Europe borrows from Peter to lend to Peter
Europe’s experiment in borrowing from Peter to pay Peter argues for a slow economic recovery with a low ceiling.
Data released by the European Central Bank on Monday showed that the supply in money is growing at best haltingly and that loan growth to euro zone households and businesses is at its lowest since records began.
Annual loan growth to the private sector slowed to 1.5 percent in June from 1.8 percent in May while the broader measure of money supply growth hit 3.5 percent.
Loans to non-financial corporations grew at a 2.8 percent annual rate, and actually fell from May. Household lending wasn’t that peppy either, with the growth rate falling to a paltry 0.7 percent annual rate.
Banks in Europe aren’t lending to consumers and businesses for a really sound set of fundamental reasons — borrowers know they ought not to be borrowing and the banks know that, of those who are asking for money, a disturbing minority can’t be trusted.
Demand is poor in other words and what demand their is has been skewed to the feckless end of the spectrum.
But there is one area of the market where both supply and demand seem to be growing healthily, or if you prefer, strongly: loans to governments.
There was an absolute surge in banks assets in June, with government bond purchases by banks up 53 billion euros, a 16 percent annual growth rate, and outright loans to governments up 19 billion euros, up 2.5 percent year on year. Financial institution holdings of government debt has risen by 271 billion euros in the year to June.
“This increase represents 3.0 percent of GDP and is thereby financing roughly half of the net general government borrowing requirement,” according to Julian Callow at Barclays Capital in London.
And this credit is from the same banks which borrowed 442 billion euros last month for a whole year at a fixed interest rate of 1.0 percent. At the same time overnight deposits at the European Central Bank rose yet again to 195 billion euros, further indicating that funds are not making it into the private economy.
Europe’s banks are borrowing from Peter to lend to Peter.
The circularity of it all is admirable. Banks in Europe borrow at very low rates from the European Central Bank. At least to judge by the data, much of the money is ending up in government bonds. This government debt is being issued, at least in part, to fund banking bailouts. Everybody is happy right?
Of course there are some substantial ancillary benefits: banks themselves will make handsome, low risk money by collecting the difference between the cheap financing they get from one arm of government and the slightly more expensive rate they collect from Europe’s governments for holding their bonds.
This rebuilds a capital base that has been sorely eroded by higher risk lending, but it is a slow process. It also does very little to encourage better banking practices for the next cycle. It does not take a genius to borrow from one arm of government and make a float lending to another, and as such we can’t really say that Europe’s banks are going to have their weakest members thinned out.
What it does do is make government borrowing cheaper than it would otherwise be, which on balance is no bad thing. Given the difficulties some of the weaker euro zone governments were facing earlier in the year, a captive, or at least pliant, class of government bond buyers is a useful counterbalance to the more flighty behavior of people who can’t borrow money directly from the ECB.
A lot of lending to banks, and lending and spending by governments can help ease a recession but its unclear if it can be the basis of a strong recovery.
Politicians, inside and outside of the euro zone, are fond of leaning on banks to lend to the real economy in greater amounts at easier rates.
British Treasury Minister Alistair Darling met with bank chiefs on Monday to urge them to lend more to small businesses, a type of photo opportunity we may be seeing more of as the recovery drags on and growth fails to ignite.
It is good theater but it does little to address the underlying issues of poor prospects for corporate investment and the economy-wide need to retire or destroy debt.
If things work out well it is just possible that in a year or so good business with good prospects will have real complaints about not being able to get adequate funding.
At that point we will see if the borrowing from Peter to lend to Peter arrangement has worked or if it will prove to be a too slow and too indiscriminate way of healing the banking system.
( At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)