There is a reason why in Europe, no matter how much some want to deny it, the Cyprus deposit confiscation "resolution" has become the norm. Quite simply, as BofA summarizes, "Europe's economy struggles with too many banks, too much debt and too little growth. A long history of empire, trade, war and commerce means a long history of banking. The world’s first state-guaranteed bank was the Bank of Venice, founded in 1157, and the world’s oldest bank today is also Italian, Monte Paschi di Siena (founded 1472). In many European countries, bank assets dwarf the size of the local economy and are far in excess of other regions in the world. This is similarly reflected in the local stock exchanges: even now financials account for 42% of the Spanish stock market and 31% of the Italian stock market versus ust 16% in the US."
Visually, this translates as the following dramatic chart, which shows why Europe no longer has a choice in kicking the can, and what we have said from the very beginning, a Mellonesque asset liquidation of bad "assets" is the only option:
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It is in Europe that the biggest debt burden lies, and it is Europe that is desperate for the biggest inflation impulse to purge away the debt in the absence of liquidation, or a spike in asset quality. However, as we showed yesterday with Europe's €500 billion NPL timebomb, the asset quality of Europe's banking sector is imploding at an unprecedented pace, and is correlated most tightly to the surging unemployment in the periphery, which intuitively makes much sense: without jobs, consumers can't pay off their debt.
NPLs:
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... compared to unemployment:
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This means that the only resolution to a massively overlevered banking sector, where inflation just refuses to arrive and assist in the bad-asset "cleansing", is the start of liability impairment, which will allow the long overdue process of balance sheet restructuring, instead of merely can kicking, to commence. Whether this implies deposit confiscation, well that matters in which country one is, and how many NPLs have been accumulated [17].
And another problem: the reason why core inflation is gone from Europe is that not only is the hot central bank money not targeting European assets (except for new Japanese Yen chasing after peripheral bonds for as long as there is a carry trade arb, which at this rate won't last long), but because credit creation in the private sector is dead: as the chart below shows, even credit growth in Germany is now negative:
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So what is the only option for a continent in which there are simply too many encumbered assets (recall that unlike the US the bulk of credit in Europe is secured [19]- perhaps the starkest difference between the two credit systems) and in which the private sector credit creation pipeline is clogged: simple - the ECB has to join the Fed and the BOJ in monetizing assets, and creating "credit growth" de novo. Alas, as the past three years have shown, when it comes to outright monetization in Europe, not only does it have to be sterilized to appease the (correctly) inflation-weary Germans (i.e., the SMP; the terms of its replacement, the OMT, still technically don't exist), but most likely has to come in the form of a structured debt vehicle or an extended loan, like the ESM or the LTRO.
In fact, none other than former ECB member Lorenzo Bini Smaghi told Goldman's Allison Nathan in a recent interview that QE by the ECB - an outcome most expect once the impact of BOJ QE fizzles - is unlikely. The reason why:
Lorenzo Bini Smaghi: QE in Europe would likely entail the ECB purchasing a representative basket of Euro area government bonds. And so they would probably have to buy large quantities of German and French bonds, rather than the bonds of countries that could use more support; the impact on spreads would not necessarily be in the right direction. So from a technical point of view, the case for QE in Europe is less clear cut.
Needless to say, his outlook on Europe is less than optimistic:
Lorenzo Bini Smaghi: In 15 years I'm a bit more confident because I think the adjustments will have been made. Europe will become more competitive and stronger. So I am a long-term optimist. But I am also a short-term pessimist; the near-term adjustment is maybe a bit too tough and too front-loaded so the next five years are going to be very difficult.
And to think all of this could have been avoided if the Mellon advice of liquidating bad assets, which have accumulated in massive proportions in Europe (and in the shadow banking system in the US, but that is the topic of a different post), had been heeded, as we suggested, from the very beginning. To quote Andrew Mellon:
The government must keep its hands off and let the slump liquidate itself. Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. When the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. A panic is not altogether a bad thing. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.
Of course, the time for liquidation will come sooner or later, only this time the pain and suffering that will accompany it will be order of magnitude greater than had the system been purged in the dark days following the Lehman collapse.