Saturday, October 02, 2010

All For One And One For All - "We AreThe Eurozone"

One of the worrying things about the handling of the current European crisis is how many of those responsible for taking the decisions seem to view the Eurozone in a way which is every bit as rigid, timeless and dogmatic as the thinking of those old school scholastics whom Galileo, in his time, found himself battling against. Rather than facilitating a dialogue, and a free and open discussion, the guardians of fortress euro seem to want to keep the doors slammed tight shut, just in case any strange and unwanted ideas should inadvertantly slip in without them noticing.

Take the issue of Eurozone aggregate data. Treating the countries that constitute the bloc as one homogenous entity seems to have become a sort of shibboleth which it is impossible to question, even though it is patently evident to all concerned that there are often enormous differences between the economy of one member country and another. Inflation is the prime example. What seems to interest members of the ECB Governing Council when they have their monthly meeting is that somewhat abstract entity, the average EU16 inflation rate, while what is obviously interesting to follow from a policy point of view (just look what happened to Ireland, Spain and Greece in the years before the crisis - see Spain chart below), is the degree to which inflation rates in individual countries diverge from the mean.

Another example would be current account balances (see chart below). Eurostat publishes data for the EuroArea 16 on a monthly basis, but I think I am right in saying they never publish the national-level breakdown (certainly I have never seen it, and that hasn't been for want of trying). But, of course, now we find ourselves with a whopping set of internal imbalances between those countries running large surpluses and those with large deficits - which the financial markets are becoming less and less willing to fund - and no one seems any too clear about what to do to restore the balance. But how were the imbalances allowed to build up in the first place? Did they creep up on us by stealth, or was no one really looking?

Exactly the same issue arises with the national breakdown of bank borrowing from the ECB. As if living in a theoretical cocoon, decision makers at the ECB move forward in way which makes them seem completely impervious to the problems posed by the way banks in one country are more dependent on funding than are those in others (M Trichet repeatedly refuses to answer questions on this kind of issue at the monthly press conference) and hence remain walled-in from the issues which actually exist in the real world which surrounds them. When pressed they simply state that there is no problem since an EU country is in principle just like a US state - try telling that to Ireland or Greece. Or try telling it to German voters when they are asked to contribute to bailouts.

The issue is of course a very telling one, since basically the whole present Eurozone debt crisis has the inter-country imbalances as its backdrop, hard as the members of the ECB Governing Council may try to avoid admitting it, prefering instead to focus attention on the fiscal profligacy (of which, naturally, there has been a good deal) of the national members state governments. In other words, the problem is not of their making, oh deary me no!

Rivers Of Liquidity Here, Credit Drought There

National divergences in bank lending constitute another very good case in point. Despite the fact that the current crisis has become known as a Sovereign Debt One, it isn't always fiscal spending and public sector debt which lies at the heart of the problem. In fact, private sector debt is often as much of an issue, and the private sector in some EuroArea countries is heavily indebted, while that in others is not. It is important to discover who is who here, and to distinguish between them, since if you don't it will be impossible to decide prescisely which kind of policy mix is appropriate in each and every case (but, of course, our modern scholastic dogmatists will tell us there are no such things as "cases" here, and continue to insist there should be no distinction between countries at the level of policy). Yet just when you need the fine grained detail, what you get are more aggregate numbers and a bunch of platitudes which really tell you very little.

Thus, in the August edition of their publication "Monetary Developments In The Euro Area" we learn from the ECB that bank lending to euro-zone businesses increased in August by €17 billion as compared with July, a rise which more than reversed the €11 billion decline in July over June. What this increase meant was that the annual rate of decline in corporate borrowing was only 1.1% in August versus a 1.4% annual drop in July. That lending to corporates is falling less rapidly is good news, but it is still falling on an annual basis.

Aggregate lending to households also picked up, rising €14 billion during August compared with a €5 billion monthly increase in July. This lead the annual rate of growth to rise to 2.9% from 2.7% in the previous month, which produced a lot of "at last" type comments in the press. And putting the two numbers together, we find the annual rate of growth in loans to the entire private sector was up at 1.2% in August from 0.8% in July. Relief all round, surely, since we are going the right way.

Unfortunately nothing is ever so simple, and once we start to dig down we find large and significant disparities - disparities which may well produce monetary policy decision conflicts for the ECB in the months to come - hidden away in the aggregates. In France, for example, lending for house purchases was up an annual 6.5% in August, and indeed over the last three months such lending rose at a 7.9% annualised rate (ie lending growth for housing is accelerating), while in Spain total house lending was only up 0.6% on the year (in July, we don't have the August data from the bank of Spain yet, but it won't be very different).

When we come to total lending to households we find the pattern repeated, since this was up 5.4% in France in August, and only 0.5% (in July) in Spain.

And when we come to corporate borrowing, this was up an annual 0.4% in France in August, while it was down 1.9% in Spain (in July).

But then, you may want to ask, at the end of the day just why would anyone in Spain want to take on more debt? Since the Spanish stock of corporate debt is around 1,300 billion euros, while the French equivalent is only 771 billion euros (and the country is about half as big again as Spain), French corporates could certainly take on some more debt (if circumstances like market and investment needs warranted) but Spain's heavily over-indebted corporates simply need to pay their debt down. In the context of Spain's shrinking economy, more credit for Spanish corporates simply means more indebtedness and more interest-roll-up loans of the kind that "gather no loss" (at least at the balance sheet level), hardly a desireable development at this point.

Evidently I have taken the two polar cases here, borrowing in Italy and Germany is much weaker than in France, while the situation in Ireland, Greece and Portugal will look more like Spain. But this is part of the point, France is the one large EuroArea country where domestic demand still has real life to it (for a variety of reasons it wasn't blown out by a bubble during the last round) but for just that very reason it would be absolute madness to turn the goose that can still lay golden eggs into some kind of "foie gras" by feeding it up with massive doses of liquidity it evidently doesn't need.

Looking at the inflation differential between France and the Eurozone average matters aren't getting out of hand yet, although French inflation is above the average in a way in which it has not been before, and the situation now requires careful monitoring.

Forward looking inflation expectations have risen in France in recent months, but they seem to a stagnated of late, so again, at this point there is no need to panic.

But the situation is one where - now what is the expression - "extreme vigilance" needs to be exercised, since naturally there is no reason why a country that didn't have a bubble last time round won't develop one next time. So perhaps one of you journalists who attend the post-meeting press conference might like to ask M Trichet whether this is the kind of approach he has in mind, and what policy options are open to him should the worst case scenario (on the upside) really start to materialise. In the meantime, all I can do is shrug my shoulders and mutter under my breath "ma eppur si muove".

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