Tito's Blog

Central Bank Of Italy Watch

As I previously pointed out, balance of payments issued by Central Bank of Italy (english) had massive amounts reported under “errors and omissions”. I could not find any mention of this topic on the internet or in the national press, please comment below if you find any relevant article.

I am closely following these monthly reports because I am curious to see the impact of the “capital repatriation” act (“scudo fiscale” or “tax shield”) that allowed an alleged €100 billion (or nearly 7% of GDP) held in tax havens accounts to be regularized no-questions-asked by simply paying a 5% capital duty. The Central Bank writes:

The bringing to light of unreported capital held abroad as a consequence of the “capital repatriation and regularization scheme” will lead, judging by the experience of the two analogous schemes at the beginning of the decade, to an as-yet-unquantifiable upward revision of residents’ assets held abroad.

In the first 11 months of 2009, Italy had a current account deficit of €54 billion, financed by €12 billion capital inflow (the “financial account” in IMF balance of payment accounting parlance) and a stunning €42 billion accounted for in “errors and omissions”. Since that figure is simply a plug to make the balance of payment balance, those €42 billion came from nowhere.

Looking at November 2009 figures, the balance of payment gives an even more puzzling picture. Both current account and financial account were in negative territory by €4.6 billion and €15.8 billion respectively. The €20 billion that fled the country in a single month came from, you guessed it, “errors and omissions”. Most of the outflow was due to “hot money” leaving the country, i.e. Italians investing abroad (€8 billion) and non-Italians selling their holdings in Italian shares and bonds at a reckless pace of €33 billion in just one month.

I wonder if the surge of “errors and omissions” comes from funds accumulated in the Italian “shadow economy” (25%-30% of GDP yearly) that are now emerging or something else. In the latest report issued in January 2010 (pdf, english), the Central Bank reported that it is shifting to a new, more accurate reporting system, causing an upward adjustment of Italian external debt by €140 billion or 9% GDP.

On the liabilities side (equities and bonds issued by residents and held by non-residents) the new system produced stocks that were significantly larger than those published previously. At the end of 2008 liabilities towards non-residents consisting of debt securities amounted to €1,036.7 billion under the new system, against €988.5 billion under the old system; those consisting of equities and investment funds amounted to €133.7 billion under the new system, against €24.3 billion under the old system (Table 1). The gap reflects the imperfections of the method of compiling the statistics under which the data where obtained by summing the flows and adding the valuation adjustments, which gave rise to a systematic distortion over time.
[…]
According to the new data, Italy’s net foreign debtor position at the end of 2008 is about €140 billion higher (equal to 9 per cent of GDP).

Unfortunately for conspiracy theorists, the change of net external debt was actually concentrated in the private sector:

In the case of debt securities a change was also found in the distribution by issuing sector. Under the new system the foreign liabilities of general government were smaller and those of banks and the other sectors were larger, which brought the Italian data closer into line with those of the other main advanced countries.

Credit Expansion As Tool To Limit Social Unrest

Albert Edwards, chief strategy of Societe Generale backs up my theory of credit expansion used purposely to reduce tensions in an unequal society …

Hence, while governments preside over economic policies which make the very rich even richer, national consumption needs to be boosted in some way to avoid underconsumption ending in outright deflation. In addition, the middle classes also need to be thrown a sop to disguise the fact they are not benefiting at all from economic growth. This is where central banks have played their pernicious part.

The Value Of Money

Through my fabulous finance/economics news finder, I found this interesting piece on the value of money and the balance sheet of a central bank:

A Ponzi scheme is a financial institution with liabilities and no assets backing those liabilities. Paper money can operate just like a Ponzi scheme, but with one important difference. Mr Ponzi promised his clients high rates of interest and/or capital gains. They would not have held his liabilities unless they believed him. The Bank of Canada promises zero interest, zero nominal capital gains, and a minus 2% real rate of interest on people who hold its paper money. Mr Ponzi could not deliver on his promise, even if he hadn’t spent the assets. The Bank of Canada can deliver on its promise, even if it gave away all its assets, provided the (real) demand for its paper money does not fall over time more quickly than 2% per year. (If the real demand for money were falling at 2% per year, a constant nominal supply of money would yield 2% annual inflation).

I had never thought about money, in the currency sense, that way.

Accountants like double-entry bookkeeping and balance sheets and stuff so they can keep track of things. They like to record assets on one side, and liabilities on the other side, to make sure that everything adds up, to check that everything’s been properly recorded. So they like to list currency as a liability of central banks (even though it isn’t, because there’s no promise to redeem it, or pay interest on it), and assets on the other side. An accountant would freak out if he recorded currency as a liability and couldn’t find an equivalent value of assets. He would say that the central bank is a Ponzi scheme. Which of course it is. And it’s just not worth the hassle of trying to explain to accountants that some Ponzi schemes are sustainable, really.

What Are Central Banks Doing?

James Saft sheds some light on the current state of the securitization world: The state-sponsored shadow banking system.

Banks now lend money to homebuyers, businesses and consumers, turn those loans into securities, park the security with a friendly central bank and get cash back, thus allowing them to effectively take on more risk and continue lending despite balance sheet pressure.

I am not sure central banks will get us out of this mess, as banks now have even more incentives to play Russian roulette for survival, in a situation that reminds me of the agency costs of debt overhang.

The banks, for their part, are engaged in a Darwinian all-or-nothing bet. If they stop lending they are probably toast anyway, so may as well lend and hope that they are amongst the survivors and can then grow rich on fat margins.

Remember that there is still $175.8 trillion in notional value of derivatives held by US institutions ready to explode. I really think that the fiat currency system that fed the world expansion phase of the past 40 years (since the Bretton Woods system came to an abrupt end in 1971) is at risk. This morning I started buying gold and gold mining companies stock.