Back in 2011, FT Alphaville made a big point of highlighting that tight bank funding conditions in the eurozone were largely driven by a “crunch” in the supply of quality collateral.
While such things as repo rates, central bank actions and Bund yields certainly supported the thesis, one very important dataset — the M3 monetary aggregate — failed to reflect the condition.
We rationalised that it might be because the data had yet to reflect the change in the market, and that actually, M3-minus-M2 (or versus the monetary base) might be a better measure anyway.
But with the latest November data having come out over the Christmas period, it seems things have certainly started to change.
First here’s the standard aggregate measure for the overall trend (charts courtesy of Thomson Reuters Datastream):
And here is our favourite measure of collateral crunchiness — M3-minus-M2:
It turns out we’re not the only ones who think this is a big deal.
Societe Generale’s rates strategy team, for example, observed this week that the M3 measure will be extremely important in determining how successful the ECB’s recent non-standard operations turn out to be.
In this respect, it’s also worth keeping the Target2 debate in mind (i.e. how giving out liquidity against rubbish collateral to one set of eurozone members simply pushes more liquidity into the deposit facilities of stronger members, who have no choice but to invest it in quality collateral — causing a quality collateral crunch — and or lacking that option straight into ECB deposit facilities).
For example, as SocGen explain (our emphasis):
In its simplified version, the Eurosystem’s liabilities are made up of the current accounts (required reserves), the autonomous factors and the deposit facility; the Eurosystem’s assets contain the OMOs (Open Market Operations) and the marginal lending facility. In other words, if the ECB allocates more liquidity (OMOs + marginal lending) than is required by the system (autonomous factors + required reserves) then the deposit facility automatically surges.
This links into M3 like this (our emphasis):
The fact that banks are borrowing so much money from the ECB – much more than is required overall in the system – suffices to show the market dislocation. Cash-rich banks prefer to deposit at the ECB (only at 0.25%) than lending in the market; hence cash-poor banks cannot get funding in the market and tap the ECB heavily.
Instead the success (for now, failure) of the ECB-style QE ought to be judged through the money multiplier. The latter measures the ‘commercial bank money’/’central bank money’ ratio; e.g. M3 money supply divided by base money (currency in circulation + reserves held by counterparties in the Eurosystem + deposit facility).
And the M3 chart versus the monetary base (i.e. how much base money is out there versus all the possible money-multiplying investment possibilities) is perhaps the most striking of them all:
¡Ay, caramba!, you might say.
As SocGen note:
Graph 2 shows that the money multiplier has collapsed. Indeed, using the weekly ECB data from 23 December, base money has increased by 46% over the past year, when broad money supply has grown by just 2% (with the counterparts of M3, loans to the private sector were up by just 1.7% yoy in November and still slowing). In other words the ECB is printing money but the transmission to the real economy is extremely weak. We have been and remain sceptical that such a passive form of QE would reverse economic fortunes. The money multiplier, now at a historical low in the eurozone, has more than halved from the peak of 2002. The pressure on banks to deleverage and the lack of appetite for non-financial private sector borrowing are such that the ECB ought to think about other plans.
In simple terms that means the money multiplier is dead.
Put another way, there are not enough creditworthy counterparties in the system to encourage any sort of money multiplication effect at all. Banks and investors just want to get their principal back and are even prepared in some cases to pay out a negative interest rate to ensure that as much of their principal as possible is returned at some date.
Put another way still, the central bank transmission mechanism has been compromised because expansion or contraction of high-powered money makes no difference to the overall amount of money which is multiplied into the system.
And as we’ve noted before, that is exactly what happened during the Great Depression.
Reason to worry? We would say so.
Are western central banks having an existential crisis? – FT Alphaville
The ugly side of ultra-cheap money – Bill Gross in the FT
When a government bond becomes a Giffen good – FT Alphaville
Introducing the 2011 deposit crisis – FT Alphaville