Economics – Italy in the trenches

taly money supply plunge flashes red warning signals
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

The illuminated euro sign at the European Central Bank’s (ECB)
headquarter is photographed on a long time exposure in Frankfurt
Real M1 deposits in Italy have fallen faster over the last six months
than in the build up to the recession of 2008.

By Ambrose Evans-Pritchard

6:15AM BST 14 Jul 2011

“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

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

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.”