David Keohane over at FT Alphaville highlighted this little chart from JP Morgan’s F&L team on Monday:
So we’re seeing a reversal of previous trends, albeit a small one (and I’m not to say what the reasons are – possibilities include ECB actions, money market funds entering Europe, SNB,
economic growth, investment opportunities – who knows).
So why is this important? Because it is a very good window into intra-Eurozone capital flows. Forget for a moment the politics of it (including the transfer debate). The problem before and now is that the private capital flows from German banks were replaced by public lending via Target2/central banks. I thought Martin Wolf did a very good job summing it up a week ago:
First, Germany has accumulated net claims on the rest of the world – and on other members of the eurozone – not because of internal central bank accounting, but because it has large current account surpluses. Germans have been running two businesses: exporting goods, at which they are excellent, and importing financial claims, at which they are not. In brief, Germany’s surpluses have exposed Germans to financial risk. But balances inside the eurosystem are not a good indicator of that risk. They have exploded, argues the paper, because of speculative financial flows, not current account imbalances.
The problem isn’t that central banks can clear money transactions – that’s essential in a monetary union. The problem is that it allows money to flow very easily from accounts in the periphery to the core, pushing yields into negative in the core, creating a broken transmission mechanism for monetary policy, and leaving the periphery with a capital shortfall.
Normally in a monetary union, the central bank can set interest rates and that’s that. In the Eurozone, however, that’s not the case. Consider Germany: Banks are flush with capital, everyone wants Bunds, and banks are willing to lend at low rates. Now consider Spain: the banks are insolvent, nobody wants Spanish government paper, and businesses can’t get loans. Two very different situations with one monetary policy. Poor Draghi.
So when the ECB lowers the interest rate it doesn’t really matter because it isn’t transmitted through to the periphery. Add to that the fact that not that many use unsecured lending any more, which is what central banks have a monopoly on, and it gets interesting.
None of this is new, of course. FT Alphaville has written a lot about it (me too), but I thought it worthwhile to write a little. Target2 is an enabler of all this – not the problem. It does, however, provide a nice window into what is happening in Europe.
So is the reversal of capital flows a good thing? Yes. Let’s see how long it lasts…