Reprinted with permission from EconomicPolicyJournal.com
Yesterday, Robert Wenzel at EPJ warned that the Eurozone economy is on the edge of a major downturn (emphasis ours):
A tight money policy by the European Central Bank is causing the eurozone to go into an "unexpected" recession.
In Germany, the second-quarter gross domestic product growth number of a mere 0.1%, was significantly lower than the 0.5% Keynesian economists had been predicting. German GDP expanded 1.3% in the first quarter.
And the Markit/BME purchasing managers’ index for the German manufacturing sector fell 2.6 points in July to 52 points, its lowest level since October 2009.
There was zero growth registered by France in the second quarter and the euro area’s overall GDP rose only 0.2% in the second quarter from the preceding three months, after growing 0.8% in the first quarter, Eurostat said Tuesday. Growth in Spain and Italy was 0.2% and 0.3%, respectively.
A non-money growth policy is the best policy, however, this policy, following a period of money printing results in the downturn of the boom-bust cycle as the economy adjusts to a non-money manipulated economy. Central banks rarely allow this correction to play out and return to money printing. Keep an eye on the ECB if it returns to money printing, we may very well be near the first near-global price inflation, as the U.S. money supply is already in near super-growth mode.
That last paragraph is indeed interesting, as only yesterday, the ECB published its consolidated financial statement of the Eurosystem for the week ending August 12, 2011. The statement reflects the first round of new bond purchases (€22.0 billion) since early January, 2011 via the ECB's Securities Market Programme (SMP). But it also shows that, contrary to the previous bond purchases, which were sterilized with concurrent liquidity withdrawals, last week there was a massive ramp in liquidity providing activities. Here's the asset side of the balance sheet:
We can see the €22.0 billion in bonds under line 7.1, "Securities held for monetary policy purposes", which is where the 2010 bond purchases were reflected week by week.
Here is the liabilities side:
In the previous bond purchasing period, there would be a concurrent increase in line 2.3, "Fixed-term deposits", which are akin to short term non-negotiable bills the ECB would issue to banks to soak up liquidity [reductions in refinancing operations would account for the balance of sterilization]. Last week's increase in fixed-term deposits? Zero. Instead, there was a €54.6 billion reduction in the regular deposit facility at line 2.2.
Going back to the asset side for a minute, we also see there was a €57.8 billion increase in line 5.2 "Longer-term refinancing operations" (LTROs), which is also liquidity providing. This combined €112.4 billion went into line 2.1 on the liabilities side, "Current accounts (covering the minimum reserve system", which increased €127.0 billion over the week. To be fair, there was a large drop in the prior week in this line of $48.5 billion, and it is historically subject to large fluctuations from time to time. However, Current accounts is now at one of highest amounts on record, as is the weekly change.
One final table, which lists the ECB's open market operations and demonstrates where most of the increase in Item 5.2 LTROs on the asset side of the balance sheet came from:
The highlighted LTRO liquidity providing operation is the fourth longest maturity on record at 203 days, the longest since December, 2009. Apparently, the ECB was spooked enough when it announced the operation on August 4, 2011, that it knew it would need to provide a cool €50 billion to banks for a guaranteed six months.
Going back to the balance sheet, what's interesting about the Current accounts line is it apparently contains both required reserves and any excess reserves. Contrary to the US Federal Reserve, the ECB does not pay interest on excess reserves (it does pay interest on required reserves), so banks typically keep excess reserves very low and put any excess money in the deposit facilities to earn interest.
One possible conclusion is that we are seeing very short term time preference by the Euro banks, where they are voluntarily foregoing all interest on excess reserves in return for immediate access to the zero maturity funds, if need be. It is also remotely possible that these are in fact required reserves, which have been increased due to regulatory change.
One week does not make a trend, but it is undeniable thatthere are some very large chairs being rearranged on the Eurosystem's deck, and the ad hoc day-to-day changes in monetary policy are setting the stage for a potential meltdown either from the previous epoch of liquidity contraction, or a new epoch of monetary inflation.