Another Day, Another Target 2 Story

Today’s FT Alphaville carries another story by Izabella Kaminska on why the Bundesbank’s Target credit and its low level of private securities owned, em, loans to German banks may be a source of problems.

Thankfully, the Bundesbank flogging off the family silver, em, gold, has disappeared from sight. This time, Izabella cites two potential problems. Taking them out of turn, there’s the argument of Perry Merhling on factors affecting the “collateral crunch” in the banking system:

A second source of demand for collateral is the discount lending by national central banks to their own private bank clients. And a third source is the Eurosystem lending between national central banks, which takes place more or less automatically through the operation of the TARGET2 payments system.

Except that the TARGET2 credits and liabilities don’t involve the use of any collateral, so this is not, in fact, a source of collateral crunch.

Izabella’s other mechanism for concern isn’t accurate either but does have a bit more plausibility about it. She notes about the process of deposits flowing to Germany that

every time the German Bundesbank attracts commercial liabilities (deposits) via this process, in an ideal world it would want to sterilise them to keep its bond market in check with ECB policy.

In order to do that, it would be inclined either to offer domestic assets into the market outright or unwind the number of bank loans it has extended against domestic collateral

In other words, Izabella reckons that to implement ECB policy on interest rates, the Bundesbank needs to control the money supply in Germany. If this was true, and the Bundesbank had no loans to German banks, then it couldn’t cut back on these loans as a way to control this supply of money and thus influence interest rates.

This is an interesting idea but it’s also pretty far from an accurate description of how European monetary policy works. A couple of points.

First, you’ll be very hard pressed to find a real-world central banker familiar with operational issues who believes that the short-term money market rates targeted by central banks depend in some predictable way on controlling some definition of the money supply. Here and here are two good papers that discuss this issue in detail. And here and here are my own teaching notes where I discuss these issues.

To summarise, the ECB influences money market rates in the Euro area via a “corridor system” determined by the interest rates on its range of instruments (deposit facility, marginal lending facility and refinancing operations) rather than via the quantity of money supplied.

Second, in an “ideal world” (i.e. a fully functioning monetary union) the supply of money in Germany should have no influence whatsoever on the rates at which German banks borrow from each other. A bank can borrow funds from any other bank in the Euro area or directly from the ECB. Even in the ideal world that preceded the crisis, the Bundesbank wasn’t attempting to hit some target for the German money supply, so there’s no loss of control for the Eurosystem relative to what prevailed before and no loss of control over price stability.

Now, of course, the absence of an ideal world means that all sorts of other complications are affecting European money markets. The super-low rates that Izabella notes here are likely related to factors such as fears about the end of the Eurozone and the drastic reduction in the amount of assets viewed as truly safe. They’re not due to the Bundesbank losing the ability (which it wasn’t using anyway) to control the German money supply.

28 thoughts on “Another Day, Another Target 2 Story”

  1. How long before The Onion gets in on this act? “Area Man Anxious About ECB Balance Sheet.” Ye gods. Millions are unemployed, Hungary is reportedly flirting with fascism — I know nowt about that but it seems like the sort of thing the EU might be concerned with as it stages a replay of the great Depression — and apparently the VSP think we ought to spend more time analysing obscure monetary aggregates.

  2. And the source for the reporter’s story is the already repudiated VoxEU column.

    Whilst I appreciate that a public policy platform such as Vox can’t be expected to peer review/pre check articles (both due to time constraint and the fact that such articles will necessarily be more airy/opinionated)…they do need to do something about articles with a wholly false factual basis. Either withdraw such articles, or put a notice on the front of them when they’re disputed.

  3. these fastidious germans – all this talk about sterilising deposits – we’re happy just to launder the stuff 🙁

  4. This stuff is obviouly way beyond me, but it is absolutely clear that Karls criticism was one money and yet no hint of criticism of that just this comment:
    “But that’s not really the issue, in our opinion. ”

    talk about moving the goalposts..
    I’m just glad Karl is on our team – go KW

  5. The Euro system just needs a much higher Gold price – yee guys make this S$£T unnecessarily complicated.
    The Bundesbank may then sell some of the shiny stuff at 10,000 Euros but not much at 1,250.
    I imagine the eurosystem can target Gold prices just like the FED can target interest rates.
    Just like that.
    http://www.youtube.com/watch?v=zhMRJMEJW2k

  6. Ok Dork, because I’m in a good mood, I’m going to bite and live to regret it.

    Here’s an invitation: Why don’t you explain to us all — clearly and slowly, we’re not all blessed with a full insight into the Dorkian framework — how the ECB can increase the price of gold and how, if they could, this would help with anything?

  7. @all Target2 heads …

    Think it is about time Jens Weidemann posted a little Bundesbank note on the blog to provide its opinions on this vexed and vexing issue.

    Or would you prefer to communicate via the Bundestag?

  8. @Karl
    Can’t they just produce euros and bid for it at lets say 10,000 Euros and no other price.
    The assets (Gold) would be balanced against the liabilties (euros)

    What happened when Roosevelt changed the price ?
    It was fixed against the $ back then but it was revalued was it not ?
    I agree most of the worlds Gold was in the US back then but
    my hunch is that there is a huge amount of Private unofficial gold withen the eurozone especially since one of the rules of eurosystem entry is that its purchase is not taxed.
    If Europe holds the majority of the worlds Gold both Official & unofficial then it has relative control of this asset.
    Much like how the FED has control albeit complete control in that case over the Treasury market and not the Bond Bears as we were told in the 80s & 90s.

  9. This whole argument is confused and complicated by the attempt to make a distinction between the ECB and the Bundesbank.

    The ECB is the Bundesbank; really the Oberkommando der Bundesbanken, but the bottom line is that the ECB is the German national central bank in all but name. It just happens to have a wider remit nowadays.

    This goes beyond the staffing and the ethos of the bank. The ECB actively implements policies which are in the German national interest. Since 2006, the German unemployment rate has fallen from 14% to 6% as the jobs of an entire continent are flow there. In pace with those are the colossal flows of capital and cash to German banks(equally insolvent though they are). And above has the the inexorable flow of political power to Germany, and the ebb of self determination for small nations across the continent.

    Do you think all this would have happened under a French controlled ECB?

    German control of the eurozone will brook no rival, and never would. On the inception of the Euro/EMU, the Bundesbank worked hard to kick the UK out of the monetary union via interest rate manipulation. Now, that ethos has extended itself to the political domain. Germany will not brook rivals in the political sphere either, and has again booted the UK out; All the better to have its way with the misfortunate vassal states now in thrall to its dogmatic central bank. France, the Germans could always bring to heel; but the UK needs a longer leash.

    The Banking Putsch of the European Union is now complete. We are now moving closer towards a German Putsch of the EU. The chief instrument of this calamity has been the ECB–the German Central Bank. It has enabled Germany to seize the jobs, wealth, futures, and now freedom of the peoples of 25 other states.

    So please, do not confuse readers with this talk of a separate Bundesbank and ECB. They are one in the same. Just as “European monetary policy” is one in the same with “German national interest”.

  10. @ Dork

    Ok — so the plan is to buy lots of gold at an inflated price. People who owned gold would benefit disproportionately from this but all the money printed would end up inflated the economy and debts get inflated away.

    Do I have it right?

    If so, why gold. Why not just have the ECB announce that it will buy all sorts of assets at an inflated price? Why gold specifically?

    If you’re point is that the ECB should print more money, you’ll find many will agree with you. It’s the gold stuff that people don’t get.

  11. @Karl
    Gold is useful for settling foregin imbalances between “sovergin” nations when the debt paper they hold against each other is next to useless , we were told nearly all Euro debt is internal and so therefore bombproof – so a inflation of base money would not make any difference to internal euro wealth on a aggregate level as that does not disappear overnight.
    Although I am not sure what it will do to oil imports.
    Germany , Italy & France hold most of the official Gold – so they would not lose their wealth to the Greeks & Irish but we would get the debt off our backs.
    As for unofficial holders well there is a thing called capital gains tax.
    While I would be happy enough I guess to walk into Dame street very discreet like with a Pamp suisse in my pocket in exchange for the new higher price – anything more then 30 % CGT and it will be probably dug up from a bog in 1000 years or so.
    Anyhow I believe if the Euro goes down Gold will crash and the $$ will rise again.

  12. @Karl, Dork

    Gold is a very problematic asset for asset managers because of the knee-jerk reaction of many to the potential for proper printing. The presence of so many levered investors holding it – who would quite likely be shaken out in a big credit crunch needed to ‘justify’ printing means you could loose a lot of dosh being right.

    Dork, maybe a more up-to-date version of central banks buying gold would be just buying other countries currencies. Note that BB discussed this about a decade ago, and what FDR really did was to devalue the dollar against everyone else’s currency.

  13. @Grumpy
    There is no final settlement when you buy other countries paper.
    As for the $ in the 30s well the majority of the worlds Gold was in the US after the Great War , with most of it after the second round.
    If I am not mistaken the UK came off the Gold standard in the 30s , while the Dollar just set a new Gold price so other countries currencies devalued against the new $ Gold price.
    Anyhow we have a floating price now – the CBs can make it any price they want.
    But the $ petro currency which slowly began after the Great war may or may not be at a end.
    Interesting quote from FOFOA
    “The US exorbitant privilege began at the International Monetary Conference of 1922 when for the first time international banks were allowed to accept not only physical gold, but also US dollars (paper gold) as reserves. But all US dollars held by foreign banks were put on deposit back in New York City banks. And there they were counted as local US deposits, the same as if you and I put our gold into the bank, in addition to being counted abroad.

    These deposits were used as the basis for credit expansion in both the US and in the foreign countries claiming them as reserves. This process doubled the money supply paid out through the US balance-of-payments deficit for the last 88 years (except that money which France demanded in gold). US deficits never contracted the aggregate purchasing power of the US after 1922, the way deficit settlement is supposed to. It also exported US inflation outward. And it continues today.

    The only solution to this problem is the explosive expansion of the gold base (volume x price). Volume can be expanded through mining, but not fast enough to suffice in a crisis. Therefore price will take the brunt of this reset. The price of gold will explode. ”
    Also

    “Now imagine you have one country with debts denominated in goods and services. Let’s call it Greece. Greece owes Germany X goods and services. Meanwhile Germany is still exporting goods and services while Greece is still importing. This leaves Germany with a structural surplus in its Balance of Payments and Greece with a deficit. But gold can reverse this flow in an instant on the BOP at a high enough price. And once it does, it will begin to exert the brake and spur forces on the two countries until the flow of actual goods and services finally corrects and reverses. Once that flow corrects, the gold flow (which is opposite the flow of goods and services) will reverse and subsequently the brake and spur forces will also reverse.”

    PS I agree , its best to hold $$ so the bastards cannot take your shiny stuff during a deflation

  14. Gold is not gold….there is a vast difference between
    A) electronic gold via etf where same might well be backed by someone else’s rehypothecated to a fare thee well gold held god knows where
    B) electronic gold in the form of futures or options etc where at least it’s done via a central clearing house but in essence this is subject to all the good and bad of derivatives
    C) physical gold held via a certificate (but when one goes to get physical possession will the rehypothecated lent out gold be there, how will you get it and import it?) which is increasingly beginning to resemble quasi-fiat currency
    D) physical gold uniquely allocated to one, via certificate, and again if Hugo Chavez is having trouble getting his hands on Venezuela gold what is your method
    E) physical gold in hand.
    I’m not sure what kind of gold dork has in mind, but it seems E.

  15. @Tonic
    Brinks Gold held outside the fractional banking system & a few Philharmonics in your pocket in case of a complete breakdown of Law.

    The little 1/10 ounce thingies are very nice.

    But I am a captured Irish citizen , the little fishes pay CGT while the big fishes don’t pay such vulgar taxes.

  16. @OMF

    +1
    ECB have at all stages protected Germany`s interests as this crisis has played
    out you are correct in that EZ wealth is flowing in to Germany ,Munich and other German cities are experiancing property bubbles lets see this crisis for
    what it is the ECB is the stick for Germany to beat us !

  17. @OMF

    +1
    ECB have at all stages protected Germany`s interests as this crisis has played
    out you are correct in that EZ wealth is flowing in to Germany ,Munich and other German cities are experiancing property bubbles lets see this crisis for
    what it is the ECB is the stick for Germany to beat us !

  18. @Karl
    Simply put – the post Great war $ was all about digging up finite but extremely valuable oil and expressing it as credit.
    Depletion was not shown on the books.
    Remember post Great war America was both Saudi Arabia & China rolled up into one gigantic credit engine.
    In 1971 it simply reversed the flow but remained on top as it passed domestic peak oil.
    Nothing that complicated – but will Fracking bring it back to its oringinal form – who knows ?
    Money is but a energy token.

  19. In praise of the Dork.

    For he values the physical economy.
    For he is very well read.
    For he refuses to be captured in his language and even in his spelling.
    For he infuriates and distracts.
    For his is a voice crying in the wilderness.
    For he is only a Dork who weeps upon the banks of the Lee.
    For he understands the value of utilities.
    For he holds spatial economics in his mind.
    For he has not foresaken Western industries.
    For he holds out both arms and encompasses right and left.
    For he considers both small and large and does not choose between them.
    For he also considers both the particular and the general.
    For he understands MMT and judges it wanting.
    For he expresses himself in delightful ways.
    For when he wishes he can be simple, and when he wishes not he can be paradoxical.
    For he takes pleasure in history.
    For he wishes money to be a servant to people and not to enslave them.
    For he believes in labour and rest.
    For he thinks.
    For he is like a lighthouse in the fog as perceived from afar: at times there is a distinct beam at others the fog closes.

    Very loosely after Christopher Smart, in praise of Jeoffry

  20. DoC: “Nothing that complicated – but will Fracking bring it back to its oringinal form – who knows ?”

    I’d venture to suggest that things (on the energy front) are a tad complex, but the MSM Spinola tends to gloss over much of the nasty stuff, and extol so-(mis)called renewables, whilst being most artful in not mentioning, that any attempt to dis-align from FF drug dependency and re-align using clean needles and syringes, is just leading folk down a very hazardous slope. It will end very badly indeed.

    Fracking is all the neo-rage at the mo. Just give it time until folk realize – (as usual), the bad way, that it is yet another useless, expensive, and well camouflaged tax-break.

    I suppose its nice to disscuss T2 and all. I would like to see some real debate on this site about the economic (and societal) implications of high energy costs, and how we will not cope with this. Money you can print ’till the cows come home. Watts are not so easy.

    Brian

    Brian.

  21. @Brian
    The energy import dependency of Europe has gone up substantially since 1999ish – was it the Euro or was it the privatisation of state electricity companies – especially EDF.
    When the Brits only made 1 Sizewell B PWR they claimed (shock horror) that it was very expensive , when you only make 1 of a kind it tends to work out this way…….
    Now EDF is only building 2 reactors in Europe at the moment but in its prime it was building 10 to 20 a decade.
    Go figure whats wrong with Euro Energy policey ?
    Its privatised utilties running down state investments for short term gain – otherwise known as Entropy Economics.
    As for Fracking I have no idea really – US oil production is up for the first time in decades , but I suspect it is short term , but short term could be 20 years , it depends on your time frame I guess.

  22. Karl,

    Brilliant! Your resources and notes are very helpful.

    Why, in undergrad, did the neoclassicals teach me such egregious myths about how CBs influence interest rates (and, by extension, how the broader economy works)? I can’t tell you how much this upsets me and how illuminating yours, and many other perspectives, are on these matters. I read similar things in Post-Keynesian literature.

    Will this be a turning point in updating the mainstream and textbook perspective on how CBs work?

    Are the people who understand this stuff mostly banking wonks, or do you find they associate themselves with certain economic schools (New Keynesian v Post Keynesian, etc), or are these distinctions meaningless anyways?

  23. Echoing wh10, but rather late. Illuminating stuff. I likewise have been under the impression that Central Bank, er, target short-term rates through money supply rather than through money cost.

    One bit I still don’t quite get – how do they put a floor under lending rates? I can see how they can put a ceiling on them, but how do they stop market rates in super-liquid, but constipated markets from heading down when the reported rates in those markets are from banks that are likely to be stronger (Deutschebor, for example, being from the German banks who will lend to each other for near nothing (on the basis that the German state stands behind them all) but not to furriners? Is it just the deposit rate that provides this floor?

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