Over the last few months there’s been a dramatic turnaround in capital flows to the Eurozone’s periphery, illustrating the success of ECB President Draghi’s rhetorical flourish last summer to do “whatever it takes” to support EMU. Today’s Financial Times carries two articles featuring ING’s number crunching on this topic, including elements of one of my current favourite charts (click here: Eurozone Balance of Payments).
The chart underlines the point that volatile private capital flows are the driving force behind the performance of the euro and the Eurozone financial markets. The other side of the balance of payments, namely the current account, has been improving since 2010, at least in the sense that the deficits of the periphery (Italy, Spain, Portugal, Greece and Ireland) have been declining. The problem is that while this has partly been due to growth in their exports, it has also been due to falling imports as their domestic demand has plunged. That plunge in turn continues to threaten the periphery’s solvency by undermining their capacity to cut their budget deficits.
Indeed, that’s precisely why there was an emerging market style capital flight of out of the likes of Italy and Spain in the first few months of last year, as fears of EMU breaking up mounted. This is vividly illustrated in the chart, which shows an exodus of private capital, equivalent to almost 20% of the periphery’s GDP, in the first eight months of 2012. Draghi’s verbal intervention in late July, followed up by September’s offer of “outright monetary transactions” to support the periphery’s government bond markets, came just in time to avert disaster. Since his comments, private capital has been flowing back into the periphery, albeit initially at a slower pace than it left: on our estimates the influx of €92.7bn in the final four months of 2012 was the equivalent of just under 9% of GDP.
The markets’ strong start to this year suggests that Draghi’s confidence trick may be gaining momentum. The trick seems to be working a treat. But unless the markets’ optimism starts to translate into stronger economic activity over the coming months, and politicians use the current breathing space to make progress on banking union and other moves towards integration, the treat may turn sour.