Will the Bank Run become a Stock Market Crash?

The WealthCycles Staff

On March 21st the chief global equity (stocks) strategist for Goldman Sachs made this announcement:

“Given current valuations, we think it’s time to say a 'long goodbye' to bonds, and embrace the 'long good buy' for equities.”

The mainstream financial comedy channels called buying stocks a “generational opportunity.”

As our devoted readers remember, three days prior to the Goldman announcement, we wrote the WealthCycles.com piece End of Covert Dollar Printing Expected to Result in Stock Selloff. We circled the opportunity to exit below:

If the Long-Term Refinancing Operation (LTRO) took us from the market perception of European crisis in the fall of 2011 to where we are today, still some 200 points higher, what happens now that there are no more money-good securities to trade in for cash?

Recall that LTRO is printing, as the 3-year loans can be extended indefinitely. The banks seeking cash are already heavily encumbered. Spanish banks have no more money-good assets to swap in a new LTRO program. With the uncertainty surrounding Greece possibly reversing the Euro-banker-bailout, depositors are pulling euros out of banks to avoid a devaluation event in the case that Germany says nein to further transfer payments.

Euros are distributed to commercial banks from the Bank of Greece, through Emergency Liquidity Assistance (ELA), under which the Greek central bank adds to what it owes Germany. For every euro pulled out of banks today (prior to June 17th elections one would think) the Germans will see a higher bill (the tally owed to Germany is called Target2, below).

This is where the cash comes from to fund the day-to-day for insolvent banks. They are not loaning short-term in overnight markets (as is happening in the U.S. for now) because European credit markets are frozen, as noted by the chief of the Australia and New Zealand Banking Group (ANZ Bank).

We warned on April 12 that far too many institutions still prefer to face the central banks in transactions rather than one another, and that the shrinking set of assets perceived as safe, coupled with growing demand for these types of assets, acts to increase systemic instability and risk.

Beyond major Australian banks seeing conditions similar to those of 2008, the threat of a bank run seems to grow by the day. We wrote about safekeeping of wealth here, referencing the Northern Rock nationalization resulting from its inability to access the shadow banking securities markets that sustained its business. Below is a Google trends search for “bank run,” the issue with these type of events are that they are reinforced socially online, advancing developments.

As cash is pulled out of ATMs all across Europe, an understanding of where that cash comes from (Germany) gives us insight into what course of action may follow. The access to Target2 is via the ELA, which the ECB or Germany could disconnect at any time. This would mean the Greek central bank would run dry, and would have to call a bank holiday in order to change deposits to Drachma. On that subject, think-tank Open Europe told The Telegraph the following:

“The activation of the so-called ELA looks to be the last stand for Greek banks and suggests they are running alarmingly short of quality collateral usually used to obtain funding. Though the ELA is meant to be a temporary emergency solution, we know from Ireland, where the programme has been running for almost a year, that once banks get hooked on ELA they rarely get off it.”

If Greeks choose to go back to their own currency, and repudiate debts, other banks in Europe will not only see direct mark-to-market losses on Greek debts, but they will also see considerable outflow of deposits beyond what has already begun in Spain, spreading contagion.

Below is the change in demand for dollars, comparing to the Eurocrisis levels of November 2011 that prompted the LTRO and 1/2% Federal Reserve loans to Europe.

This rush out of everything and as a result, demand for dollars, is short-term liquidity-crisis driven. This costs positions denominated in dollars; for example it now takes fewer, stronger dollars to buy the same ounce of gold. Seeing the uncertainty of the much anticipated (after four years) end of printing coming up June 30, combined with the Eurozone insolvency, markets may react violently from here forward.

Recently there has been significant jawboning in light of the market pressures (lower), as too quick of a drop, a stock market crash, would be undesirable considering the fragility of the system. 

Two Fed presidents have recently come out repeating what they have repeated all year, that “if economic conditions deteriorate…,” along with the Bank of England saying that the Bank of Japan had room to print further! Neither bank has chosen to print recently, as there is an effort underway to excuse Fed printing in a timely manner, and any, even small, quantitative easing (QE) could boost oil prices to a level where printing changes from politically positive to no longer possible in the U.S. Observe the matching stance on Iran that the U.S. has taken in recent months, also easing pressure on a potentially disrupted oil supply.

Here is what the New York Fed branch president Dudley said in a speech today in New York:

“If the economy were to slow so that we were no longer making material progress toward full employment, the downside risks to growth were to increase sharply, or if deflation risks were to climb materially, then the benefits of further accommodation would increase in my estimation and this could tilt the balance toward additional easing,”

So there is the plan. We were well advised, all year long. Best to buy hard assets and monetary metals before the stick-save mid-selloff whenever the powers that be decide enough is enough. Even the International Monetary Fund came out today calling for more printing, saying “further monetary easing is required,” referring to the Bank of England decision to defer to the Fed. Today’s Wall St. Journal has the headline “Treasuries signal lower expectations for inflation, offering leeway for stimulus.” Even (especially) the investment banks (who are the marginal buyers in the market) have given the green light for the stock market crash (excusing Fed action). From Citibank:

"Our impression is that markets will need to act as the proverbial 'attack dog,' forcing the issue on the political agenda. We can't escape the sense that it is probably politically easier to let the markets run loose for the time being to make it apparent that further intervention is needed. But 1000bp on Crossover [bond index] is much closer than you imagine."

This means the last few days have simply been a relief rally, giving larger players a few days to reposition before further mayhem commences. Other big banks with “desks that trade size” will be on board, thanks to this letter of coordination.

Time to back up the truck and buy the only asset both ensured not to default and to rise like a phoenix when the paper-printers do exactly what they have been hinting they would do, all year long.

Quantitative easing is central banker speak for creating currency to buy debt or other assets.

The process of quantitative easing is fairly simple—it involves printing currency and buying assets from banks—but it can take many different forms. Central banks can use Q.E. to buy relatively safe treasury securities, pumping cash into their vaults to stimulate lending; or they can buy assets that have lost value (think mortgage-backed securities) in order to make banks whole and attempt to shore up their balance sheets. Central banks can also target certain maturities of the assets they purchase, to push down the cost of short-term, medium-term, or long-term borrowing. 

The natural rate of unemployment, it is considered to be consistent with a level of unemployment that predominantly comprises voluntarily unemployed workers. In other words, those members of the labor force who really want a job have one.

Deflation is a contraction of the currency supply, which causes prices to fall and the value of currency to rise. When prices fall, a boom becomes a bust, and suddenly a recession becomes a depression.  Fed Chairman Ben Bernanke, a scholar of the Great Depression, knows the dangers that deflation poses to a debt-based economy.

Investment banks are financial institutions that underwrite new stock and bond offerings, advise clients on mergers and acquisitions, and make markets—or act as a middleman in stocks and bonds.

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I think we are probably looking at support around the 1200 levels now. As much as it looked like new highs were on the way, we may need to regroup first before we make a solid run.

-highfrequencytradingprofit.com

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