ECB LTRO – Fatter than El Gordo

By: Adrian_Ash

Gasp at the sheer size of El Tro, the €1 trillion money storm raining down on Europe's banks...

The FATTEST PRIZE in the world's biggest lottery, El Gordo – the "Fat One" – just keeps getting fatter, according to its promoters.

But even the fattest total of prizes to date – some €2.5 billion at Christmas 2011 – looks a tin-ribs next to El Tro, the storm of money now raining down on Europe's banks.

Wednesday's Long Term Refinancing Operation took the grand total of giveaway money to more than €1 trillion, pumped out by the European Central Bank and known by the acronym LTRO. It is christened El Tro by us here at BullionVault today via the Catalan for "thunder". Because that's just what people keep calling it – El Tro.

"You can't argue with [that]," reckons one Credit Agricole analyst, nodding at the €530 billion which El Tro will hand to commercial banks when the latest chunk of cheap-money loans is settled on Thursday. But he should add two exclamation marks (¡the first upside down of course!) and do PR for the Spanish lottery's El Gordo instead.

Because El Tro – Europe's money storm – demands a far stronger sales pitch than that.

In just two operations in barely 11 weeks, the ECB has created an additional 10% of the Eurozone's entire money supply, lending out €3,084 for every soul in the 17-nation union. Throw in the non-Euro banks scrabbling to scoop up El Tro's gifts on Wednesday, and this latest offer was met by some 800 different institutions. Even the cash raised from shareholders by all US and Eurozone banks added together during the crisis of 2007-2010 fails to match the size of El Tro's gifts.

And make no mistake: the LTRO is a gift. Even if price-inflation subsides to average the ECB's annual target of 2.0% between now and start-2015, the central bank will make a loss of €44.7bn in real terms. Inflation stuck (or pushed above) the latest reading of 2.6% would cost the Frankfurt lenders nearer €62bn...a full 6% of the €1,018 billion now lent out in total.

Any bank looking to book an instant profit meantime can simply stick the cash into 3-year government bonds and turn their 1.0% annual cost into 1.10% with Finnish debt, 1.55% with Belgian debt...or a massive 5.41% per year with Italian debt. Hell, you could buy German Bunds and make risk-free money on anything above 6 years to maturity.

So c'mon! Everyone's a winner with El Tro. Except the central bank, of course. And the banks themselves, if Belgium, Italy or one of the rest fail to make good on their bond repayments. Which the banks already have a very clear interest in avoiding, seeing how they're backed by state guarantees, whether stated or implicit.

How does one play El Tro? To get a ticket you need a banking license inside the European Union. Then the central bank pings you an email, and makes you an offer you really cannot refuse:

Unlimited loans for 3 years at a cost of 1% per year!

Last December, the prize draw totaled €489 billion. This week the cash pay-out totals €529bn. Apparently that's your lot. ECB president Mario Draghi says today's giveaway was the last. But a trillion Euros will be a lot of money to find when the loans need repaying at start-2015, even though they'll no doubt be worth much less in real terms. We wouldn't bet against a new offer – and with fatter prizes – in the next couple of years. Anyone wanting to bet on it might think buying gold or silver a smart move. But they'll likely need nerves of steel, especially at first.

Just as with US and UK quantitative easing, buy-the-rumor, sell-the-news also applies to Europe's LTRO. Gold tumbled more than 3% on Wednesday, and silver slumped almost 9% at one point, despite the biggest 1-day deluge of money ever seen in history so far. But such volatility is to be expected, we're coming to learn. Trying to fatten the money supply of the world's largest economic region by 10% in one morning is sure to make everyone queasy. And net-net, quantitative easing and El Tro look very similar. The aim looks exactly the same.

Money is handed to banks on terms they wouldn't dare have imagined pre-2008. Officially, the plan is to boost lending to small businesses. The central banks all promise that this cash injection is only temporary (3 years for LTRO, undated for QE and clearly indefinite in the case of Japan) and will be withdrawn in future. A good chunk of it winds up in government bonds. Very little, if any, reaches what TV news anchors calls the "real economy".

"The idea that the long term repo operations have eased the supply of finance to small businesses in the Euro area is a myth," as Bank of England governor Mervyn King to UK politicians in London today.

"What it has done is to provide a source of funding to banks particularly in the southern member countries of the Euro area which were experiencing a bank run, enabling them to fund the withdrawal of funds."

Note that our Mervyn didn't say the loans were a round-a-bout way of keeping Spain afloat, even though Spanish banks – heavy players of El Tro the first time – accounted for 97% of the increase in Eurozone government debt held by all Eurozone banks in the 3 months to Feb. Because note too that, by the end of next month, the Bank of England itself plans to hold one-third of all UK government bonds in issue.

So pot, kettle and all that. And just as with the US Fed and Bank of England's un-ending queasing, so the ECB's unlimited loans look likely to become a permanent and regular feature for gambling fans.

By Adrian Ash
BullionVault.com

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Formerly City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2012

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