New Globl View Published "Eurozone: Shuffling Towards the Abyss"

by Michael J. Howell4. April 2013 18:21
Special report on skidding Eurozone liquidity and the Target2 imbalances suggests that ECB are getting it wrong again. Lower Euro ahead!

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Target2: The New QE .... and QT

by Michael J. Howell4. April 2013 11:24


To solve US funding problems, the Fed has willingly and unambiguously taken the dysfunctional US wholesale money markets and essentially put them on to its balance sheet. The ECB has indirectly, unconsciously and, possibly, unwillingly done the same through the Target2 system. The Target2 balances measure the cumulative balance of payments disequilibria between Eurozone economies. More accurately they underpin these disequilibria because Target2 is an automatic lending system that prevents the need for the deficit economies to adjust.


This was not, of course, how the system was designed. No one truly foresaw that the wholesale funding markets could disappear for so long and that the ECB would be compelled to finance these funding needs for years. Consider an example. Say, a Spanish bank loses deposits for whatever reason to a German bank – capital flight or trade. Normally, the Spanish bank would either correspondingly reduce its loan book (and investments) or replenish the funding by borrowing indirectly from the German bank through the wholesale money market. Credit concerns now rule this out, so instead the Spanish bank effectively borrows from the ECB (via the Bank of Spain). The German Bank can now choose either to increase its overall lending; increase its reserve balance at the ECB or reduce any borrowings it has from the ECB. The actions of Spain keep the Spanish component of the Eurozone monetary base intact; the actions of Germany will increase the German monetary base if German banks build up their reserves, or leave it unchanged, if the banks pay off ECB loans. Commercial forces likely push the German bank to maintain its funding and build up reserves, thus increasing the German component of the Eurozone monetary base.  Adding these bits up, the total Eurozone monetary base should rise and fall pari passu with the Target2 balances.

The actual data tell a staggering story: over the period since the Euro started in 1999, the correlation between the Eurozone monetary base and the size of German Target2 balances (both measured in Euros) is 0.027; from 2009 this jumps to 0.511; from 2010 to 0.623 and since 2011 to 0.787. From 2012 onwards, it hits a whopping 0.954, showing that the two series move virtually step-for-step. They are indistinguishable. Therefore, the latest fall in Target2 and the associated drop in the Eurozone monetary base shows a inadvertent tightening of monetary conditions. We have been warned.

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Another Eurozone Crisis Ahead?!

by Michael J. Howell11. February 2013 12:43
Both the ECB’s rhetoric and its actions are strangely out-of-step with the trends elsewhere. Eurozone is again heading for the buffers and the odds of another bout of market volatility have jumped according to our latest liquidity data. The ECBs monetary stance is strangely conventional at a time when more unconventional thinking is needed. Gross liquidity provision, which gives a better indication of support for Europe’s banks, slid back to E1.5 trillion in early February 2013 from E1.67 trillion last June, and the growth of base money has slowed sharply to pedestrian annual rates. More dramatically, our monthly index of ECB liquidity provision plunged to 6.3 (‘normal’ range 0-100) at end-January 2013 from a whopping 97.4 in June 2012. This has all the ‘fire-fighting’ hallmarks of the ECBs previous crisis responses: react to banking strains by throwing liquidity into markets and then progressively withdrawing it over following months as the crisis abates. Until the next time! We restate our end-2012 comment that, in our view, the risks in the Eurozone in 2013 far out-weight the potential rewards. This was not the case for 2012, where the reward/ risk ratio was extremely favourable and the chances of some ECB action high. The problem 12 months on is exacerbated by the recent Euro strength and notably the near 25% rally versus the Yen. Germany has been the rock that has supported fragile European business over the past year, but this latest loss of competitiveness will not help German export performance. Europe’s financial problems are all about lack funding rather than insolvency: a less active ECB and a declining pool of German savings will again heighten these problems.

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