The rise in the Euro area money supply looks permanent and therefore inflationary

by Shaun Richards

Today out focus switches to the Euro area and the European Central Bank. We cam open with yet another failure for economics 101 as a surge in the money supply is supposed to lead to a weaker currency.Yet last year ended with Bloomberg reporting this.

The European Central Bank is closely monitoring the euro’s strengthening against the U.S. dollar, Governing Council member Olli Rehn says

Regular readers will recall that what used to be called jawboning but these days are called open mouth operations began around 1.18 versus the US Dollar and we are now at 1.2275 as I type this. So we see that even adding the vocal weapon to the money printing I will come to in a moment is not stopping the Euro’s rise.This matters because with so many commodities priced in US Dollars it reduces inflation in the Euro area which the ECB is desperately trying to increase.

We can also look at this via the trade-weighted or effective exchange rate.It is hard not to have another wry smile in the direction of economics 101 as the QE and negative interest-rate era of the ECB has coincided with a Euro rally. It bottomed around 101 in April 2015 and is now at 123. For our immediate purposes the recent move started at 112.6 on the 18th of February. If we try to ignore the excitement back then we have seen a move from 114 to 123 which we know what to do with.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points. ( The Draghi Rule)

So around a 0.4% fall in inflation from this source.

Soaring Money Supply

This morning has brought a new record.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, increased to 14.5% in November from 13.8% in October. (ECB)

This compares to a pre pandemic growth rate of 8% or so showing how much of an effort the ECB has put into this. There was an 115 billion Euro increase in November of which some 13 billion was for currency in circulation. That is another arrow in the eye for those who predict the demise of cash because whilst there are perfectly good reasons for using it less right now the reality is that it is expanding. The M1 measure now totals so 10.1 trillion Euros.

Broad Money

Unsurprisingly after the news above this has also moved higher.

Annual growth rate of broad monetary aggregate M3 increased to 11.0% in November 2020 from 10.5% in October.

Indeed as we break it down we see that the increase was narrow money driven.

Looking at the components’ contributions to the annual growth rate of M3, the narrower aggregate M1 contributed 9.9 percentage points (up from 9.5 percentage points in October), short-term deposits other than overnight deposits (M2-M1) contributed 0.3 percentage point (down from 0.4 percentage point) and marketable instruments (M3-M2) contributed 0.7 percentage point (as in the previous month).

This will be disappointing for the ECB as all the effort is to also get the M2 and M3 components rising but in November they outright declined. The M1 push of 115 billion Euros saw only a 104 billion rise in M3.

There is another way of looking at this but I caution against relying on it too much as when it was used as a policy in the UK for £M3 it failed.

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As a reflection of changes in the items on the monetary financial institution (MFI) consolidated balance sheet other than M3 counterparts of M3, the annual growth rate of M3 in November 2020 can be broken down as follows: credit to general government contributed 7.7 percentage points (up from 7.3 percentage points in October), credit to the private sector contributed 5.1 percentage points (down from 5.2 percentage points), longer-term financial liabilities contributed 0.7 percentage point (up from 0.3 percentage point), net external assets contributed -0.2 percentage point (down from 0.1 percentage point), and the remaining counterparts of M3 contributed -2.3 percentage points (up from -2.5 percentage points).

The push from the government sector does look genuine though.

Is this about to be permanent?

There are various issues around velocity from the above but also how permanent this is? The latter arises because central bankers regularly state that they can reduce the money supply as easily as they boost it. I mean here that they state it because you see there is rather a shortage of examples of them actually doing it. So as you can imagine topics like the one below in a Financial Time opinion piece catch my eye.

In Europe, soaring debt has led some senior Italian officials to ask the European Central Bank to ease debt burdens by forgiving sovereign bonds it owns. That proposal was quickly dismissed by Christine Lagarde and other central bankers and economists.

We looked at this last year and I noted both Lagarde’s shocking track record and the fact that these things are always denied and then somehow find their way onto thw policy action sheet. Well let;s continue with the FT piece.

Their rapid rejection of debt cancellation as part of the recovery from the pandemic misses one very obvious fact. In a world where a lot of sovereign debt is being bought by central banks, intrinsically, all we are doing is allowing the left hand of the government to owe the right hand of the government a lot of money. At some point they could just shake hands and throw the debt away.

They could but the explanation then gets very confused.

For any country bold enough to consider such extreme action, there may also be a first-mover advantage, because the moment this takes place, borrowing costs should go up. I hasten to add that if a country does go down this route, safeguards are needed. Ideally the government would enshrine in its constitution that this is a one-off emergency response. It cannot continue to print money whenever it wants to do something.

If we look at a country which cancels a lot of debt why would its borrowing costs rise? He must be assuming the central bank stops any future QE but why should it when in the immortal words of the apochryphal civil servant Sir Humphrey Appleby “It has worked so well”?

How many “one-offs” have been repeated in the credit crunch era? Let me make the job easier for you by instead asking how many have not?

Also I am not sure where this is going as even before the credit crunch more than a few broke these rules.

Many EU countries have already breached the bloc’s fiscal rules on debt levels and there is little room for manoeuvre. Debt cancellation needs to be an option in the toolkit.


We have been observing a monetary push for some time now but we now see a major change and a nuance. The major change is that something I have been pointing out from the beginning is that the money supply boost will be permanent. In the debt cancellation narrative above the increased money supply is left standing. The first casualty is the truth as we have been lied to on a grand scale.

Next comes another lie which is the measurement of inflation. The official measure which we in the UK call CPI but which more formally is called HICP is designed to avoid the consequent inflation. For example it completely ignores the owner-occupied housing sector in spite of the ECB admitting that housing can be a third of all personal expenditure. Why might that be?

House prices rose by 5% in the euro area (EA19) and by 5.2% in the EU27 in the second quarter of 2020 compared with the same quarter of the previous year.

Next comes the nuance which is in fact important. The narrow money growth is money supply but broad money growth relies in fact on demand and we can see that demand for loans is not going so well. Such demand as there is comes unsurprisingly from governments.

The annual growth rate of credit to general government increased to 21.4% in November from 20.3% in October, while the annual growth rate of credit to the private sector stood at 4.8% in November, compared with 4.9% in October.


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