European Bankers go to the Mattresses

Are Europe’s banks now playing a game of hide-and-don’t-lend? According to overnight deposits made by European banks at the European Central Bank, the answer is “yes.” The Financial Times reports that European banks parked around €350 billion at the ECB on Friday. There, huddled with all the other frightened deposits, it earned 0.25% in interest.

This is the equivalent of bankers hiding their money under big government mattress. Yes, it’s different than what Sonny meant by in The Godfather. Sonny wanted to “go to the mattresses” against Sollozzo. It meant, we think, getting ready for war and hunkering down for a big battle.

If all that tarted up and pretty European money had been out on the street hustling – you always want your money working for you and not you for it – it would have earned closed to 0.32% in a money market account. But the streets aren’t safe for paper money these days. You never know what kind of inflationary fire or deflationary pot hole is just around the corner.

Taken with two other signs – the falling euros versus the USD and widening credit default swap spreads on sovereign European debt – it shouldn’t come as much of a surprise that gold (which is made of metal and not paper) made a new high in euros and nearly US AND Australia dollars. The euro price of gold reached £1070 by mid-morning in New York. Meanwhile, the August gold futures contract on Comex traded at $1,240.80, up nearly two percent.

Here in Australia, gold is bobbing along nicely as well. It’s good as. Now it’s hard to say if this is related to concern about the Aussie dollar and the Aussie economy or if it’s just relative strength in the U.S. dollar as investors bail on the euro. Either way, as you can see below, the Aussie gold price is within spitting distance of the 2008 high of $1,546.

Aussie Gold Price Nears High

Aussie Gold Price Nears High

The last time the Aussie gold price went this high, the dollar plunged and the post-Lehman world teetered on the edge of systemic collapse. Is that where we are this time? Hmm.

In this second stage of the Global Financial Crisis, the bad debt problem is now a sovereign debt problem. The consequences for institutional failure are larger when the institutions are governments. But governments now seem to know that the status quo is not good enough.

The big change to that story in the last week is that the G-20 meeting in South Korea over the weekend seemed to indicate that Europe’s political and financial authorities are not going to inflate their way out of the crisis. At least not yet. Austerity could breed anger. Anger could lead to protests. And protests to violence.

Why then, if the G-20 meeting signalled more fiscal austerity, is the euro getting weaker? Well, for one, no one has any confidence that the bad debt problems are contained. When one bank’s assets are another government’s liabilities, you get a bit of doubt. But at the very least, Europe is not going to spend its way out of debt.

But in the long-run fiscal austerity promotes a healthy body politic in the same way that living beneath your means promotes financial health. Besides, the demographics in Europe and Japan simply don’t favour growing your way out of debt by spending (a suggestion made by the youthful looking U.S. Treasury Secretary Timothy Geithner).

It’s true that older populations will consume their retirement savings on living expenses as they get older. But if anything, this means declining frivolous consumption. It also means, we reckon, fewer accumulated savings available for government bond purchases. Read: higher interest rates. And that’s probably true here in Australia, not just in Europe, Japan, and America.

As Robert Gottleibsen points out today at, Australia’s Federal budget relies on some optimistic assumptions about global growth to get Australia’s public finances back into surplus. Is that realistic now? Reducing sovereign debt levels will reduce global growth. But not reducing sovereign debt levels threatens to destroy…a lot.

So here we are. The difference between now and 2008 is that there is more sobriety in the market. The cheap thrills that came from cheap money have worn off. Stocks rallied from their 2009 lows. But it’s now clearer that based on earnings, stocks are pricing in a recovery and growth that aren’t going to happen.

And then, of course, there is the little matter of the resource super profits tax. For ideological reasons (reclaiming ownership of the means of production in the name of the People) or for political reasons (putting the budget back into a theoretic surplus before the election) the government picked the worst time possible to make a disastrous economic proposal. Kevin Rudd has single-handedly made global investors suspicious of Australia as an investment destination (although Wayne Swan deserves a great deal of credit too).

The tax is largely an attack on private property and entrepreneurship in the name of social equity. But populist appeals to win elections in a global marketplace can backfire with real world consequences that raise the cost of capital for Australians (which makes variable rate mortgages more expensive to service).

Giving it to the miners good and hard might make people good for awhile – especially when the tax captures a lot of accumulated profitability in projects that have taken years and billions to develop. But when investment in Australia goes down…and when Aussie banks find themselves competing with other corporate borrowers and national governments for a dwindling pool of available global savings…it won’t feel so good then.

In the meantime, we’re sticking with the investment strategy we laid out in our “Exit the Dragon” report. And we’re headed away to America’s Northwest for a week to do some thinking about what’s next. A hint: the vulnerabilities of Australia’s financial sector and possible hedges against them.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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2 Comments on "European Bankers go to the Mattresses"

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The euro price of gold reached £1070 by mid-morning in New York.
So the Euro is now priced in UK pounds is it?

Jon Bain

that is one scary graph

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