The OMT will replace the SMP.
But to get an OMT, you first need to apply for an EFSF or ESM.
Or, if you’ve already been to see the EU or IMF, you qualify for an OMT anyway. So, well done.
What does all that nonsense have to do with financial markets?
Well, the creation of the OMT caused the FTSE 100 to rise 2.1%. The DAX added 2.9%. The Spanish and Italian indices gained 4.9% and 4.3% respectively. And the US market gained 2%.
Of course GOLD climbed too, trading above USD$1,700 this morning.
As for Aussie stocks, we expect the ‘good news’ to flow here too. But beware. Like prior false rallies, you shouldn’t think this one will last long either…
If you haven’t read today’s news you may wonder why overseas markets went berserk overnight.
The answer is due to Europe’s grand new plan, the Outright Money Transactions (OMT) programme. The Financial Times sums it up this way:
‘[European Central Bank president,] Mr Draghi said the bank could potentially buy an unlimited amount of Eurozone sovereign debt with maturities of between one and three years.‘
So there you have it. In effect, the ECB will print money to buy bonds from debt-laden Eurozone countries.
More free money.
Of course, some will claim it’s not free money because the Spanish and Italian governments will pay interest on the loans.
While that’s true, the point is it’s free money because the ECB will create the money from thin air. The money used to buy the Spanish and Italian bonds won’t be the proceeds from productive labour or capitalism.
The money printing is pure monetary inflation. And monetary inflation is always bad for consumers because it competes with money earned from productive labour and capitalism.
And because it’s unearned money, it naturally devalues the earned money. So while markets tend to cheer central bank money printing, and stock markets rise as investors bank on the new free cash going into stocks, what’s unseen is the negative impact the free money has on your wealth.
Why Free Money is Irrationally Exciting
Among all the stories on the Bloomberg News website covering the ECB’s latest plan was a story titled, ‘Why Free Stuff Is So Irrationally Exciting’.
The article reviews a book called Predictably Irrational: The Hidden Forces That Shape Our Decisions, by Dan Ariely.
The article reflects on the history of giveaways used in marketing products. For instance, a toy in the cereal box (we remember the tiny plastic submarine in the Corn Flakes box that was powered using baking powder), or the McDonald’s Happy Meals.
As the article notes:
‘From a business perspective, incentives have been a smart strategy from the start. They have a way of persuading us to buy goods we otherwise might not have, to buy them in greater quantities than we had intended, or to waste valuable time standing in line for a free item we have no use for…
‘It overrides the rational part of our brain that would calculate how much something offered for free might actually cost us.’
This irrational behaviour is exactly what you’ve seen in the financial markets for the past four years.
The prospect of free money printed by the world’s central banks tends to excite investors. But they don’t always think about the long-term effect of the money printing.
So just as a consumer irrationally buys a box of corn flakes to get the free plastic ship, investors irrationally buy stocks to get the effect of the free money. Their brain switches off and they follow the crowd.
However, as exciting as it may be for the first couple of times to watch that ship buzzing around the bath, the joy soon wears off…just as the joy of money printing has worn off for stock investors.
Free Money Fun Won’t Last
The red dots on the chart below show the approximate periods when the US Treasury or Federal Reserve implemented stimulus programmes (including money printing):
The last red dot on the right denotes where talk began in earnest of the next round of money printing. The market has gotten a boost even though it hasn’t started yet.
But for all the previous stimulus packages (TARP, QEI, QEII, Operation Twist), it’s had an impact, but not a lasting impact.
As the effects wear off, investors decide they want more free stuff, so markets begin to fall. That leads the central bankers’ to act again, fearing the economy will collapse.
Meanwhile in Europe there have been so many crises and bailouts that the following chart looks as though it’s got a bout of the measles:
As we pointed out yesterday, money printing and stimulus creates more, not less uncertainty for markets and businesses.
The market gets excited, but as soon as the effects start to wear off, the market is looking for the next buzz.
So now the ECB has told the world that it will buy an unlimited amount of bonds, the attention will turn back to the US to see what Dr. Ben S. Bernanke can come up with.
Buy Stocks, but Buy This Too…
In the short term, this all looks great. It’s why we’ve encouraged you to have some exposure to the stock market so you can benefit from the idiocy of central bankers.
But in the long term, we also know that getting something for free doesn’t always represent value for money. So go ahead, buy some stocks and get excited by 2% daily stock market gains.
But also remember to take note of the warning signs that show the market isn’t as sound as the mainstream would have you believe. Gold has quietly gained ground over the past month.
And as the central bankers keep doing what they’ve been doing, we’d expect it to gain more ground over the coming months.
Buy stocks. But most of all…buy gold.
Cheers,
Kris.
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