Saturday, December 3, 2011

Italy's rapidly shrinking money supply is a sign of impending recession

The money supply statistics for Italy continues to be alarming. Ambrose Evans-Pritchard, who often writes on the issue for the Telegraph had been ringing the alarm bell about the declining money supply indicators.
The Telegraph: The broad M3 measure tracked closely by the European Central Bank as an early warning indicator shrank last month by €59bn to €9.78 trillion, a sign that Europe's long-feared credit squeeze is underway as banks retrench to meet tougher capital requirements.
Below is a chart form Banca D'Italia showing the three measures of money supply.

The rapid decline in the narrow measure M1 is particularly alarming because it includes bank deposits.  That decline can be caused by accelerating decline in liquidity for the corporate sector and individuals, but it can also be the result of new lack of trust in the Italian banking system.  There has been some anecdotal evidence of Italian citizens pulling their cash from local banks and moving deposits abroad.
Reuters: A Swiss tax adviser has also noticed a rise in the number of Italians ready to pack up their bags and move to Switzerland. "It's pensioners or businessmen who want to get Swiss residency and move their operations there. I have had more requests to this effect since the summer than over the past 10 years." In Lugano, a Swiss lakeside town close to the Italian border, bankers report a shortage of deposit boxes -- a favourite way for investors to hide their money from the taxman.
What is interesting about the current crisis, though, is that businesses and individuals are not simply trying to find ways to hide their money to avoid tax. "The transfers are being made in the light of day, either to ad-hoc trust companies or in any case by declaring them in the tax returns," said one Swiss banker.
The decline in M1 may in fact be an indication of a depositor shift away from Italian institutions. Whatever the reason for the decline, it is clearly a sign of a serious credit crisis in Italy,
The Telegraph: "This is the first sign of an emerging credit crunch," said James Nixon from Societe Generale. Banks cut their balance sheets by €79bn in October, while mortage lending saw the biggest drop since December 2008.
Italian banks are increasingly becoming reliant on the central bank to fund themselves. The table below from Banca D'Italia shows a significant increase in financial institutions' borrowings (over EUR 111 bn) from the central bank between October and September of this year.

Such declines in the money supply combined with increasingly high interest rates would typically be met by an easing of the monetary policy.  However in the case of the euro-zone, the ECB drives the policy and gives significant weight to the overall money supply in order to make policy determinations.  Therefore the Italian central bank is at the mercy of the ECB to help ease such tight monetary conditions.  The ECB however, influenced by Germany who is paranoid about inflation, is not in a hurry to do so. 

If the confidence in the banking system continues to deteriorate, a full scale run on the banks may be possible.  Either way there is no question that these money supply conditions will lead to a severe economic contraction in Italy.

Banko Ditalia - Italy Central Bank Statistics
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