reduced the interest rate on its deposit facility to 0.25 percent and the rate on the marginal lending facility to 1.75 percent, bringing all rates to match record lows reached in 2009.

ECB President Mario Draghi will discuss the Governing Council's decision at a 8:30 ET news conference.

The cut was the second in as many months, and means that the ECB has reduced borrowing costs in both meetings since Draghi has taken over as president of the central bank from Jean-Claude Trichet.

Geithner to the Inflationary Rescue!!

The heavy US muscle is rolling in to make sure Europe gets its inflationary money printing act together.

The Treasury has just announced that Secretary Tim Geithner will travel to Europe December 6-8, 2011.

On Tuesday, December 6, the Secretary will arrive in Frankfurt, Germany, for meetings with European Central Bank President Mario Draghi and Bundesbank President Jens Weidmann. In the afternoon, he will meet with German Finance Minister Wolfgang Schauble in Berlin.

On Wednesday, December 7, Secretary Geithner will be in Paris, France, to meet with French President Nicolas Sarkozy and Finance Minister Francois Baroin before traveling to Marseille, France, for a bilateral meeting with Spain’s Prime Minister-elect Mariano Rajoy Brey who will be in France for other meetings.

On Thursday, December 8, the Secretary will visit Milan, Italy, for a meeting with President of the Council of Ministers and Minister of Economy and Finance Mario Monti. Later that day, Secretary Geithner will return to Washington.

Prepare for massive global inflation. You will never, ever, see oil under $100 per barrel again.

HOT: Fed Announces Massive Global Central Bank Intervention

Developing...

UPDATE 1: The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank have just announced coordinated actions to enhance their capacity to provide liquidity support to the global financial system.

UPDATE 2: According to the Fed, the purpose of the actions is to ease strains in financial markets and "thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity."

UPDATE 3: The central banks have agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points. This pricing will be applied to all operations conducted from December 5, 2011. The authorization of these swap arrangements has been extended to February 1, 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank will continue to offer three-month tenders until further notice.

As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the U.S. dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise, the Federal Reserve said. These swap lines are authorized through February 1, 2013.

BOTTOM LINE:Central banks have agreed on a major global money printing scheme. Major global inflation is on its way.