Eurozone M3 money plunge flashes deflation alert for 2014
Eurozone in danger of Japanese-style deflation that will cripple Club Med nations as money supply drops to record low levels
By Ambrose Evans-Pritchard
5:35PM GMT 28 Nov 2013
Loans to non-financial companies shrank at an accelerating pace of 3.7pc, but with drastic differences between North and South. Yacine Rouimi from Societe Generale said total credit plunged by 5.7pc in Italy, 6.6pc in Portugal, and by an “alarming” 19.3pc in Spain.
Source: European Central Bank, SG Cross Asset Research / Economics
Jacques Cailloux from Nomura said the ECB’s actions have yet to restore a functioning interbank market in Europe, and it remains unclear whether the nascent recovery will be enough to lift the region out of “dangerously low inflation”. Nomura said eurozone risks being trapped in “secular stagnation” until the middle of the decade.
The dire credit data may force the ECB to take bolder measures. The Süddeutsche Zeitung said the bank is exploring a variant of the Bank of England’s funding for lending, offering credit lines to banks provided loans are passed on to credit-starved firms.
“The ECB needs to cut rates to zero and launch quantitative easing (QE) to head off deflation, but they are not there yet,” said Lars Christensen from Danske Bank. “The debt problem in Italy will be much worse if they let nominal GDP fall, leading to yet more austerity.”
Chart: Spain's financing of non-financial corporations
The ECB’s governing council appears deeply divided. While doves have opened the door to QE and a negative deposit rate to force down the euro, a German-led bloc of hawks remains adamantly opposed to such steps. The two German members opposed the bank’s quarter point rate cut last week.
Mr Congdon said regulators have made matters worse in Europe by forcing banks to raise capital buffers too fast. “This is causing them to dump assets and destroy money. The regulators think they are curing the patient but they are killing it instead,” he said.
A report by PricewaterhouseCoopers said European banks face capital shortfall of €280bn in 2014 to meet Basel III rules and the ECB’s asset quality review, with €180bn of this coming as fresh capital. “European banks are facing another turbulent couple of years,” it said.
There was broad consensus among monetary experts at an Institute of Economic Affairs forum this week that “pro-cyclical” regulation is a key reason why recovery has been so weak.
Lord Skidelsky, the biographer of John Maynard Keynes, said that even Keynes would have viewed the current clamp-down on banks as folly. He cited a letter written by Keynes to President Franklin Roosevelt in 1933 warning that US policies intended to achieve “recovery and reform” at the same time were in conflict. Keynes said recovery must come first.
The ECB’s own policies appear to be in contradiction. Its latest Financial Stability Review warned that bond tapering by the US Federal Reserve could lead to an interest rate shock, with a sharp rise in bond yields. Yet it has been slow to mitigate the dangers with pre-emptive stimulus.
Mario Draghi, the ECB’s president, told an audience in Berlin last week that bank needs a “safety margin against deflationary risks” after eurozone inflation fell to 0.7pc.
He warned that low inflation makes it harder for crisis states in Southern Europe to control their debt trajectories while at the same time carrying out internal devaluations within EMU to regain competitiveness, though he denied that the two goals are inherently contradictory.
“If average inflation is allowed to drift too low, adjustment runs into major head winds as demand suffers and real debt burdens rise,” he said.
Mr Draghi has to walk through a political minefield. The German constitutional court has not yet ruled on the legality of his back-stop plan for Italian and Spanish debt (OMT), making it very risky for him to push his case too hard. While Germany does not have a legal veto on ECB decisions, it has a de facto political veto.
Veteran EU watchers say the sacred contract of monetary union is that Germany will never be overruled on crucial matters. Mr Draghi has to work in tandem with Germany’s ECB board member Jörg Asmussen. The bank is in reality a twin-headed institution.