Image: Bill Fleckenstein

Bill Fleckenstein

Last week I mentioned in passing the "lack of action" on the part of the European Central Bank at its meeting on Oct. 6. It turns out that I missed an important nuance, but my oft-quoted friend the Lord of the Dark Matter straightened me out.

While not mentioned in its press release, the 12- and 13-month long-term refinancing operations that the ECB mentioned during a press conference were, in the LODM's words, a "big deal" and "the closest anyone will ever see the ECB come to doing QE (quantitative easing)."

In debt they trust

This explains why banks and debt markets have traded higher since what was otherwise basically a "nothing done" by the ECB. The long-term refinancing operations are significant, because any one of the 7,500 banks that have access to the ECB can present any eligible collateral and the ECB will lend it however much it wants at fixed rates for 12 months and then 13 months (though some limits do apply based on the quality of the collateral).

The net effect is not the Ben Bernanke-style quantitative easing we've seen from the U.S. Federal Reserve, but it's the closest the ECB can get at the moment. So while it isn't permanently buying bonds (as the Federal Reserve does, hoping you believe it will sell them back to the market someday, which it never will), once the ECB implements this long-term refinancing operation, it could always decide somewhere down the line, when the next crisis hits, that it will unilaterally extend these facilities indefinitely. This would effectively monetize the debt it accepts as collateral. That is not what has occurred, but you can now see how the ECB could get there from here.

From gas to liquid, but not exactly solid

One thing is certain: A liquidity crisis in the European banking system is now less likely. Of course, this does not address the fact that the government debts still have a question mark over them, because European Monetary Union countries don't have access to printing presses they can use to conjure money to buy whatever debt they spew forth.

The potential insolvency of sovereign debt was brought back to the front of people's minds on Oct. 7, after Europe's equity markets had closed. The Fitch investment rating service downgraded Spanish and Italian debt two notches. In addition, last week, on Oct. 10, Greece continued to worsen, as its one-year debt traded at an eye-popping yield-to-maturity of 150%, and on Oct. 12, the yield on Italian 10-year debt rose to 5.7%, perilously close to the supposed supercritical danger zone of 6%.

Nevertheless, this long-term refinancing move is a clever step toward money printing, and I believe it has probably defused the nuclear "tripwire" Europe has been, at least temporarily.

Thus, the questions now are whether the ECB can find a way to use the European Financial Stability Facility to recapitalize some banks and if the ECB can deploy some weasel words, whereby "solvent government debt" will be purchased. If so, it may be able to deal with the inevitable Greek default without having the entire continent implode.

Out of the frying pan, onto the bandwagon

If by some chance this European rescue that has been cobbled together "works" for a little while and October does not turn out to be a disaster, there are liable to be any number of money managers who have to react. They will have too much cash and be forced to chase the market higher, just as they drove it lower trying to get out on the mistaken belief that it was 2008 all over again.

I am not suggesting that is a reason for anyone to do anything, but I have seen this movie many times before, where market action forces folks to do something. In any case, I think it is worth keeping in mind as we see how things start to develop.

This column is a synopsis of Bill Fleckenstein's daily column on his website,, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.