Right at the front of the monetary welfare queue is the government of Italy.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

As the Eurozone economy continues to grow, pressure is rising on Europe’s biggest bond buyer, the ECB, to withdraw from the market, a process it has already begun. No one believes that more than the head of Germany’s Bundesbank, Jens Weidmann, who recently told Spanish newspaper El Mundo that the ECB should soon set a date to end its multi-trillion euro asset-buying program.

”The prospects for the evolution of prices correspond to a return of inflation to a level sufficient to maintain the stability of prices,” he said. “For this reason, in my opinion, it would be justifiable to put a clear end to the buying of bonds by establishing a concrete date (for ending the program).”

Weidmann, who is hotly tipped to replace Draghi in 2019, has been one of the most vocal critics of the ECB’s QE program.

“Central banks have become the largest creditors of nation states,” Weidmann noted. “With our program of bond purchases, the financing conditions of Member States depend much more directly on monetary policy than in normal times. This could lead to political pressure on the ECB board to maintain lax monetary policy for longer than would in fact be justified from the perspective of price stability.”

Though it has lowered its asset purchases to €30 billion a month, the ECB has pledged to keep buying until at least September. But with the Eurozone economy growing faster than it has since the crisis and inflation comfortably above 1%, the ECB is widely expected to wind down the program thereafter. “If the economy continues to do so well, we could let the program run out in 2018,” ECB rate-setter Ewald Nowotny told Sueddeutsche Zeitung.

But what would that mean for the countries, companies, and banks that have grown to depend so much on the ECB’s extraordinary largesse?

Right at the front of the monetary welfare queue is the government of Italy, which is saddled with one of the biggest public debt mountains on the planet. The ECB now holds €326 billion of Italian bonds, an amount that far exceeds the €246 billion increase of Italy’s gross national debt since 2012, when this program started. The ECB’s binge buying of Italian debt has enabled just about every other investor in the market, including Italian, French and German banks, to offload some of their holdings.

As the ECB cuts its purchases of Italian bonds, those investors will have to come back into the market in a big way; otherwise the yields on Italian bonds will begin soaring, driving up the costs of funding for the government. This will be a huge, perhaps even insurmountable, problem for a country whose economy is still 6% smaller than it had been before the global financial crisis of 2008.

But the problem of mass financial dependency in Europe created by the ECB’s unconventional monetary programs extends far beyond national governments. As the IMF warned in its latest note on Spain’s financial system, Spanish banks have also grown dangerously dependent on ECB liquidity in recent years, with 6% of their total funding now coming directly from the central bank’s coffers

In this case it’s not the ECB’s QE programs but rather its myriad TLTRO programs, clocking in at almost one trillion euros, that have fuelled the dependency. Many banks used the virtually free loans the ECB offered them for carry-trade purposes, acquiring 2-3% yielding Spanish bonds and pocketing the difference. According to the IMF, by the close of 2016, one entity (whose identity it refuses to disclose, for obvious reasons) relied on ECB funding for 17% of its liquidity needs.

Although the report’s authors acknowledge that overall Spanish banks’ finances have improved in recent years, they have serious reservations about the banks’ capacity to access sufficient funds in an adverse market scenario. They also believe that replacing ECB financing, which is virtually free of charge, with funds provided by the more expensive wholesale market could be “detrimental” to the stability of Spanish banks. There could even be “liquidity tensions” if the ECB opts to cut off the liquidity tap too fast.

Also at risk of a drastic draw down in ECB funds are the hordes of zombie companies for whom the ECB’s buying of corporate bonds and the artificial regime of low or even negative interest rates have provided a desperate lifeline. According to research by Bank of America, about 9% of Europe’s biggest companies could be classified as the walking dead — that is, companies with interest-coverage ratios at 1 or less and that risk collapse if the support dries up.

In other words, rather than helping to address the myriad systemic issues plaguing Eurozone banks, the ECB’s multi-trillion euro monetary policy measures have merely delayed the inevitable while creating a mass culture of monetary dependency at the very top of Europe’s shaky economic edifice. By Don Quijones.

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