Professor Sinn Doubles Down

I know this is getting silly now and everyone knows what’s going on with the Target 2 debate. Still, it’s entertaining to see Professor Sinn doubling down on his false claims about the operation of the Eurosystem.

By the end of 2010, ECB loans, which originated primarily from Germany’s Bundesbank, amounted to €340 billion.

Em, no. I don’t know how to explain this any better than here. But, like I say, really, honestly, no.

But, he’s on a roll now is Professor Sinn, so now we get a new nonsensical talking point:

If this continues for two more years as it has for the past three, the stock of refinancing loans in Germany will disappear altogether.

Indeed, Deutsche Bank has already stopped participating in refinancing operations. If German banks drop out of the refinancing business, the European Central Bank will lose the direct control over the German economy that it used to have via its interest-rate policy. The main refinancing rate would then only be the rate at which the peripheral EU countries draw ECB money for purchases in the center of Europe, which ultimately would be the source of all the money circulating in the euro area.

I literally laughed out loud when I read this. So Deutsche Bank don’t borrow from the ECB? Who cares? There have always been banks with surplus liquidity and banks that are short of liquidity. That’s why interbank money markets exist.

The fact that the ECB stands willing to make unlimited amounts of short-term loans to all Euro area banks at 1.25% is clearly the key influence on short-term rates throughout the Euro area.  Deutsche Bank may not be borrowing from the ECB but they certainly won’t be able to lend their funds out on a short-term basis at rates that are much higher than the ECB’s.

So ECB rates are clearly setting German short-term interest rates just as they set them elsewhere in the Euro area. (Note also the resemblance between ECB rates and short-term German government bond yields.)

So another scary sounding but ultimately baseless claim from Professor Sinn.

16 thoughts on “Professor Sinn Doubles Down”

  1. @KarlW/all

    What happens Target2 wise when UK/US institutions invest(ed) in Irish senior bank debt ? Also how does such investment affect overall money supply ?

  2. I get the feeling in all this that Prof Sinn thinks the ECB and the Bundesbank are in fact the same operation. Or if not in theory, they should be in practice.

    If German banks drop out of the refinancing business, the European Central Bank will lose the direct control over the German economy that it used to have via its interest-rate policy.

    I thought the ECB was not supposed to have control over any economy in normal circumstances and indeed in abnormal circumstances. It is supposed to control in respect of the whole EZ economy, not in respect of a favoured member.

  3. Well well, I fear Whelan’s attempts to rebut or laugh off any claim Sinn makes start looking as compulsive as Sinn’s attempts to make exaggerated claims about Target2. Of course there are always banks with surplus liquidity and banks with a shortage. But if ALL banks with surplus liquidity are in the European core, and ALL banks short of liquidity in the periphery, and the periphery banks are the only ones that refinance themselves at the ECB, and there is no functioning interbank market linking the core and peripheral banking systems – then this has little to do with normal central bank operations, but points to a severely distorted and segregated financial system that triggers severely distorted central bank operations as a result. To the extent that Sinn points to this he makes a perfectly fair point.

    Sinn is also right, btw, that the ECB refinancing rate would cease to determine German short-term interest rates – the relevant rate for Germany would then be the ECB deposit rate.

    HK

  4. @ Henry

    “Sinn is also right, btw, that the ECB refinancing rate would cease to determine German short-term interest rates – the relevant rate for Germany would then be the ECB deposit rate”

    …which the ECB would still have control over, whether by changing the refinancing rate (and so the deposit rate), or by changin gthe rate corridor between refinancing and deposit rate.

    Btw, for all this suggestion that “core banks do not refinance at the ECB”, i assume no one is familiar with Depfa Bank and their landesbank bretheren…

  5. I think the argument of the total loss of efficacy of the ECB refi operation is a valid one. Recently the ECB refi rate is the rate applied to a collateralized loan to a un-creditworthy bank providing worthless collateral. Therefore it is no surprise that the interbank Eonia and the interbank repo trade lower than the MRO rate, and the spread between the MRO and the effective funding rate of the economy ( i.e. the Eonia/repo rate in the interbank) is not any more controlled by the ECB.
    The total segregation of the money markets , where low credit banks fund at the ECB/ELA with their respective local NCB and the rest of the market trades independently and only with the ECB depo rate as a floor, is an important issue.
    Moreover there is the issue of Eurosystem Net Financial Assets (NFA) which is a little understood balance sheet item of ESCB NCBs that is effectively providing long term liquidity to the economy.
    The question is what happens if say all the MRO is taken by low credit quality banks and in the same time excess extreme liquidity conditions in the euro area make banks net long overnight cash and therefore oblige ECB to withdraw liquidity with reverse repos: then the effective interest rate will be the deposit rate.
    More generally , is the ECB the sole possible provider of “central bank money” at least as far as required reserves go? If not then that means that they have effectively lost control of monetary policy?

  6. Tongue-in-cheek Karl,

    I am wondering, whether HWS should reconsider his Delphi Conference, which is proposed for September 23rd and 24th on Hydra Island in Greece, discussing the following topics:

    Reforming the Stability and Growth Pact
    • Financial stability of the EMU
    • The role of ECB
    • Fiscal imbalances and sovereign default in the EU
    • Debt consolidation strategies
    • Dealing with Current Account Imbalances
    • The role of EURO in the emerging world monetary system

    It would seem to me that the chosen location could be a little tricky, then again, besides HWS they have George Economides as a scientific organizer.

    😉

  7. @ Henry

    “points to a severely distorted and segregated financial system that triggers severely distorted central bank operations as a result. To the extent that Sinn points to this he makes a perfectly fair point.”

    I never like this style of argument, i.e. defending somebody by pointing to something they didn’t say. Nobody could deny that current central bank operations are very unusual and reflect serious core-periphery financial strains.

    But that’s not the point I was addressing. I was addressing Sinn’s claim that “If German banks drop out of the refinancing business, the European Central Bank will lose the direct control over the German economy that it used to have via its interest-rate policy.” That claim goes way beyond saying central bank operations are distorted. And, again in what appears now to be a deliberate pattern, it appears to be designed to sound scary to a German audience (“the ECB has lost control over our economy ….”).

    As for your claim that “the relevant rate for Germany would be the ECB deposit rate”, I don’t think you’ve understood my argument. The ECB has a “corridor style” system, so it’s main refinancing rate, deposit rate and marginal lending all play a role. However, the rate the ECB’s targets (EONIA — overnight interest average) has tended to track the main refinancing rate pretty closely.

    A bank that has surplus funds will get a better return lending it to other banks at something like the EONIA rate than it will get on deposit at ECB. So the main refinancing rate is still the key rate determining market conditions.

  8. @ Karl

    … except that no core European bank lends to a peripheral European bank (beware of at EONIA) — this is why the peripheral banks turn to the ECB in the first place.

    Thus, if all central bank money goes to banks in the periphery and is transferred to banks in the core in the process of paying for peripheral imports, the relevant short-term term interest rate for the core baks is the rate at which they can deposit surplus liquidity at the ECB — which is lower than the ECB refinancing rate. Put differently: the segregated nature of the Euro Area financial system and the distorted central bank operations it triggers will ultimately force rates in the European core to the lower bound of the ECB’s interest rate corridor. Certainly an unintended and unwelcome outcome, and the opposite of what the booming German economy needs.

    Btw, I am not trying to “defend” Sinn in any way (as my posts on the matter should make clear, see the links below). I have no dog in this fight. I believe, however, that this debate is important, while distorted by high personal stakes of many participants that result in exaggerated claims (on both sides).

    One way of seeing the issue is that in times of crisis the Eurosystem functions like unlimited IMF-type liquidity support for countries in the European periphery. I.e., peripheral banks have unlimited access to hard currency to fund domestic absorption. This is very different from current account crises in the past: neither did Thailand in 1997 or Argentina in 2001 have access to unlimited US Dollar liquidity, nor could Latvia or Hungary in 2008 tap unlimited euro liquidity. These countries had to operate within the constraints of tight multiltateral rescue packages, and had to make up for the parts of domestic absorption that these packages could not fund by adjusting spending.

    A relevant and in my view perfectly legitimate question – which should be at the center of this debate – is whether unlimited access of peripheral financial systems and economies to hard currency through the Eurosystem prevents necessary adjustment. This needs to be analyzed on a case-by-case basis. In my personal view it is hard to make such an argument for Ireland, given that its current account has swung into surplus and Ireland’s exports and GDP are growing. I.e., the Irish economy is adjusting while and in spite of enjoying unlimited access to hard currency. Greece and Portugal may be a different matter though. Going by Sinn’s last article (the sections you don’t quote), he seems to see this similalrly.

    P.S.: the links (first post comes with an English version):

    http://kantooseconomics.com/2011/06/16/wo-hans-werner-sinn-recht-hat-und-wo-nicht/

    http://kantooseconomics.com/2011/06/23/die-usa-sind-in-der-tat-anders-%e2%80%93-ganz-anders-nachtrag-zur-sinntarget2-debatte/

  9. @ Henry

    As to whether you’re trying to defend the good Professor, I’ve read a lot of blog comments and I know how people interpret language such as “Sinn points to this he makes a perfectly fair point” and “Sinn is also right, btw.” But I’m happy for the clarification.

    On the main point, even if you think I’m being “compulsive” I think it is important to address Sinn’s claims that we are facing the prospect that “the European Central Bank will lose the direct control over the German economy that it used to have via its interest-rate policy” as I’m sure this sound pretty disturbing to many German readers who trust the great Professor.

    You and CB above have made various points about the unusual nature of current ECB operations. But they do not at all add up to ECB interest rate policy becoming irrelevant for private rates or “losing control over the German economy.”

    As for “if all central bank money goes to banks in the periphery and is transferred to banks in the core in the process of paying for peripheral imports” I have not spent time discussing the question of linkages between central bank operations and current account deficits, though I agree with what Buiter has written on this. Still, it’s worth point out that, in Ireland, the transfer of money from banks in the periphery to banks in Germany has not been related to the financing of a current account deficit.

  10. Ah … giv up yer oul sinns! [Young Dub – age 6]

    (anyone got a link to a recording?)

  11. I don´t really understand why HW Sinn is compaining about Germany loosing out under the Target2 mechanism. After all the only thing that has changed compared to the situation prior to the crisis is that payments are settled through the Target2 system rather than via the interbank market.
    So instead of german commercial banks(indirectly the taxpayer) facing 100% potential losses, Germany as a whole now faces ~28% of any losses in case of default, whilst reaping the full benefits of higher capacity utilization, lower unemployment and higher tax revenues.
    If any Euro-zone countries are being disadvantaged here it, it would seem to be countries like France and Italy, who´s Target2 balances are broadly in equilibrium. They carry part of the cost of financing a potential default, without reaping any of the benefits.

  12. Can anyone explain Target2 in terms of money supply, and specifically for 2 cases:
    1) A US institution, wishes to invest USD 10 billion, in the EUR denominated sub debt of a new Irish bank
    2) As above, except they wish to pput it on deposit

    As such my understanding in EUR to EUR terms is that Target2 will not increase nett money supply (merely usage), which is why I’m curious about effects of another currency

  13. @ Gordon T

    If you don’t understand, its because it makes no sense. Don’t worry about it.

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