Wednesday, 27 March 2013

Show me the money. Hidden bailout

The Euro debt crisis took another nasty turn in Cyprus. It is worrisome that Cyprus would be the first Eurozone country to impose capital controls which is supposed to be against the fundamental tenets of the EU. Cyprus is facing a bank crisis and also a confidence crisis. ATMs are almost empty and real printed notes seem to be in high demand as few trust the banking system or the Cypriot/European officials.
Greece found itself in a similar position. Greek citizens not trusting their government withdrew cash from banks or transferred their money outside Greece. The main fear in this case was Grexit. How did Greece cope with the increasing demand for printed notes?

The total amount of printed notes in circulation is listed in the consolidated balance sheet of the ECB. Currently it stands at around 884bln. Part of it (8%) is held by the ECB itself and the remaining 92% is distributed according to the percentage capital contribution each Central Bank has done.
Thus for example Italy has 145bln of Notes in circulation and Greece around 23bln. However, as the crisis intensifies and Europeans lose confidence in their governments they withdraw cash notes which are kept either in bank safe deposits or at home.
This increases the demands for printed notes which can only be satisfied if the respective central bank borrows the notes from other central banks that may have surplus. The central banks cannot print new notes to throw in circulation at will.

This is shown on the balance sheet of the individual central banks. For example Greece records the amount of extra crispy notes they borrowed from other banks in item 9.2 while their allocation is item 1. In the Graph above we show how Greece doubled the amount of cash in circulation to satisfy the appetite for real cash. This was money borrowed from the Eurosystem. This of course in a Target2 liability which is added to the Target2 balances of the country. It is this cash that kept the ATM going in Greece. Since June 2012 the trend is downward. Any reversing of this trend and we are back on crisis mode.
Conversely, it seems that Italy was net exported of printed notes (possibly to Greece) and the item is recorded as “Other claims within the Eurosystem (net)” (item 9). Currently this is at 5.8bln.
An early warning sign of distress in the southern European countries could be the increasing demand for printed notes. Digging that number up from the consolidated balance sheets sometimes poses a challenge.