July 14 (Telegraph) -- Monetary experts are increasingly
disturbed by the pace of money supply contraction in Italy and
most recently France, fearing that it could prove a leading edge
of a sharp economic slowdown over the winter.
"Real M1 deposits in Italy have fallen at an annual rate of
7pc over the last six months, faster than during the build-up to
the great recession in 2008," said Simon Ward from Henderson
Global Investors.
Such a dramatic contraction of M1 cash and overnight
deposits typically heralds a slump six to 12 months later.
Italy's economy is already vulnerable – industrial output fell
0.6pc in May, and the forward looking PMI surveys have dropped
below the recession line.
"What is disturbing is that the numbers in the core eurozone
have started to deteriorate sharply as well. Central banks
normally back-pedal or reverse policy when M1 starts to fall, so
it is amazing that the European Central Bank went ahead with a
rate rise this month," Mr Ward said.
Italy is not a high-debt nation. Italian households are
frugal by Spanish and UK standards. However, Italy has a toxic
trifecta of problems that affect long-term debt dynamics: a
public debt stock of €1.8 trillion or 120pc of GDP; rising
interest rates; and economic stagnation. It is the interplay of
these elements that has set off flight from Italian bonds.
Italy has to roll over or raise €1 trillion over the next
five years, with a big spike as soon as August. "Any new issuance
will be above the average rate. That is the real cause of the
destructive market action," said Paul Schofield from Cititgroup.
The Italian and Spanish bond markets stabilised yesterday
after coming back from the brink. News that US bond fund Pimco
has taken advantage of the sell-off to accumulate Italian debt
cheaply helped restore calm.
The IMF has endorsed Italy's €40bn austerity package, though
the measures are "back-loaded" with most of the pain in 2013.
However, RBS said the eurozone storm is far from over. "We
expect the crisis to continue deteriorating, and threaten to
undermine the entire euro area as European policy-makers still
misunderstand market dynamics. They show no sign of catching up
with reality," said Jacques Cailloux, the bank's Europe
economist.
Mr Cailloux said the EU's bail-out machinery (EFSF) must be
increased to nearly €3.5 trillion in committed funds to staunch
the crisis. This would give the authorities effective firepower
of €2 trillion. "It is a lot of money but the euro is a big
project. This is all about political appetite. The longer they
wait, the worse it gets.."
A fund of this size would amount to 27pc of eurozone GDP.
The effective lending power of the EFSF at the moment is just
€255bn, and half of that will be needed for Greece, Ireland, and
Portugal. Greece's problems took a further turn for the worse
yesterday after Fitch downgraded the country by three notches to
CCC.
RBS compares the euro crisis with exchange rate turmoil in
East Asia in 1998, though the EMU effect has this time switched
risk from devaluation to bond default. Eurozone borrowers face
the same "reversal in confidence" after years of deceptively
benign conditions.
Hopes that eurozone leaders would deliver a "big bang"
solution at a summit on Friday have been dashed after German
officials said Chancellor Angela Merkel may not attend. Finance
mininster Wolfgang Schauble warned against a "hectic" response, a
way of saying Berlin will not be bounced into a decision. There
is stiff resistance in Mrs Merkel's coalition to steps that drag
the country into a fiscal union where sovereign debts are shared.
German officials are drawing up possible plans to allow the EFSF
to lend to countries such as Greece so that it can buy back its
bonds in the market at a discount.
However, Bundesbank chief Jens Weidmann issued a caustic
critique of the plan."It has a high cost, limited use, and
dangerous secondary effects. This discussion is going in the
wrong direction," he said. He added that the ECB would not accept
Greek bonds as collateral if Athens defaults. "It is not our job
to finance insolvent banks, let alone countries," he said.
The real M1 data show countries are vulnerable. There have
been sharp contractions in Austria and Belgium. The Netherlands
and Germany are negative.
The ECB believes sluggish money supply figures reflect the
reduction of an "overhang of liquidity" left from before the
crisis and are benign. The claim has raised eyebrows among
monetarists.
Tim Congdon from International Monetary Research said the
ECB had drifted away from monetary orthodoxy after the departure
of Otmar Issing as chief economist in 2006, tolerating "crazy
lurches" in the broad M3 money supply. "The ECB did not see the
collapse in money growth in 2008 and the great recession that
followed, and they are getting it wrong again."
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