Worse than Sinn

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I have told myself to stay out of the Target 2 debate, partly because this pretty much sums it up and I’ll just end up repeating myself and partly because the brave Olaf Storbeck has taken this on himself so many times.

However, this article by Tornell and Westermann is worth bringing up because the appearance of two people who are not Hans Werner Sinn making Sinn-like claims might suggest there is a point here. In fact, this piece has even less to add (and more to subtract, if believed) to the stock of useful knowledge than Sinn’s various pieces. (Unfortunately, its points were repeated on the usually-excellent FT Alphaville.)

Tornell-Westermann (TW) repeat the fallacy that the Bundesbank has loaned money to the so-called GIPS central banks. Their new twist on this story is that “In order to fund these loans, the Bundesbank sold its holdings of German assets.”

They back this up with a table showing information from the Bundesbank balance sheet. A line labelled “Private securities owned by central bank” shows a large decline in recent years.

What does this line correspond to? Well, TW’s line for “Private securities owned by central bank” equals €224 billion in 2009 and €277 billion in 2008.

Let’s go consult the Bundesbank’s own description of its balance sheet for these years (page 148 of this file). It tells us that “Lending to euro-area credit institutions related to monetary policy operations denominated in euro” equalled €223.61 billion in 2009 and €277.425 billion in 2008. I’m going to guess that the resemblance between these figures and those reported by TW is not coincidental and that TW’s figures correspond to the same entries.

Is “Private securities owned by central bank” – as best I can see a terminology invented by TW – a more accurate description than the terminology used by the Bundesbank, which effectively means “loans”?

Well, no. These entries correspond to loans. They are securitised loans, specifically repurchase agreements, so the Bundesbank holds a security as collateral for the (usually short) maturity period of this loan. But the value of the loans are less the value of the corresponding securities (i.e. a haircut is applied to the collateral) so the asset on the Bundesbank’s balance sheet is the value of the loan, not the value of the asset. Also, the asset remains on the balance sheet of the borrowing bank because the bank regains the asset on repayment of the loan and thus the transaction does not correspond to the accounting requirements for “derecognition” of assets.

So, this item – lending by the Bundesbank to German banks – has declined in recent years, from €277.425 billion in 2008 to €37.6 billion in August 2011 (the latest figures I could find – page 111). The reasons for this are not too surprising. There has been enormous capital flight from the periphery into German banks which, as a consequence, have had far less need than previously to borrow funds from the Bundesbank for liquidity purposes.

Note also that Eurosystem policy in recent years has been to supply banks with a full allotment of funds requested in refinancing operations, so the Bundesbank has not made any conscious decision to reduce the amount of lending it has done.

If “the Bundesbank has done less lending because German banks have asked for a smaller amount of loans” sounds different from “the Bundesbank has had to sell off securities to fund loans to peripheral central banks” that’s because it is. The first statement is true and the second isn’t.

The rest of Tornell and Westermann’s article is not much better.

· The presentation of the Bundesbank’s “Other claims within the Eurosystem (net)” (i.e. the Target 2 credit) as some kind of enforced loan to the rest of the system rather than the accounting entry that reflects a transfer from the rest of the system to Germany mirrors Professor Sinn’s ability to make something that is good for Germany appear to be Germans getting ripped off.

· The idea that the Bundesbank is about to “run out of money” – “the Bundesbank will soon exhaust the stock of securities that it can sell to fund further loans to the Eurosystem” – is completely without basis in reality. Still, the stuff about the Bundesbank’s gold holdings and the German public not wanting to sell it will appeal to paranoid goldbugs everywhere.

· The material about Target claims being collateralised by, for example, Greek bonds sounds scary but, in reality, is just false.

· The less said about TARGET being “overwhelmed” because “the ECB has a relatively small capital base” the better.

The crazy thing is that the Euro area is undergoing a real crisis and there is a huge need for an informed public debate on potential solutions. We don’t need academics making up fake crises and stirring intra-European resentments based on a misunderstanding of central bank arcania.

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47 Responses to “Worse than Sinn”

  1. Desmond Brennan Says:

    @Karl
    I’d raised that article on an earlier thread as I’m confused, is ELA

    1) Pure money printing
    2) Money printing with a form of notional sterilisation / offset
    3) A loan from ECB backed by real assets of their’s ?

  2. Karl Whelan Says:

    @ DB

    Great, I love MCQs.

    Correct answer: Number 1.

  3. How the ECB could be forced to print money | Felix Salmon Says:

    [...] Karl Whelan takes issue with Tornell and Westermann’s assumptions. « Previous Post [...]

  4. How the ECB could be forced to print money | Felix Salmon Says:

    [...] Karl Whelan takes issue with Tornell and Westermann’s assumptions. « Previous Post [...]

  5. The Dork of Cork Says:

    Paranoid ?
    Why did we not call their bluff so ? , via a target 2 trade war….. – putting all tax increases into anything with a engine capacity of over 1 litre………………..

    Just because you have read too many Stephan King novels doesn’t mean they are not out to get you.
    http://www.youtube.com/watch?v=mLhFIwkbtJI

  6. Stephen Kinsella Says:

    By that Sinn fell the angels?

  7. Desmond Brennan Says:

    @Karl

    Thanks…I’d understood (1) to be the answer…and have been getting very puzzled by all these Target2 claims (see what I did there ;) )

  8. Stephen Says:

    http://xkcd.com/386/

  9. Ahura Mazda Says:

    I think Germans have benefitted from target2. Private german wealth flowed to the periphery and is partly to blame for these countries loss of competitiveness by causing inflation. The irish property bubble didn’t fund itself. Target2 has enabled safe passage of private wealth back to germany; leaving peripherals’ taxpayers with the losses.

  10. Karl Whelan Says:

    @ Stephen

    Yes, I know, I know.

    Thanks — it’s my all-time favourite cartoon.

  11. Karl Whelan Says:

    While we’re at it, my other favourite xkcd cartoon

    http://xkcd.com/795/

  12. jmg Says:

    “lending by the Bundesbank to German banks – has declined in recent years, from €277.425 billion in 2008 to €37.6 billion in August 2011 (the latest figures I could find – page 111).”
    The latest figures for September and October 2011 you can find here – page 95
    LINK: http://www.bundesbank.de/download/volkswirtschaft/monatsberichte/2011/201111mb_bbk.pdf

    And here is another paper on Target2 from Germany, if you can bear it:
    “TARGET2 Unlimited: Monetary Policy Implications of Asymmetric Liquidity Management within the Euro Area”
    José M. Abad, Axel Löffler , Holger Zemanek
    LINK: http://www.ceps.be/book/target2-unlimited-monetary-policy-implications-asymmetric-liquidity-management-within-euro-area

    And this is from the german “Sachverständigenrat” (academic advisory council to the german government), my translation:
    There are no technical limits for the TARGET balances. If the current trend continues, it can soon reach a point where the refinancing loans of the German banks go to zero. Additional inflows to Germany will result in a reversal from a net debtor to net creditor position of German banks to the Bundesbank. To avoid a drop in the overnight rate to zero, the ECB would have to offer interest-bearing investment opportunities for surplus central bank money. This can be done either through term deposits or through the issuance of short-term bonds by the ECB. In countries with high foreign exchange market interventions, such a constellation is often observed.

  13. David O'Donnell Says:

    @Karl Whelan

    I admire your patience with Herr Professor Sinn. Thankfully, I have come to the conclusion that he is but one of a (thankfully again) small number of influential (unfortunately) German academics of a somewhat narrow and zenophobic disposition, and that he is probably beyond enlightenment as he would much prefer had it never happened and a romantic elite continued to rule Germany. He is not alone – and has mirror images (thankfully again) in other EU countries, including (unfortunately) our own.

    @Herr Professor Sinn

    As Herr Professor Whelan has been described by Gene Kerrigan as a ‘responsible professor’ and I note tha he is a member of The Royal Irish Academy, I now challenge you Herr Professor Sinn to an open debate with Herr Professor Whelan, which I’m sure Herr Professor Lane, moderator of this blog, is capable of organising as part of the European Integration Group at Trinity College Dublin. I suspect that Herr Professor Habermas, holder of the Ulysses Prize from University College Dublin, might even fly in as an interested observer for such an event.

  14. Colm Brazel Says:

    I find Karl’s position paper fascinating especially since I’d also read Karl’s work on ELA, promissory notes and having read D Brennan’s link to Tornell and Westermann referred to again by Karl above, as a layperson, found the arguments compelling. Right now Karl’s article above has me confused. On the basis its better to be confused rather than misinformed, perhaps Karl can clear up some inconsistencies I find confusing; if cleared up, might help me be more informed :-)

    1)

    Suppose there was a regional bank-run in, for example, the district overseen by the Federal Reserve Bank of San Francisco and this meant that the San Francisco Fed did not have sufficient gold or securities to settle its Fedwire balance. Who does Professor Sinn imagine San Francisco Fed President John Williams is going to ask to provide the money to settle this balance? If such a scenario ever arose, Mr. Williams would most likely call Ben Bernanke to explain that the annual settling of balances would not be taking place this year. He wouldn’t find any disagreement on the other end of the line.

    (i) My understanding is not only would there be no ‘annual settling of balances’, something else would happen. The Fed would counterbalance the bank run with an infusion of liquidity to help stabilise the economic activity inside that Central Bank Area. The Fed would balance that book with taking out liquidity from other CB’s where positive balances led to too much liquidity leading to inflation in those areas.

    (ii) Karl explains “These entries correspond to loans. They are securitised loans, specifically repurchase agreements, so the Bundesbank holds a security as collateral for the (usually short) maturity period of this loan.” He explains there has been enormous capital flight into German banks as evidence of their diminishing requirement for ECB/Bundesbank lending. Fair enough, point taken, Bundesbank is not running out of money.

    But here’s my confusion. There has been huge activity by the ECB intervening in the form of the provision of ELA funding to Irish banks. This funding is significantly different to ‘securitised’ repo loans described by Karl above.

    Karl, in answer to D Brennan above, describes ELA as ‘ pure money printing ‘

    But the mandate of the ECB is it cannot indulge in ‘ pure money printing ‘. Putting 2 and 2 together, my understanding persuaded so by TW was that repo funding of ELA was required; and the Bundesbank was paying for this through the sale of securities now diminishing sharply because of these purchases. Perhaps also diminishing through events such as support of Italian bond purchases.

    Karl must agree he has given evidence

    lending by the Bundesbank to German banks – has declined in recent years, from €277.425 billion in 2008 to €37.6 billion in August 2011

    is accounted for by diminishing need for repo lending from Bundesbank by German banks.

    But he has not accounted for the effect on Bundesbank Target2 accounts re support of banks throughout the EMZ of ELA in Ireland and elsewhere across the EU and its recent interventions in the bond markets in support of Italy. Perhaps he could explain this a bit more :-) ELA is not ‘pure money printing’, it has to be accounted for in terms of repo funding backed by assets and collateral somewhere? If it was ‘pure money printing’ then the ¢40 bn or so supplied of ELA could be made disappear in the morning, as it was conjured out of nothing? So Irish taxpayers shouldn’t have to pay it back?

  15. David O'Donnell Says:

    Yeah – let’s do cartoons (It got Reagan a 2nd term; might do for Sinn)

    http://www.presseurop.eu/en/content/cartoon/1254551-crosshairs

  16. Dan Says:

    @Karl,

    Don’t look now but Martin Wolf uses Prof. Sinn to prove a point in his latest article – “The European System of Central Banks has played a huge role as lender of last resort to the banks, as Hans-Werner Sinn of Munich’s Ifo Institute argues (http://www.nber.org/papers/w17626).”

    http://www.ft.com/intl/cms/s/0/396ff020-1ffd-11e1-8662-00144feabdc0.html#axzz1fnyGaMSQ

  17. Frank Galton Says:

    Torygraph also in on the Target2 fun

    http://www.telegraph.co.uk/finance/financialcrisis/8939146/Bank-of-France-debts-jump-tenfold-on-capital-flight.html

  18. PR Guy Says:

    Thanks for the education there Prof. Whelan. I thought that didn’t sound right…

    ‘German CB sells perfectly good assets to keep PIIGS in clover and now faces disaster’ is the kind of thing a journalist makes up.

  19. Phil Says:

    Sorry but this critique mistakes the TW paper and blows smoke on the issue. Felix Salmon also mis-summarizes the TW paper a little. It’s rational for Germany to swap euro denominated private sector assets for liabilities owed by the ECB, because the ECB is the best possible euro credit – it can always repay any debt in Euros. And the Bundesbank is not taking GIIPS bank liabilities or taking GIIPS exposure – it takes ECB exposure, which is different. The problem in the mix is that the ECB is still taking GIIPS collateral and putting itself in a position to have to monetize the collateral gap. But the Bundesbank will lose either way if they hold Euro denominated private assets or ECB liabilities – so they might as well take the best euro denominated credit risk – the ECB. And they won’t sell their gold or foreign currency reserves simply because they’re not euro denominated – not because the Bundesbank is a gold bug.

    The point about German banks no longer needing funding is consistent with the TW story. In fact they actually specifically provide an example of euros flowing from a Greek bank to a German bank to explain the situation they are highlighting. Two sides of the same coin.

    People should read the TW paper themselves on Voxeu.org, slowly, and make their own conclusions. It’s all there.

  20. Karl Whelan Says:

    @ Colm

    The ELA is collateralised by the promissory notes and various promises from the Minister of Finance. ELA differs from other CB loans in that it relies on collateral that is not on the Eurosystem’s eligible collateral list.

    In relation to my answer to DB, even a collateralised loan can be described as “pure money printing” and there’s nothing in the mandate of the ECB — beyond its price stability mandate — that limits the amount of money it can create. Anyway, his two other options certainly weren’t correct.

  21. dsquared Says:

    As far as I can see, the root of the confusion here is to treat the European Central Bank as a meaningless conduit between the Bundesbank and the Central Bank of Ireland. The ECB doesn’t “borrow from the Bundesbank” in order to create lending balances in Ireland (it’s a central bank, not a bank), and so there is no need for the Bundesbank to “finance its lending” to the ECB. I think T&W have accurately characterised what the problem would be if Europe was on a gold standard and the ECB was the London Clearing House, but that’s not the case.

  22. hoganmahew Says:

    @Karl Whelan
    Thank you for that. So, if anything, what the figures show is a decline in liquidity in the German zone – the need for the Bundesbank to drain liquidity has declined.

    What’s interesting, though, is that the Bundesbank appears to be literally printing money – look at the expansion of the base notes.

    My own favourite:
    http://xkcd.com/552/

  23. hoganmahew Says:

    By the way, I’d still like to know what the initial Target2 balances were set at. Did they account for flows that had already happened? If not, then the current balances are entirely artificial. If they did, then the current balances indicate how much Germany has benefitted from the EU single market…

  24. Kevin Donoghue Says:

    From hoganmahew’s link: “Correlation doesn’t imply causation, but it does waggle its eyebrows suggestively and gesture furtively while mouthing ‘look over there’.”

    Nice one.

    Because I’m lazy and because Karl Whelan seems happy to answer questions which permit yes/no answers, I’d like to know whether he agrees with dsquared’s comment. Since they are both shrewd former central bank economists I’m inclined to take it that, if they are in agreement, then they are right.

  25. Eamonn Moran Says:

    @ Karl
    I was watching newsnight last night and I am nearly sure the German representative was spouting some of the “Bundesbank has in effect lent billions to peripheral nations” story.

    From your piece in June
    “In this sense, the Bundesbank is not owed money by the Central Bank of Ireland. It is owed money by the ECB. If the Irish Central Bank refused to pay, it would be the ECB on the hook, not the Bundesbank. The Bundesbank can only lose money if the ECB refuses to pay it back.”

    I think the problem here is that many Germans still believe that the ECB don’t print money and that every cent they give out is backed up.

  26. Karl Whelan Says:

    @ Phil

    “Sorry but this critique mistakes the TW paper and blows smoke on the issue. Felix Salmon also mis-summarizes the TW paper a little.”

    Felix summarises the paper just fine. It’s you that seems to have invented some different version of the TW paper to defend.

    Here’s what you say is going on:

    “the Bundesbank is not taking GIIPS bank liabilities or taking GIIPS exposure – it takes ECB exposure, which is different. The problem in the mix is that the ECB is still taking GIIPS collateral and putting itself in a position to have to monetize the collateral gap.”

    That’s a reasonable summary.

    Here’s what TW are saying:

    “To fund these loans, GIIPS central banks borrowed mainly – via the ECB – from other central banks, in particular the Bundesbank. In order to fund these loans, the Bundesbank sold its holdings of German assets.”

    That’s not true at all.

    Maybe you think there’s some underlying issue that should be discussed (e.g. problems with ECB collateral standards) but defending a paper that’s full of false claims isn’t a good way to have that debate.

    But I agree with you that people should read the paper slowly and decide for themselves.

  27. jmg Says:

    @hoganmahew
    On bank note issue in the eurosystem, take a look at
    John Whittaker: “Eurosystem debts, Greece, and the role of banknotes”
    LINK: http://www.lancs.ac.uk/staff/whittaj1/eurosystemNov2011.pdf
    “The inclusion of debts arising from banknote flows makes a notable difference to the overall magnitudes of these debts, compared with
    the TARGET2 positions alone.”
    See table 2 on page 3.

    The Bundesbank and the Banque de Luxembourg are now the printing press central banks in the eurosystem.
    Whittaker,page 3:”Around 98% of the Luxembourg note issue is in high value notes.”

  28. tull mcadoo Says:

    Karl,

    hypothetical question: what would be the implications for the BUBA if the Euro broke up and the porcines left and devalued by 30-40%?

  29. hoganmahew Says:

    @tull
    That’s why we are not going to be kicked out… nor Greece neither, a least, not until someone is prepared to swallow those and other losses (direct loans from banking system to ELA).

  30. hoganmahew Says:

    Oops, “direct loans to banking system from ECB”…

  31. Colm Brazel Says:

    @ Karl,

    In relation to my answer to DB, even a collateralised loan can be described as “pure money printing” and there’s nothing in the mandate of the ECB — beyond its price stability mandate — that limits the amount of money it can create.

    That was my understanding as you have clarified in your par before the second par quote above. Basically the promissory note is the collateral, a promise us taxpayers will pay it back some way, maybe give them some islands also or transfer over some other state assets, most likely though taxpayers to pay through the nose for this.

    But I disagree with paragraph above. As far as I know in Stability Growth Pact under ECB mandate, it has a governing mandate above all to reduce inflation. If it were to print money without a brake, inflation would kick in a danger of hyperinflation. Plus interbank borrowing the subject of agreements and supports from other Central Banks including the FED, CB’s of Japan, Canada etc who have to be paid back in dollars for their lending swap supports of European banks, would need a lot more euros to repay their dollar loans given that the euro would fall in value against the dollar. Plus Trichet has warned also of this ‘race to the bottom’ and is the reason for his lack of support and criticism of FED QE1/QE2

    political cartoons :-) http://politicalhumor.about.com/library/bl-economic-cartoons.htm?PS=6%3A21

  32. Colm Brazel Says:

    more paranoid psychosis here :-)

    http://politicalhumor.about.com/library/bl-economic-cartoons.htm?PS=6%3A27

  33. Target2 – The Zombie Returns | Economics Intelligence Says:

    [...] Whelan debunks the  arguments by Tornell and Westermann convincingly in a piece entitled “Worse than Sinn”. His conclusion is straightforward: “this piece has even less to add (and more to subtract, [...]

  34. Bond. Eoin Bond... Says:

    @ Colm

    “Plus interbank borrowing the subject of agreements and supports from other Central Banks including the FED, CB’s of Japan, Canada etc who have to be paid back in dollars for their lending swap supports of European banks, would need a lot more euros to repay their dollar loans given that the euro would fall in value against the dollar”

    Its a swap, the amounts for both sides (ie EUR and USD) are the same at start and at maturity, plus a minor, known adjustment.

    Also, re “If it were to print money without a brake, inflation would kick in a danger of hyperinflation” – isn’t the “without a brake” part the important qualifier?

  35. Frank Galton Says:

    This post should have been titled Peccavimus.

  36. Joseph Ryan Says:

    This issue is no longer about facts. It is about the deliberate representation of the peripherals as wasters and unnutzen essers.

    It is important to note where these kind of misrepresentations are coming from and their purpose. This false propaganda has a willing and attentive audience.

    It is important to keep refuting it.

  37. Gavin Kostick Says:

    @ Frank Galton

    One of the great puns:

    From the biog of the 19th century General Sir Charles James Napier activities in India:

    His [Napier's] orders had been only to put down the rebels, and by conquering the whole Sindh Province he greatly exceeded his mandate. Napier was supposed to have despatched to his superiors the short, notable message, “Peccavi”, the Latin for “I have sinned” (which was a pun on I have Sindh). This pun appeared in a cartoon in Punch magazine in 1844 beneath a caricature of Charles Napier. The true author of the pun was, however, Catherine Winkworth, an English girl then in her teens, who submitted it to Punch, which then printed it as a factual report.

    http://en.wikipedia.org/wiki/Charles_James_Napier

  38. tull mcadoo Says:

    JR,

    jeez, I hope you are not accusing “the core” of racial stereotyping.

  39. grumpy Says:

    @colm

    If the govt had issued a gilt instead of writing a promissory note, it would have mopped up actual money from investors. If it then pledged that gilt as collateral in exchange for money from cbi (via Anglo) then that money would go back into the system, via Anglo bondholders etc. Not much difference on balance.

    No gilt was sold though. No money was mopped up to start with. When the cbi handed out money to Anglo it was printing, on the understanding the sterilisation would take place over a length of time according to the repayment schedule for the pro note.

    Genuine, temporary printing. You can make it permanent by defaulting on the note presumably.

  40. hoganmahew Says:

    Is it not sterilized through Target2 with the Bundesbank selling assets to mop it up? ;)

  41. Assorted links — Marginal Revolution Says:

    [...] 1. How the sellers of wedding dresses limit arbitrage, and is the Target 2 debate all screwed up? [...]

  42. Karl Whelan Says:

    @KD

    Do I agree with dsqaured. Yep, completely.

  43. Kevin Donoghue Says:

    @Karl Whelan
    Thanks. The creator of the ‘shorter’ concept delivers again.

  44. grumpy Says:

    @hogan

    “You print it – vee vill burn it!” :-)

  45. PR Guy Says:

    Peston on Target 2

    http://www.bbc.co.uk/news/business-16086672

  46. rpc Says:

    Sinn et al. are obviouly right. And it’s a pitty that most people here are closing there eyes on it. So far, it’s true that the ECB hasn’t “print” any money regarding Target2 system. But if Greece and Portugal didn’t get a single dime from any private investor for at least 4 1/2 years now, and have big deficits, how are they paying for it then: THEY (their CBs) keep printing money (Ireland does it too).

    In order to keep the amount of EUR-money at a constant level, other EUR-countries have to pull out this same amount from the system. So far, the Bundesbank had to sell over 500BLN EUR of their real value assets (that they build up in over 50 years) to pay for that. In fact, this has been a big and unfortunately legal rip off of the Bundesbank by GIIPS CB’s. And Germany can’t stand it anymore.

    The USA had the same problem in the mid of the 20th century, and made some important rules to stop that (transfer of real value assets as compensation between district CB’s, no valueless junk bonds).

  47. CrisisMaven Says:

    No matter how “dangerous” TARGET balances are or not – taken together with many other measurements they show dislocations just as taking the temperature shows if someone has developped a fever or not. The question to be rased is: would such imbalances accrue if the Euro system were not in place? And the answer is simply no. Then: do these imbalances serve a positive goal? Well, I’m afraid, I don’t see why they should. Fever at least can be a step towards self-curing a malady.

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