26 August 2012

“Kick the Can” Policy Has Run Its Course

Last week I estimated the total debt hole of the eurozone and found it to be at least EUR 5.16 trillion (as of 20 August 2012). This number was calculated based on the comparison of the current debts and sustainable levels of debt for non-financial sector in advanced economies. The basic finding is that European “kick the can” policy has run its course and Germany has not enough money to bail everyone out. Today I’ll add a few graphs and comments to further illustrate this.

The first figure below shows finances of the Eurosystem (the ECB plus the national central banks of the 17 eurozone member states) over the period of January 2002 till August 2012.

Note the increase in leverage (total assets of the Eurosystem / capital and reserves):  
* From January 2002 to September 2008 it increased from 14.2 times to 20.0 times which means a decrease of the simple capital ratio from 7.0% to 5.0%.
* From September 2008 to June 2011 it increased (with ups and downs following the collapse of Lehman Brothers) from 20.0 times to 23.5 times, i.e. the capital share as a percentage of the total assets decreased from 5.0% to 4.2%.
* By August 2012 Eurosystem’s leverage ratio has increased to 36.0 times which means that the share of capital is only 2.8%.

36.0 times leverage is a big number, but that is not only. As you can see, the recent rapid growth of the Eurosystem’s consolidated balance sheet has mainly come from assets related to monetary policy. This includes EUR 281.2 billion in securities held for monetary policy purposes and more than one trillion euros of exposure resulting from the ECB’s Long Term Refinancing Operations (LTRO). Mostly such “assets” reside in the so-called PIIGS countries and the ECB has so far (as of 26 August 2012) even not participated in the “voluntary” write-off of the Greece’s debt.

The second graph presents the monetary statistics of the eurozone: change of the Eurosystem’s consolidated balance sheet since January 2002 vs. changes in the different monetary aggregates:
* M1 which is a “narrow” monetary aggregate that comprises currency in circulation and overnight deposits;
* M2 which is an "intermediate" monetary aggregate that comprises M1 plus deposits with an agreed maturity of up to two years and deposits redeemable at notice of up to three months;
* M3 which is a “broad” monetary aggregate that comprises M2 plus repurchase agreements, money market fund shares and units as well as debt securities with a maturity of up to two years.

Most importantly, as you can see, the ample newly “printed” money during the last 12 months has not really reached the real economy. Instead, it is “sitting” in the balance sheets of the banks and central banks, and the broader money supply measures have increased very little. The reasons are multiple and much debated. Banks say that there is no more viable credit demand – and they are right as there is far too much excess debt already. In other words, all the attempts of the ECB have even not worked, and given over indebted public sector for the eurozone as a whole are unlikely to work without major write-offs. Such write-offs again are not feasible because of the high leverage of the Eurosystem and the fact that these very same indebted governments are guaranteeing the ESM and the other “kick the can” measures.

That “kick the can” policy has run its course does not necessarily mean break-up of the eurozone (which would happen if the policy makers fail in the following). It does mean an urgent need for a major restructuring, including resolution of the banking sector (as discussed earlier), and a fiscal and political union. It is unlikely that high inflation can be avoided once the money creation process starts all over again.  

Buying more time has no point unless we know for what we are paying (i.e. what is going to be made with the time bought) and do agree with it. Otherwise the time that we have should better be used for building a different kind of society... It looks like we have wasted far too much time and money already. The current financial, economic and political systems appear just so unsustainable, increasingly complex and difficult to understand for normal people (a development exactly in wrong direction). Perhaps it’s time to actually start considering and support building alternatives also for people currently in power.


  1. 1. Is there an actual ceiling? To what numbers? Or does it just get increasingly leveraged?
    2.The risk of leverage is default on bank debts which can bring the banks into default. Right?

    1. 1. No ceiling as far as I know.
      2. There is clearly a limit to what central banks can do, and we may be very close to this limit. An interesting study has been published on Dallas Fed website: http://dallasfed.org/assets/documents/institute/wpapers/2012/0126.pdf