5 May 2013

The Eurozone needs €19.3 trillion of interest free money creation to fix the debt crisis

If you've been following my recent blogs, you will know that I am trying to understand how it is possible that Eurozone Debt is 2.5 times larger than the Money supply. Specifically, if you take the BIS figures for the 3rd Quarter 2012 for Household debt (€6,214 billion)  together with Nonfinancial (business) sector debt (€9,435 billion) and add in the ECB figures for public sector debt at the end of 2012 (€8,795 billion), you reach the eye watering total of €24.5 trillion of debt. That number is roughly 2.5 times bigger that the latest figure for M3 (€9,810 billion).

So, where's the other €14.7 trillion that we need to pay off our debts?

Some people have been telling me that the M3 figure is not complete because it doesn't include long term loans. I find that odd. If a bank has €1 million in reserves and lends it to someone for 10 years with a 5% per annum interest charge, normally that money really exists, and it should be included in the money supply, irrespective of whether it is being loaned for 10 years, 10 weeks or 10 hours.

The fact that it isn't, and that for some reason long term "loans" don't count, looks very fishy to me. It sounds like a way for banks to create money without it being subject to scruteny. I suspect that this may explain how, when you look at the assets of the 50 largest banks in the world, you discover that the average bank owns assets that are worth 380 times as much as their capital. Could this be because they have been buying up huge amounts of stuff with non-existent money? Stranger things have happened.

To get a better understanding of precisely what does and what does not get included in Money Supply figures I had a look at the lastest monthly document produced by the ECB on "Money Developments in th Euro Area" for March 2013 that was published on the 26th of April. The document includes a set of tables at the end with a whole pile of figures that break down the components of M3, and provide information about the assets and liabilities of MFI (Monetary Financial Institutions). I extracted the numbers to try and make some sense out of them. Here's the table I produced.

From that, you can see that total of M3 (€9,810 billion) is made up of Currency in Circulation (€867 billion), overnight deposits (€4,336 billion), deposits with an agreed maturity of up to two years (€1,785 billion), deposits redeemable at notice of up to three months (€2,102 billion), Repurchase agreements (€122 billion), Money market fund shares/units (€458 billion) and Debt securities issued with a maturity of up to two years (€140 billion).

Then we have MFI Liabilities which total €7,854 billion. These include holdings against central government (€295 billion), capital and reserves (€2,421 billion), and various longer term financial liabilities vis à vis other euro area residents which are divided according to the duration period involved.

Then we have a section on MFI assets which total €17,675 billion (though I had to get that number myself, since it is not actually provided by the tables in the ECB document). These include €3,432 billion in loans to general government, and €13,058 billion in credit to other euro area residents, of which €10,832 billion are in the form of loans. To that you can add another €1,058 billion in net external assets, which I presume includes loans to people, businesses and governments outside the Euro zone. Finally, there is a something called "Other components of M3 (residual)" that sounds a bit like a fudge factor to me.

How are these three areas related? What is the relation between M3 (€9,810 billion), MFI Liabilties (€7,854 billion) and MFI Assets (€17,675 billion)? Well, I have a suggestion which is shown in the next table.

The numbers in lines 1 to 3 are directly from the ECB document. Line number 4 shows that if you take total MFI assets, and subtract MFI Liabilities and M3, you get a final number of €11 billion, almost nothing when we are talking about totals of €17.7 trillion. It could almost be a rounding error!

So, I seem to be making some progress here.

One way of making sense of this would be to invent a new monetary aggregate that, in addition to the components of M3 (which only goes up to two years), includes the numbers for MFI Liabilities that exceed two years. These include €2,406 billion that are deposits with an agreed maturity of over two years and debt securities issued with a a maturity of over two years €2,631. I propose that we might call that M5 (because M4 is a term that has already been used by the Bank of England).

So, lets call M5 the number that allows us to balance the €17,675 billion that the MFIs have in assets.  We haven't accounted for all the debt, because there is another €6,829 billion to find if we want to account for all the debt in the Eurozone (€24,504 billion). I note that the figures here only includes €3,432 billion in loans and credit to general government, so that this implies that there is presumably a further €5,363 billion of credit to general government from outside the Eurozone to make up the total of €8,795 billion in public sector debt.

I've put these numbers in the following table where again, the black lines correspond to numbers extracted from official sources, and the red ones correspond to my (educated) guesses.

Even if we add in that external government debt, we still don't account for the entire €24.5 trillion. That's why I have added a final line with €1,466 billion of Non Eurozone Credit to Euro area residents which would include both households and businesses.

So, I think that I have a plausible explanation of where all the debt is, and why the total is 2.5 times what we are supposed to called the money supply (M3). First, there is €6,829 billion of debt held outside the Eurozone. Quite a bit of that could be held by banks and pension funds in the UK and the US for example.

But the biggest factor seems to be the fact that there is an arbitrary distinction between money created in the form of short term loans (up to 2 years) and loans made over longer periods. Why?

Actually, it seems to me that there is only really one type of real money. It's the money that is in circulation. It is the stuff which is held on overnight deposits. It's the stuff that is not tied up in the form of debts.  It's M1. And that stands at just over €5 trillion. My conclusion is that the amount of real debt free money that needs to be injected into the Eurozone is not €14.7 trillion (i.e. total debt minus M3). It's €19.3 trillion, that is the total amount of debt minus M1.

Now you know how much debt free money needs to be injected into the Eurozone to get things back under control.


  1. Simon, nice work on trying to confront money and debt. I understand that your M5 is made up of M3 + MFI liabilities which is 17,664 billion. However, I couldn't find any data source on euro debt held outside of the Eurozone anywhere on the internet. Could you please explain how did you come up with the 6,829 billion. One more difficulty that should be accounted for when comparing the level of money and debt is that some components of the debt are included twice. For example when the I borrow the money from the bank this constitutes brand new money created alongside with the debt. This money goes into circulation and some of it might be used for buying government bonds so the money goes to the government. It is the same money, but now there is additional debt included - government debt. In the government statistics there should be a column with euros borrowed directly from the banks + government bonds held by the banking sector. These would be new money. Other forms of financing the deficit from non-banks would be "old" money - money once already borrowed into circulation. The total debt for the purpose of your comparison should be then reduced by the "old" debt.

  2. Wow! Really informative stuff you have collected and posted here for us. thanks a a lot for this post.You have clearly explained all terms in this post and is easy to understands.Thanks again

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