The Italian Job: An 'Explosion in Slow Motion'

While much of the damage control attention in the rapidly escalating Italian crisis has fallen on the ECB's purchases of Italian debt, German Profressor Hans-Werner Sinn points out how the Bundesbank (and other European central banks) have been conscripted into lending a neighborly hand:

The ECB directed the central banks of all Eurozone members to buy huge quantities of Italian government bonds during the crisis. While the national central banks have not revealed how much they bought, the aggregate stock of all government bonds purchased rose from €74 billion ($102 billion) on August 4, to €165 billion this month. Most of this increase was probably used to purchase Italian government bonds. 

The German Bundesbank, which was forced to buy most of the bonds, strongly opposed the program, but was unable to stop it. In response, ECB Chief Economist Jürgen Stark resigned. He followed Bundesbank President Axel Weber, who had resigned in February because of the earlier bond repurchases. Meanwhile, the new Bundesbank president, Jens Weidmann, openly objects to the program, while German President Christian Wulff has publicly accused the ECB of circumventing the Maastricht Treaty.

Not to be outdone the Banca d’Italia has started printing money:

But the bond purchases are just the tip of the iceberg. Equally important, but largely unknown, is the fact that the Banca d’Italia has resorted to the printing press to cover Italy’s gigantic balance of payments deficit. The extra money printing and lending, as measured by the so-called Target deficit, effectively means drawing a credit from the ECB. 

This credit replaces the private capital imports that had hitherto financed the country’s net purchases of foreign goods, but which dried up because of the crisis, and it finances a capital flight, i.e. the purchase of foreign assets. The ECB in turn draws the Target credit from the respective national central bank to which the money is flowing and which therefore has to accept a reduction in its scope for issuing refinancing credit. 

Until July, only Greece, Ireland, Portugal, and Spain had drawn Target credit, for a combined total of €330 billion. Italy was stable and did not seem to need the printing press to solve its financial problems. No longer. 

In August alone, Italy’s central bank drew €40 billion in Target credit, and it probably drew roughly another €50 billion in September, when the Bundesbank’s Target loans to the ECB system increased by €59 billion (after a €47-billion hike in August). This is the highest Target loan ever drawn from the Bundesbank in a single month, and in all likelihood it went primarily to Italy.

Full commentary here. 

What's the Difference Between 'Financial Repression' and 'Macroprudential Regulation'?

Axel Weber and German Chancellor Angela Merkel

The most striking remarks made by former Bundesbank Chief and ECB frontrunner Axel Weber in a recent WSJ interview were his comments on the possibility of using financial repression to solve the Greek and wider European debt crisis:

“Ultimately, there will be a debate about financial repression. Take what we had in Germany — the Zwangsanleihe [compulsory loans introduced after World War I to help make reparation payments]. If voluntary contributions don’t add up, then the one tool that is still on the shelf is financial repression.”

To my knowledge, this is the first time a major senior policymaker (albeit one who recently stepped down) has publicly used the term 'financial repression'. As economist Carmen Reinhart and others have noted, the policies associated with financial repression are typically couched under the more benign, positive sounding 'macroprudential regulation'.

Update: News today emerged that Weber will become Chairman of Swiss megabank UBS, which perhaps explains the reasoning behind his choice of words.

Economic Newspeak

The term 'financial repression' was first coined in 1973 by two Stanford economists, and the word choice was intended to disparage developing economies which enacted what were deemed to be anti-competitive (and hence anti-growth) policies. In other words, the term 'financial repression' was invented with negative connotations in mind.

Can the contrast between 'financial repression' and 'macroprudential regulation' be viewed along the same lines as the difference between 'quantitative easing' and 'printing money'? The two monetary terms can mean approximately the same thing, although those who oppose Fed policies, like QE2, tend to embrace the use of the latter, which is arguably both more provocative and transparent to a broader audience.

This blog has in the past been highly critical of other examples of opaque, economic 'newspeak', such as Yale Professor Robert Shiller's argument that terms like 'bailout' should be replaced with ‘orderly resolution’ so that the voting public 'gets it'.

Does the Euro's bounce signal all is well?

The Euro, after failing to crash through the $1.18 level, has bounced up over $1.23. Pinched short sellers and the financial press are openly wondering whether this signals that all in Euroland is well.

It appears that Europe's "shock and awe" $1 trillion rescue package has bought a respite from the "wolf pack". In particular, the ECB's unlimited, cheap three-month loans to banks through the end of summer should keep the financial system lubricated.

How long will this work?