Money Circulation in the Eurozone- “Banks’ Deposits” under the lens!
Today a guest post by Erwan Mahé, from OTCex group. Unlike standard ECB analysis the article focuses on monetary differences between Euro countries and dynamic as well as changing relations between monetary and other variables. The ECB was very helpful in explaining and providing data.
from Erwan Mahé
Regular Thaler’s Corner readers are well aware of the importance I assign to money circulation, as per the famous MV of MV=PQ equation, which has enabled to avoid a good number of pitfalls in recent years.
But it is crucial to view this equation in the context of today’s real world, and not as some of our Stone Age monetarists would have us believe, with a more or less stable V, and a confusion between money supply and monetary base!
As such, my approach is at the polar opposite of that adopted in the ECB statutes. I admit to taking cruel pleasure in citing the relevant excerpts (emphasis mine, link here)
The ECB’s monetary policy strategy
At its meeting on 13 October 1998 the Governing Council of the ECB agreed on the main elements of the stability-oriented monetary policy strategy of the ESCB. These elements concern: the quantitative definition of the primary objective of the single monetary policy, price stability; a prominent role for money with a reference value for the growth of a monetary aggregate; and a broadly based assessment of the outlook for future price developments.
The prominent role of money has been signalled by the announcement of a reference value for the broad monetary aggregate M3.
The reference value for monetary growth
In December 1998 the Governing Council of the ECB announced the first reference value for monetary growth, namely an annual growth rate of 4½% for the broad monetary aggregate M3. This reference value was confirmed in December 1999. It was also announced then that the reference value would henceforth be reviewed on an annual basis.
The derivation of the reference value was based on the standard relationship between money, prices, real activity and the velocity of circulation.
This premise, which recalls the gold standard days, assumes a static relationship between money supply, prices and money velocity as per MV=PQ, but with a V set in concrete, which explains how the ECB ended up impaling itself on the Great Financial Crisis. It sparked the crisis in Europe by hiking key rates in July 2008, due to its total inability to understand that the collapse of the securitisation market would also collapse V !
Then there is the ECB’s absurd fixation with the HICP, which includes commodity and energy prices and indirect taxes, in contrast to the Fed’s focus on the core inflation index. This obsession forced it to harden monetary policy with each new surge in commodity prices, as if higher interest rates would somehow boost wheat harvest or lead to greater oil extraction.
In reality, these rate hikes only serve to hinder economic growth as illustrated by the ensuing contraction in household spending pushed down demand and thus the prices of these items.
While we are on the subject, let’s not forget that the HICP, as Mr Trichet used to say, “the sole needle in the ECB compass”, does not at all include real estate costs, which it classifies as an asset and investment, and therefore beyond its area of competence! It is worth noting that the Fed, with its rent equivalent index, factors real estate prices into its benchmark index. This in part explains why the Fed began to hike interest rates in June 2004 while the ECB waited unit December of 2005 to up rates and continued to do so until July 2008. In the meantime, the Fed stopped increasing rates in June 2006. The US central bank started lowering them in September 2007, but in Europe we had to wait until Lehman Brothers went bottom up before the ECB decided to (at last!) begin to reduce the cost of money with its oh-so “courageous” reduction in the refi rate to 3.75%, which compares to the Fed’s benchmark rate at the time of 1.50%
If there is one thing that we can learn from the study of the functioning of a modern monetary system, it is that a central bank actually has no control whatsoever of money supply creation. Of course, it can increase the size of the “monetary base” by buying private-sector held securities on financial markets and replacing them with pure electronic money, as per quantitative easing. But the only way it can increase “real money supply” is for it to engage in a famous “helicopter drop”, which has never been tried by any of the major modern central banks.
In practice, the main consequence of the current unorthodox measures taken by central banks (QE, LTRO) is their affect on more or less long-term interest rates, depending on the maturity targeted by the interventions.
The operational truth of today’s financial systems is that only commercial banks create money when they grant loans (as in “loans make deposits) and they can do so without the slightest size limitation, because even in the case of required reserves ratio restraints, the central bank to which it is dependent will have to provide it as much as these same reserves as it needs, because otherwise it would totally lose control of its benchmark interest rates!
The ECB’s insistence that it can navigate M3 money supply via adjustments in benchmark interest rates is in reality a subterfuge to avoid admitting that its interest rate moves have no impact on the cost of money. Since this is one of the major variables in determining investment projects and consumption via the credit cost channel, its real aim is to modulate the growth rate of the real economy. We can even say that that, when it hardens monetary policy, it is trying to increase the unemployment rate of the active population (decline in payroll costs), one of the key variables of its neo-classic bias, as illustrated by the famous ISLM curve.
Since I am above all interested in the real money supply in macroeconomic forecasts, I have decided to go directly to the heart of the current problems on the eurozone in this Thaler’s Corner by making a country-by-country basis examination of “loans make deposits”.
But first, I would like to express my thanks to the ECB and Eurostat services, which helped me navigate the jungle of published statistics on the matter and go right to the heart of the problem. For masochists of statistical immersion, you will surely enjoy this direct link to the ECB web where these data are compiled (link here):
However, instead of drowning in a pile of dry statistics, I have highlighted the key figures and transcribed them in the form of graphs, which I hope you will find a bit more meaty, below.
First, the following graph allows us gives us an indication of our direction.
I have combined deposits of eurozone residents, including overnight deposits, deposits with agreed maturity and redeemable at notice deposits.
Here we are talking about money supply of slightly over €10 trillion, which compares to €5 trillions in 2000.
Deposits in the eurozone banking system
But, as always when speaking about growth on a multi-year time frame, the most important point is the rate of annual growth, which enables us to avoid the “interest compounding” trap.
As can be seen in the graph below, the growth rate of these deposits match coincide perfectly with what we call the “boom credit years”, as illustrated by the growth of the American commercial paper volumes, which was so useful for us in 2007 in discerning the skid to a half of credit velocity and its subsequent collapse.
Since the end of 2009, this growth has been stagnating between +2% and +4%, which is in line with inflation, and at historically low levels, which should, at the very least, calm the fears of those who continue to kneel before the altar of “quantitative monetarism”.
The positive impact of the last two VLTROs should make itself felt, at least marginally, in these statistics and end the reduced growth trend of this curve.
Annual growth rate of deposits
But the most important point in the context of the eurozone is to examine the changes country-by-country in order to try and discern potential tension points, especially in the current context in which all eyes are directed at the potential new victims of a PSI other such amputation.
I did not include Germany in the following graphs, since the enormity of its weight would render the curves of the other countries fairly unusable. It is enough to know that deposits in Germany total about €3 trillions, which compares to €1.85 trillion in France (eurozone’s second biggest economy by deposits) and that, while they have been growing by just an annual 4% for 18 months, that still represents a significant share of European deposits. That said, we know this is not a point of tension, and it is precisely the topic that concerns us today.
The first graph represents the deposits of countries of comparable size: France (1.85T), Spain (1.55T), Italy (1.28T), the Netherlands (0.84 T) and Belgium (0.45 T).
These curves seem to validate the current attitudes of investors, who have shown a significant preference for the Italian bond market to that of Spain in recent weeks.
While Spain underwent huge deposits growth from 2004 to 2009, even overtaking France, their growth has come to an abrupt halt!
In contrast, Italy, like France, deposits have continued to increase but with greater spurts, undoubtedly due to the various tax amnesty plans approved by the Berlusconi government, which resulted in spurts of substantial capital repatriation.
Not much to add about the particularly flat curves of Belgium and the Netherlands.
In Italy, the 2009 tax amnesty had effect in the spring of 2010 (link here):
French banks, in turn, surely benefited from the transfer of life assurance volumes and their repatriation to short-term liquid investments (interest-bearing deposits and Livrets A, link here) :
France, Spain, Italy, the Netherlands and Belgium
The following chart tracks the deposits of countries on life support: Greece (175 B), Ireland (194 B) and Portugal (232 B).
No one will be surprised at the dramatic shape of the Greek curve; its evolution has been on the front pages of business journals for many months.
That of Ireland, which is hardly surprising either, is directly linked to worries about the condition of its banks.
Portugal, however, seems to be strangely pulling its chestnuts out of the fire.
Greece, Ireland and Portugal
In the next chart, I traced the path of these volumes from the beginning of 2010 and the acceleration of the European crisis in order to compare country-by-country changes measured in euro billions.
The surprise here is the France’s very positive growth, whose growth in absolute terms surpasses that of Germany, which I was able to include here!
As we can see, the deposits plunge in Spain is in reality nearly equivalent to that of Greece in euro billions!
Change since January 2010 in billions
The graph below is a bit more interesting in that I recalculated these changes by including what they would have been if deposit volumes of each one of these countries had simply followed the rate of inflation. For purposes of simplicity and with the conceptual drawbacks that implies, I used the average eurozone HCPI.
Given Spain‘s higher starting point and thus the higher growth resulting from this inflation parameter, its plunge appears even steeper than that of Greece!
Inflation included from January 2010
In the last graph below, in order to illustrate the real impact of changes in the deposits of national banking systems on the real economy, I included in the latest changes, which account for the natural change due to inflation by recalculating the gain/loss of deposits as a percentage of GDP.
In effect, it would leave a skew view to say that Spain loss more deposits than Greece, as per above, given the differences in the size of the two economies. With GDP statistics for year-end 2011 still unavailable for these countries, I used the CIA estimates, which have the merit of existing (link here):
Before looking at the curves, check out this table, which indicates the GDP figures I used, the bank deposits in these countries at end January and their relative GDP weight. The figures are pretty surprising:
One comment before I go further. While Italy’s low figure may appear to be consistent with the country’s image whereby its citizens tend to favour cash savings or accounts abroad, France’s case is surprising. However, bear in mind that French savers use money market SICAVs (similar to mutual funds) a lot for their short-term savings plans, which are included neither in the above table nor in my curves, because they do not represent directing financing of national banks, like deposits. In the other eurozone countries, savers tend to use interest-bearing deposit accounts.
Moreover, check out this surprising line the ECB’s statistic table, number 1.7, entitled Remaining Assets. France shows a record €1,646 B, which compares to €336 B for Spain and €1,302 B for Germany. If we had this amount to the €48 B from money market funds (vs 0 in Spain and €1.3 B in Germany), we come out with a more reasonable figure for France.
Still, I am waiting for news from the ECB on this matter, because the item, Other Assets, looks murky to me.
However, this table reminds us that Spain, even if after accounting for its lost ground since 2010 in terms of deposits/GDP as per the above graph, still seems to be benefiting from a sizeable amount of liquidity deposits in its banking system, with a record high 145% vis-à-vis GDP!
That may appear surprising, given the huge demands of Spanish banks during the VLTROs, but it undoubtedly reflects more its difficulty in obtaining access to unsecured debt financing for these banks. The same applies to Portugal and Ireland, which, at 117% and 136%, respectively, do not present an image of banking systems suffering from a run. It is still worth noting the substantial decline in their countries’s nominal GDP in the past three years.
If we now look at these data dynamically, that is in terms of the losses/gains of deposits as a percentage of GDP adjusted for the natural inflation change, we come up with the following graph.
The table is fairly horrendous for Greek banks, since the decline on two years comes to 34% vis-à-vis GDP! And that’s despite the decline in national GDP. We are thus observing a genuine bank run, but that hardly comes as a surprise.
Ireland and Spain, at-20% and -12%, are also in a tough situation, but the remarkable things is the 6.6% growth for Portugal, which outpaced both Italy (+6%) and Germany (+2.5%).
It is difficult to reconcile the strong resistance of Portuguese deposits with the distressed level of Portuguese sovereign debt, but it is obviously suffering from the Greek PSI and the total loss of our beloved leaders’ credibility. If we also take in account the fact that the ECB intervened on this market within the framework of its SMP, which we know cost dearly those investors who made the mistake of listening to the injunctions of government leaders to remain exposed to Greek debt, it is easier to understand this market’s “head for the hills” attitude. In effect, if there is a Portuguese PSI and new ECB escapade with an opportunist swap, the haircut be all the more brutal for those investors who are still present.
But the most surprising part is France, which, at +11%, shows a record hike in deposits/GDP. This certainly takes into account the transfer of life assurance to the above-mentioned liquidity deposits, but it is still an impressive performance.
I will dig more into this topic once I receive some feedback from the ECB about the Other Assets item.
Perhaps this phenomenon explains the very positive performances of French sovereign paper on the short end of the curve, with 1-month T-bills back in negative territory (-0.05%) and 2-year notes between 0.50% and 0.60%, i.e. their lowest ever!
From January 2010 as % of GDP