As The ECB ’s Plan Fails Again, Quantitative Easing Is The Only Option Left

The European Central bank has announced the total amount of money which was taken up by the banks in its second large push to shove its Long-Term Refinancing Offer (LTRO) down the throats of the banks. After the failure of September of this year where only a handful (255) banks took just 82.6B EUR, all eyes of the financial world were aimed at the December offering of the LTRO. As ECB President Mario Draghi repeatedly said he was aiming to pump 400 Billion Euro in the market through these LTRO’s, the expectations were high as one would have expected at least 250 Billion Euro to have been taken up by the banks. This number of 400B EUR wasn’t just pulled out of thin air, as it was based on 7% of the outstanding loans made by the banks to private borrowers.

The actual number was much lower at just 130B EUR spread over 306 banks for a total take-up of 212B EUR which is just more than half of what the ECB was hoping for. Needless to say this outcome was quite humiliating for the ECB and especially for president Draghi who said he was sure the take-up in December would be much higher than in September. Okay, yes, he was right, the banks drew down more cash from the ECB, but the total number is still 185B EUR less than what he was eyeing, so we can’t really say it was a huge success.

It gets even worse. If one would simply read the headlines, he would think that the ECB successfully 212B EUR into the financial system which is better than nothing. This statement would be true but we can’t ignore the repayments of the money which was previously lent to the banks in previous long-term refinancing operations. So what does this mean? Well, banks are using the ‘new’ funds to repay the ‘old’ loans so the entire system stays in an almost exact status quo. Nothing is changing and no NET new liquidity is being pumped into the markets. In the exact same week the ECB distributed 130B EUR, roughly 40B EUR in old loans were repaid, and we are expecting more repayments to occur shortly.

Source: The Wall Street Journal

And it gets worse. Looking at the current oil price, the price per barrel is now roughly 20% lower than the oil price the ECB assumed in its ‘economic shock’ parameters to determine the health of the banks. This means that instead of creating and increasing the credibility of the banks of the Eurozone, the ECB’s test results have become somewhat unreliable as it’s becoming clearer and clearer that the ‘stress test’ wasn’t tough enough.

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This also creates another problem. If the Eurozone banks don’t want to play the middle men in some kind of liquidity-enhancing scheme (the total amount of loans to the private sector has reached its lowest level since the start of the Global Financial Crisis, see the previous image), the European Central Bank is now really running out of ideas, and the call for a Quantitative Easing program is sounding louder and louder. And indeed, it seems to be the only option left if the Mario Draghi was serious about his bazooka and about his intent to expand the balance sheet of the ECB to 3 Trillion Euro again. The Italians are obviously in favor of a Quantitative Easing program as they would obviously hugely benefit from such a program as it would allow the debt-loaded state to raise debt at a lower cost if the government bond yields were to be influenced by the ECB.

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2015 will be an extremely important year for the Eurozone as the ECB has no options left than to print cash to buy government bonds on the open market. We saw what happened with the USD and the JPY when that happened, so one can be quite sure the Euro will take a hit. More importantly, lower government bond yields could push insurance companies into a distressed state as their investment income will decrease sharply, making it tougher to meet the payout needs. Quantitative Easing seems to be the only way to go, but we can’t warn you enough that this might be just the first domino piece to fall. That should obviously be good news for the gold price as an increased money supply could very well cause a flight to hard assets.