Big Bazooka Theory and Practice - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 7 August 2012
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Paris, France

This message is one of a series. It began when Mario Draghi, former Goldman man and now head of the European Central Bank, promised to do "whatever it takes" to save Euroland.

The issue on the table: whatever does it take to bring a real recovery?

First, whatever it takes, Mario Draghi didn't seem to have it. Or maybe he did. The situation in Europe is so complicated it's hard to tell. So, investors have been fearful one day and cheerful the next. At the beginning of last week they thought all was lost. Then, by the end of the week, stocks were rallying again. The Dow rose more than 200 points on Friday. Yesterday, it still had some forward momentum... going up another 21 points.

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What does Mr. Draghi have? This report from the Telegraph, which has been hard on the story from the beginning, suggests that at least Mr. Draghi has something:

Mr Draghi has secured a mandate for "unlimited open-market operations", a far cry from the half-hearted and self-defeating bond purchases of the last two years. The ECB at last has a license to act with overwhelming force, like the US Federal Reserve.

'Overwelming force' is what Ben Bernanke has, which is thought to be the same as 'whatever it takes.' But is that enough? What force do central bankers really have? All they can do is provide the markets with more cash and credit. And even if they give it all they've got that still won't be enough to cause a real recovery. Because you can't cure a debt crisis with more debt. If you could, no one would ever bother with austerity.

Households, governments, businesses - faced with too many debts and not enough money -- sooner or later have to straighten up, reduce spending and reckon with their bad debt.

On the other hand, we've never heard of a counterfeiter who failed to pay his debts. And since the bank of Ben Bernanke has the power to print money, investors are inclined to give him and the US some slack. That's because he has 'whatever it takes.' At least, they give him more slack than they give to, say, Greece. When Greece is in a pinch, it defaults. That's what it has done many times. Half its history since independence in 1828 has been spent in default. But when the US is in a pinch, it prints!

That's the Big Bazooka Theory in a nutshell, where it belongs. And here's a forecast, too. Readers take note: this is not a formula for a healthy economy. Nor does it bring a recovery. It's only a formula for blasting the can so far down the road that most investors and savers can't see it, and therefore don't worry about it. .

As for Mario Draghi, we don't know. He may have the power to use unlimited force. Or he may not.

According to the theory, you bazooka can't be just big, it has to be infinitely big. Because, the only way you can hold off a default is by promising to print an infinite quantity of cash. And you have to mean it. If you just print up a few hundred billion, speculators take out their calculators. If they see you're a little short, they sell your bonds, fearing that you will default. Then, other speculators buy them at low prices, betting that you will print more of whatever it takes. Then, when you do print more, prices soar and the speculator sells the bonds back into the market...

....and the whole process repeats itself...until you finally default.

As long as the amount you print is limited, speculators can look ahead and see when it runs out. The only way to end this speculation against your bonds is to say: 'don't bother selling my bonds, I'll print an infinite amount to protect them.'

Then, the whole drama goes away. Savers and investors just want to know they'll get their money back. Your willingness to print, completely unrestrained by law or common sense, reassures them.

In fact, in today's world, they'll buy so many of your bonds that your interest rates will fall below the level of consumer price inflation (which is usually falling too)...making the real yield actually negative! In other words, if you agree to act like a damned fool, they'll lend you money and ask for no real yield.

That's because you will have 'whatever it takes.'

All of which is passing strange. But very amusing.

But it still leaves us with the question: whatever does it take to bring a real recovery? This is the question we teased you with last week. And that is the question we leave you with today. Tune in tomorrow for the answer.

Promise.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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1 Responses to "Big Bazooka Theory and Practice"

Rajiv Gupta

Aug 7, 2012

Dear Bill,

Yes, you are right. They just bail themselves out by printing money and exporting their problem to the other countries. What I mean to say is that US prints US100 and gives at ridiculously low rate of interest of less than 2%. Now this money comes to India and becomes 5600. If Indian borrows Rs. 5600, he will have to pay interest in excess of 13%. Therefore, FIIs can always control the market and cause havoc and make money in the process just by way of synchronized trading. The FII s buy and the domestic institutions are selling. They take the market up and once the domestic institutions start buying, they sink the market. Even if they make 5% in the bargain, they make huge amount of money. Whereas on the other hand, the domestic institutions and the retail investor will always bear the brunt of such mischief because they will not make money because of high interest and high inflation. The game is very uneven.
Further, the FII s do not want to pay any taxes for the progress of the nation from which they are making huge amount of money. They oppose GAAR tooth and nail and the FM like Chidambaram quivers and succumbs to the pressure without understanding the implication of it that the FII s are treating us as drones, who will toil hard to pay these landlords. Therefore, wrong policies are the root cause of our ills. If the western world has taxes on assets held in their jurisdiction and profit arising out of it then on parity basis, India should levy such tax prospectively without fear and if western world has GAAR then India should put GAAR in place to collect fair share of taxes.
If there is no level playing field then we will always be at the receiving end and will only crumbs falling from the table of the FII s. This cannot pave way for the success of India.

Would appreciate comments and the same will be responded.

Best Regards,

Rajiv Gupta

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