Sunday, April 29, 2012
Europe faces Japan syndrome as credit demand implodes
The long-feared credit crunch has mutated instead into a collapse in DEMAND for loans. Households and firms are comatose, or scared stiff, in a string of countries.
Demand for housing loans fell 70pc in Portugal, 44pc in Italy, and 42pc in the Netherlands in the first quarter of 2012. Enterprise loans fell 38pc in Italy. The survey took place in late March and early April, and therefore includes the second of Mario Draghi’s €1 trillion liquidity infusion (LTRO).
The ECB said net demand for loans had fallen "to a significantly lower level than had been expected in the fourth quarter of 2011, with the decline driven in particular by a further sharp drop in financing needs for fixed investment." Demand fell 43pc for household loans, and 30pc for non-bank firms.
Mr Draghi told MEPs today that his three-year loans had at least averted a horrendous crunch. "Our LTROs have been quite timely and successful. I think buying time is not a minor achievement." He is certainly right about that. The mess he inherited from the Merkel/Sarkozy expropriations of bondholders in Greece, and the Trichet/Stark tightening of monetary policy was calamitous.
This slump in loan demand is more or less what happened during Japan’s Lost Decade as Mr and Mrs Watanabe shunned debt. Zero interest rates did nothing. The Bank of Japan was "pushing on a string" (though it never really launched bond purchases with any serious determination).
It is true that banks have slowed the pace of credit tightening, but they are nevertheless still tightening. "A banking crisis remains very much in play for much of the region," said David Owen from Jefferies Fixed Income.
The credit squeeze is entirely predictable – and was widely predicted – given that banks must raise their core Tier 1 capital ratios to 9pc by July to meet EU rules, or face nationalisation. (The pro-cyclical folly of this beggars belief: by all means impose higher buffers, but not during a recession, and not by letting banks slash their balance sheets. The US at least forced its banks to raise capital, an entirely different policy since it does not lead to a lending crunch.)
The IMF said last week that Europe’s banks would slash their balance sheets by €2 trillion – or 7pc – by next year. This amounts to an economic shock. The Fund said deleveraging on this scale at a time of sharp fiscal tightening risks a "bad equilibrium".
Indeed it does. It ensures hell for countries containing 200m people, or more. Judging by the rise of Sinn Fein, the Dutch Freedom Party, the Dutch Socialist Party (hard-Left), France’s Front National, and some true fire-breathers in Greece, they victims will not readily put up with this.
Julian Callow from Barclays Capital said there is no almost no historical precedent for the sort of deleveraging under way in the EMU periphery. Credit rose from 100pc of GDP to over 200pc in Ireland, Greece, Portugal, and Spain in the EMU boom. "This is far higher than in Japan during the 1980s. It is hard to find an historical parallel or any insight from economic theory for where we are going," he said.
Mr Callow said Spanish houses are only halfway through their correction and are likely to fall another 20pc before clearing the overhang of stock. The shock for banks will be ugly. The Bank of Spain said yesterday that mortgages fell 49.6pc in February from a year ago.
Mr Draghi called for a "Growth compact" today – but so did Chancellor Merkel, illustrating how meaningless such rhetoric can be. Mr Draghi’s plea is a cop out. The proper policy mix for Euroland – in as much as it is possible to devise policy for such a menagerie – is a moderate pace of fiscal tightening (much slower than now), offset by monetary stimulus a l’outrance. That means cutting rates to the zero-bound (0.5pc) and launching fully fledged QE until the M3 money collapse in Club Med is halted, and M3 for the whole eurozone is growing at 5pc.
And no, the LTRO is not QE. It does not shift the risk onto the balance sheet of the central bank. It does not work through the quantity money mechanism (or at least, not efficiently). It concentrates the risk on the books of private banks, many of them engaged in a Hail Mary gamble on redemption by buying Spanish and Italian bonds with ECB money.
Or one analyst said, the LTRO lets northern banks dump their bond holdings onto Club Med banks. The renationalisation of the eurozone financial system goes a step further.
The LTRO "carry trade" is already revealing the sting in its tail in any case since the banks are by now underwater on a lot of bonds. What happens if and when they need to sell those bonds to cover debts falling due over the next year?
Until the ECB conducts monetary policy with proper energy, calls for "Growth Compacts" from governments amount to humbug. The ECB needs to do its own work.
We all know why it will not do so: because Hayekian romantics at the Bundesbank hold sway, and none of the other governors dare say boo. Live with the consequences.