Italy’s Capital Flight

MUNICH – In August, the European balance-of-payments crisis moved beyond the Eurozone’s periphery and began buffeting Italy. Interest spreads for Italian government bonds began to rise, Prime Minister Silvio Berlusconi’s administration was alarmed enough to implement an austerity program, and the European Central Bank helped with extra liquidity.

The ECB directed the central banks of all Eurozone members to buy huge quantities of Italian government bonds during the crisis. While the national central banks have not revealed how much they bought, the aggregate stock of all government bonds purchased rose from €74 billion ($102 billion) on August 4, to €165 billion this month. Most of this increase was probably used to purchase Italian government bonds.

The German Bundesbank, which was forced to buy most of the bonds, strongly opposed the program, but was unable to stop it. In response, ECB Chief Economist Jürgen Stark resigned. He followed Bundesbank President Axel Weber, who had resigned in February because of the earlier bond repurchases. Meanwhile, the new Bundesbank president, Jens Weidmann, openly objects to the program, while German President Christian Wulff has publicly accused the ECB of circumventing the Maastricht Treaty.

But the bond purchases are just the tip of the iceberg. Equally important, but largely unknown, is the fact that the Banca d’Italia has resorted to the printing press to cover Italy’s gigantic balance of payments deficit. The extra money printing and lending, as measured by the so-called Target deficit, effectively means drawing a credit from the ECB.