The Strategist

How Italy became completely dependent on the ECB

05/09/2017 - 06:13

Italy is relying on the ECB in terms of reducing bond yields, given that foreign investors are hastily getting rid of Italian bonds, thus boosting their profitability.

Guy Sie via flickr
Guy Sie via flickr
Analytical agency Eurointelligence notes that a sharp increase in the yield of Italian sovereign bonds is another evidence of the outflow of capital from Italy.

Bank for International Settlements says that international banks axed their operations in Italy by fifteen %, or by more than $ 100 billion, in 2016. Half of them fell on the last three months of 2016.

An analogue of this reduction is growth of the negative balance of Target2 in Italy. The ECB has already attributed it to investments of foreign investors in its asset purchase initiatives and reinvestment of income outside of Italy. Eventually, Italy's financial stability has become increasingly dependent on the ECB.

Obviously, there is some kind of plot, yet distrust in the Eurozone’s third economy is widespread as well, especially from the German banking system. Its exposition in the country at the end of last year hardly reached a little more than a fourth of what was provided by French banks. Now, it is 30% lower than what Germans had in Italy in 1999. No other large banking system retreated to such an extent, as though the integration of a single currency never began.

The deprivation of $ 100 billion will result in a blow for large foreign bank investors, not in purchase of Italian ECB bonds. Basically, the issue of transfrontier banks is connected with intervention of the ECB, because it has a chance to sell a significant part of its bonds of Italian government. It's no accident that the national debt spent abroad has decreased by 42 billion euros only for the first 9 months of 2016. Therefore, the ECB's invasion and withdrawal of foreign banks are closely linked. Thus, financial stability of Italy is increasingly dependent on support of the international institution that will almost certainly cease next year.

Results of March showed that about 793 billion euros were withdrawn from the banking systems of Italy and Spain through the TARGET2 system. At the same time, Germany faced a capital inflow of 830 billion euros. A similar situation was observed on the eve of the EU debt crisis in 2011.

TARGET2 data, as a rule, reflects demand for liquidity. There is a deficit in countries where additional funding is required, and in the event that liquidity is excessive, a surplus is recorded.

Distressed Eurozone countries face an inflow of funds to the most stable economies, such as Germany. Thus, decrease in the surplus indicates an increase in liabilities of the region’s troubled countries in the framework of TARGET2. This situation indicates an improvement in the state of the euro-zone economy.

The TARGET2 system contributes to deepening the debt crisis in the euro area, as it allows free flow of funds from peripheral countries of the monetary union to "trailblazers", primarily to Germany. The situation continues to worsen, as the system has caused a serious trade imbalance between the countries. This became visible only after the crisis in 2008, which provoked the banking crisis and exposed bottlenecks in the Eurozone’s financial system.

Deficit of the payments’ balance between countries is financed by formation of credit obligations between the central banks of these countries. Moreover, this deficit is not limited by anything, there are no restrictions in lending in the TARGET2 system. The passive trade balance can be financed by creating an unlimited number of claims against the ECB.

As a result, Germany's strong export activity has caused a significant imbalance between Germany and the troubled euro-zone countries. Within this model, the Bundesbank actually receives credit obligations in exchange for exports. Ultimately, the aggregate debt of central banks of Greece, Spain, Italy and other Eurozone countries to the Bundesbank is constantly growing.

In view of the deteriorating situation in the monetary union and the growing risk of bank collapse in troubled countries, depositors have been actively withdrawing funds from their accounts and opening accounts with banks in Germany, which economy is perceived as a safe haven. This only exacerbated the situation, since it contributed to the growth of the debt of the aforementioned countries’ central banks to the Bundesbank.

However, given the fact that the Bundesbank is not an issuing center and cannot "print" money, it will be forced to keep lending to troubled countries at the expense of its funds, thereby contributing to an increase in the imbalance in the TARGET2 system. If one of the countries leaves the currency block or collapses, the German Central Bank will be find itself a deplorable state, and taxpayers will be forced to save the institution at their own expense.