Great Graphic: Financial Disintegration Revisited

This Great Graphic from Sober Look is taken from the ECB's latest report.  It provides more evidence of our presented here and in our recent letter to the editor at the Financial Times that the financial integration process in Europe is going in reverse. 

Financial integration is the cross-border movement of capital. A key part of this integration process was that the private sector in creditor nations recycled their surplus to the deficit countries.  This process is now going in reverse, hence financial disintegration.  

The chart to the left depicts the decline in cross-border movement of overnight money market transactions.  A point the ECB underscores is that country risk is the most important consideration when banks assign counter-party credit lines.  

The chart to to right shows another dimension of the financial disintegration.  If the home bias has returned, and banks are buying primarily assets in their own countries, then the collateral they will have (which are those assets) are also going to be less international.   And that is exactly what is happening.

European economic and monetary union was predicated on convergence.  What we are talking about here is divergence.  Financial integration was an essential part of the glue that holds the  disparate region together.  Since European officials define the problem differently, such as the breakdown of the transmission mechanism of monetary policy (ECB) or fiscal recklessness (Germany), they have not deigned to address it. In this context, our concern is official attempts to deal with the monetary transmission mechanism or the fiscal crisis will make it more difficult to arrest the financial disintegration.