Thursday, May 27, 2010

The Snake Swallows Itself: Odd Italian M3 Activity

First, it needs to be kept in mind that Italy uses the euro as its currency, so I am very reluctant to call Italian M3 data as "money supply" data. It is not. The euro, at this point, will determine price inflation activity in Italy. That said, the M3 data should not be ignored, not because it is important as money supply data, but because it tells us other things about the Italian economy.

Here's FT Alphaville on the data (although in my view they refer to it incorrectly as "money supply" data:
Eurozone money supply is contracting all over at the moment — except in Italy.

Which is curious. And possibly sovereign debt-related.

According to Jamie Dannhauser of Lombard Street Research, year-on-year M3 contractions of 2 per cent and 3.4 per cent have respectively hit Germany and Spain recently, but . . .

. . . in Italy, the monetary picture is completely different: year-on-year M3 growth remains robust at 6.5%...

Which, Dannhauser argues, may be due to some frisky buying of Italian government bonds:

Unlike banks across mainland Europe, Italian banks are continuing to expand their private sector loan books; but this is not the main reason for the relatively rapid increase in the money supply. Instead, the major stimulus to monetary growth has been a huge increase in net lending to the Italian government, as banks have gone on a shopping spree for public sector debt. Covertly, the local banking system has bought the majority of securities issued by the Italian government to finance its budget deficit over the last year... this has left Italian banks heavily exposed to a deterioration in sentiment towards Italian government debt....Although the public sector deficit is relatively low in an EA context at around 5% of GDP, gross debt issuance remains substantial. While immediate fears that the Italian government will not be able to pay its bills are not the problem, we are concerned about potential illiquidity problems (i.e. underbidding) for Italian government debt if banks look to reduce their exposure.
Other's can say what they want, but this aggressive buying by Italian banks of government is crowding out private sector funding. In other words, it is cutting off funds to the income producing sector of the Italian economy and pushing it into bureaucratic consumption. This may take awhile, but it is a snake swallowing itself. This is not going to end pretty. What happens when Italian banks are so stuffed with Italian government debt that they can't buy anymore? Who is going to buy any additional Italian debt then?

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