Imagine you went down to your friendly, neighborhood corner bank. You plunked your bag of nickels, dimes, quarters and dollars down on the counter and said: “I’d like to deposit this, please. How much will I make this year in interest?”
Then imagine the banker chuckled. And instead of telling you “2 percent” or “5 percent” or whatever, he said: “Actually, you’ll owe us interest. For every $10,000 you stick in our vault, it’ll cost you $10.”
You’d probably laugh your way out of the branch … then go stick your cash in a safe in your closet. But if you can believe it, what I just described is essentially what the European Central Bank (ECB) is going to do.
This morning, the ECB took the radical step of cutting its deposit rate to negative 0.1 percent. It also lowered its benchmark lending rate (similar to the federal funds rate the U.S. Federal Reserve has been raising and lowering for decades) to 0.15 percent from 0.25 percent.
Furthermore, it tried to boost the mortgage and business loan businesses by offering to buy Asset Backed Securities (ABS) and by launching more Long-Term Refinancing Operations. Without getting too deep in the weeds here, the idea is that by offering to buy up bundles of loans from banks at advantageous prices, banks will be more likely to make loans in the first place.
|The ECB is hoping to drive the euro lower against the dollar and other major world currencies.|
While central banks in Sweden and Denmark took tentative steps in the direction of negative rates, the ECB’s move is unprecedented because no major world central bank has ever tried it before. The theory is that banks are parking hundreds of billions of euros at the ECB rather than doing something productive with it, like lend it out. By actually penalizing that behavior, ECB policymakers are hoping to change the behavior.
They’re also hoping to drive the euro lower against the dollar and other major world currencies. The theory is that by driving the euro lower, it will give a boost to European-based export firms by making their goods cheaper on the world market. A lower euro currency would also put upward pressure on inflation by driving up the cost of imported goods.
To understand how a negative deposit rate would impact the currency, consider that global investors typically direct their money toward economies where it will be treated best. Or in plain English, they invest their money where it’ll earn the most yield.
“Will this incredibly risky gambit be the tipping point for the markets?”
It’s just like when you go shopping for a certificate of deposit. You’re not going to stick it at Bank A if that bank is paying 1 percent … and Bank B across the street is paying 1.5 percent, assuming the risk of either bank failing is equal, are you? Of course not!
But notice how I keep saying “the theory is this, the theory is that?” That’s intentional! The truth is, no one knows what the heck this will do — including the central bankers themselves!
Let’s just say for the sake of argument that the big European private banks do exactly what you would do if your bank said you had to pay the bank interest on deposits, rather than the other way around.
Maybe rather than pay millions of euros in interest to the ECB, they’re going to yank their money out and put it in a metaphorical wall safe?
Or the functional equivalent of a can in the back yard, like their own fortified vaults?
That would hurt, rather than help, the European economy by causing even less lending and less circulation of money throughout the system.
The only true judge of the success or failure of the latest Frankenstein Financing scheme from central bankers is the market.
Will stocks rally on the news, inspiring investors and lenders to gain more confidence in the future?
Will bonds sell off, driving interest rates higher and further boosting confidence in economic growth?
Will the euro weaken significantly, unleashing a fresh flood of liquidity on the world stage as investors borrow ever-cheaper euros and invest them in higher-yielding investments of all shapes and sizes?
Or will this incredibly risky gambit push us closer to the tipping point for the markets? We’ve already seen volatility plunge, stocks surge, and investors chase risky assets like at no other point in history, save 2006-07. That, of course, was right before the markets crashed.
What we’ve lacked is a catalyst for change — a real “Emperor Has No Clothes” moment. By that, I mean a moment where investors realize that their friendly central bankers really have no idea what the heck they’re doing! Could this ECB move be that catalyst? Enquiring minds want to know.
I personally have been riding the heck out of this rally in stocks for more than a year and a half now. It’s been a great one, especially for the kinds I have repeatedly emphasized: High-quality, higher-yielding stocks in private bull markets in select sectors with strong momentum. But with market conditions so stretched, complacency so high, and volatility so low, risk is rising.
That’s why I just dedicated my entire June Safe Money Report issue to the risks and opportunities here, and included important steps to take. That issue was just posted to the web, so make sure you check it out if you’re a subscriber.
Not on board yet? Then consider clicking here or giving us a call at 800-291-8545. I believe the concrete investment recommendations therein could help make the difference between a great 2014 or a much rockier one.
|OUR READERS SPEAK|
As for how to power the next leg of growth in the U.S., many of you agreed that coal is a dirty fuel. But there were a few dissenters who are skeptical of global warming or mankind’s contribution to it. Others felt the transition costs associated with shifting from coal to other fuels could be steep.
Reader Clay weighed in on the cost problem specifically, saying:
“Eliminating coal with no transition strategy will punish the most needy by raising their heating and cooling costs. The 2 percent inflation rate is a lie as it excludes gas & food. Our real inflation rate is above 10 percent. Reducing coal use also puts more people out of work. By this time we should know there is no coherent plan in Washington for anything except political party above all else.”
At the same time, Reader Norman worried about the even more distant future — what happens after even the gas is gone. His comments:
“The issue with switching from coal to natural gas derived from fracking that I see is, how long will this source last? Articles that I read say about 35 years. Since it takes a long time to migrate everything over, we have to start working on this now. What will we migrate to after using up the fracked gas?”
Certainly there are a lot of questions being raised — and no easy answers. But I personally believe natural gas is one of our best options as a country, and investing in the companies that are levered to the gas boom has certainly paid off nicely in the past couple of years.
Any other thoughts? Share them here folks.
|OTHER DEVELOPMENTS OF THE DAY|
Initial jobless claims rose to 312,000 in the most recent week from 304,000 in the prior one. That was roughly in line with consensus estimates. Tomorrow is the big Kahuna though — the monthly employment report.
More telecom consolidation is the name of the game, with reports that Sprint (Weiss Ratings: S, C-) is getting closer to buying T-Mobile US (Weiss Ratings: TMUS, C-) for about $32 billion. That’s about $40 on a per-share basis. But questions remain as to whether regulators would permit the third-largest and fourth-largest U.S. wireless phone providers to combine.
Speaking of mergers, the soap opera around British firm Smith & Nephew (Weiss Ratings: SNN, C) continues. Both Medtronic (Weiss Ratings: MDT, A) and Stryker (Weiss Ratings: SYK, B-) have been mentioned as potential suitors for the maker of artificial joints, wound care products, and other medical devices.
Color me excited about the upcoming World Cup, which begins a week from today with a match between host nation Brazil and Croatia. I’ll be pulling for the U.S. and Germany … and hoping I don’t jinx every team I root for like I did in 2010!
Reminder: If you have any thoughts to share on these market events, all you have to do is hop on over to the blog and leave your comments.
Until next time,