More Target 2 Fun: Bloomberg Edition

This post was written by Karl Whelan

This could have been a useful contribution to the discussions about Target 2 if it was tweaked a bit.

For instance, the following slight re-wordings may have helped to inform rather than mislead:

Involuntary money acquisition is what happens when your spouse wins the lottery and gives you loads of money. At some point it dawns on you that you’re rich.

Or this

The bottom line: Germany’s Bundesbank—BuBa for short—has quietly, automatically received €495 billion to the European Central Bank via Target2.

Ok, no big deal. Financial journalists in getting things wrong shocker!

However, the piece does address a new aspect of the question that was not discussed in earlier discussions about the Target 2 balances. What happens if the Euro area breaks up?

Mr. Coy from Bloomberg is pretty sure it will be bad for Germany:

If the euro zone breaks into sorry little pieces, Germany could possibly lose its entire €495 billion claim. That’s more than $650 billion. It is 60 percent bigger than Germany’s annual federal budget.

But let’s take a closer look. Who is this “Germany”? Will the German residents who got their accounts credited as a result of the Target2-facilitated transfers out of Ireland now lose their money? No. There will be no losses to private citizens. Despite all this misleading stuff about “enforced lending”, German citizens will be very grateful that they managed to repatriate their money to German via Target2.

So who loses? Well, the Bundesbank has a Target2 credit from the ECB, an organisation that used to be considered sound and a good credit because they have the power to print money.

If the ECB ceases to exist and the Bundesbank wanted its balance sheet to still balance, it could simply replace the “Target2 credit” by writing itself a big check and sticking it in the vaults. Call it “Sondervermögen Ersetzen Vermögensverwaltung Früher als Target2 Kreditkarten Bekannte“ (“Special Fund Replacing Asset Formerly Known As Target2 Credit” – blame Google Translate!)  Just like that, the Bundesbank’s balance sheet is balanced again.

Now watch how many commenters will try to convince you that placing a piece of paper in an empty vault will unleash hyperinflation.

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65 Responses to “More Target 2 Fun: Bloomberg Edition”

  1. RebelEconomist Says:

    So, you seem to saying that Sinn is right, and that Germany has indeed loaned a lot of money to Greece, albeit via the eurosystem, which it can lose if the eurosystem breaks up. And make no mistake, this would be a real loss to Germany, because the eurosystem credit bore interest paid by the rest of the eurosystem, whereas any interest on the Buba’s replacement assets (realistically, bunds granted to the Buba) would be paid by Germans.

  2. David O'Donnell Says:

    Oops - just posted above ….

    An alternate theory is that there’s really nothing to worry about. University College Dublin Professor Karl Whelan says Sinn, Tornell, Westermann, and other economists who have raised red flags over Target2 are being alarmist. While Europe has plenty of other problems, “this is a crisis that is not about to happen,” Whelan wrote in a recent article posted at VoxEU.org, a forum mostly for European economists.

    In an interview with Bloomberg News on Dec. 13, Bundesbank President Jens Weidmann expressed more concern about the collateral than the volume of ECB balances. “In a situation like the current one, where we are providing solvent banks with liquidity,” he said, “for me the size of the Target2 balances is less important than the risks we are taking on. It is my concern that we limit these risks as much as possible.”

    The clarity of the Bundesbank now parallel to the decisiveness of the ECB.

  3. Ludwig Heinrich Edler Says:

    Now watch how many commenters will try to convince you that placing a piece of paper in an empty vault will unleash hyperinflation.

    Hyperbolic and sarcastic anticipation of objection - an effective, if somewhat poisonous, rhetorical device. You nearly scared me away from even trying.

    But let me see:

    Bundesbank lends €100 to ECB. ECB breaks up. Bundesbank writes off €100 debt and prints a new €100 asset.

    Fine. But the €100 still exists in the wider euro monetary system.

    So it’s not the piece of paper in the empty vault that is the problem, it’s the fact that this paper has been used twice in the money supply.

    How is that not inflationary, unless the Germans up and leave the €uro?

  4. Brian Di Palma Says:

    It’s inflationary if it gets spent and put into the real economy but if it’s sat on because of sheer terror then that won’t cause inflation.

  5. Karl Whelan Says:

    @ Rebel Dude

    “So, you seem to saying that Sinn is right, and that Germany has indeed loaned a lot of money to Greece”

    Here’s how the Target 2 debate proceeds:

    “Karl Whelan: White is white

    Random Internet Commenter: Aha, so you agree with Professor Sinn that Black is White”

    In relation to interest bearing assets, the Buba could add to the “Special Fund” each year an amount equal to the interest on the Target2 credit, i.e it could mimic the Target 2 credit in every way.

  6. Karl Whelan Says:

    @ LHE

    “How is that not inflationary, unless the Germans up and leave the €uro?”

    I was under the impression we were talking about Germany leaving the euro.

    Nor was there anything sarcastic about the “paper in the empty vault” remark — you do appear to think this would be inflationary.

  7. Ramanan Says:

    “But let’s take a closer look. Who is this “Germany”? Will the German residents who got their accounts credited as a result of the Target2-facilitated transfers out of Ireland now lose their money? No. There will be no losses to private citizens. Despite all this misleading stuff about “enforced lending”, German citizens will be very grateful that they managed to repatriate their money to German via Target2″

    This is incorrect Karl.

    The Net International Investment Position of Germany reduces by €500bn or whatever. This number is Germany’s Net Asset Position.

    “Who is Germany” is best answered by the International Investment Position way of doing accounting.

    The TARGET2 balance of BUBA is included in the International Investment Position.

    So the nation as a whole loses €500bn (at least), even without considering other assets which will be defaulted on such as other sectors’ assets held abroad.

    [Of course, I believe in most of what you say and nothing of Prof Sinn and Co. ]

  8. Ramanan Says:

    PS:

    I believe most of what I quoted from you, but the fact is you quoted that in reply to Bloomberg which was right on this particular point.

    Anyway I think, your intuition of “who is Germany” is inaccurate.

  9. RebelEconomist Says:

    Perhaps the Buba could add to the “special fund”, but that would not generate external income for Germany, which the TARGET2 claim does.

    By the way, I am hardly a random internet commentator. I have thought about this quite a lot: http://reservedplace.blogspot.com/2011/07/right-on-target.html

  10. Ludwig Heinrich Edler Says:

    @ Karl Whelan,

    Well, it’s inflationary unless the BB and the German govt, post-breakup, do some drastic capital controls to stop the slosh of old euros coming into the Neumark zone.

    That’s a pretty severe game of chicken, when you think about what that kind of a closed Neumark would mean for German exports. (Neumark would then hugely increase in value against le nouveau franc, an punt nua, het nieuwe gulden, nea drachni, etc.,…making Mercedes’ very pricey indeed on the export market)

    Certainly, it’s not as simple as the magic empty vault you are making out.

  11. RebelEconomist Says:

    LHE, the hole in the Buba’s balance sheet would not necessarily be inflationary, as it would not affect the amount of base money in circulation. However, an inflationary danger would arise if the Buba needed to allow the base money supply to contract for some reason, and, because of its losses on TARGET2, did not have enough marketable assets to sell for the purpose. Instead of selling its own debt or asking for a grant of debt from the government, the Bundesbank might then be tempted not to absorb the surplus base money and to allow prices to rise rather than to realise its loss on TARGET2. But, knowing the Bundesbank and the Germans, they would not do this.

  12. Karl Whelan Says:

    @ LHE

    “it’s inflationary unless the BB and the German govt, post-breakup, do some drastic capital controls to stop the slosh of old euros coming into the Neumark zone”

    I really don’t know what you’re talking about. The new BB and German government can do whatever it wants — capital controls, restricted supply of new marks, high interest rates. It’s currency will likely hugely appreciate making Germany’s exports far cheaper.

    Deflation rather than hyperinflation due to the magic check in the empty vault is a far more likely post-breakup scenario for Germany.

    But I don’t expect to see much else from German commentators other than worrying about inflation.

  13. The Dork of Cork Says:

    I think we have to make a distinction between the remaining wealth in the eurozone and claims on that wealth.
    The present monetory systems claims on this wealth is interfering with new wealth creation , that is pretty clear to see - as the stock of real physical wealth either human or inanimate is depreciating faster then creation as year passes after year.
    ( what is actually happening is that stocks of wealth in certain areas are declining to feed wealth claims in other areas - but most of this stuff is consumption of one sort or another , very little of what I consider as core capital creation is being built - so in the long term this is a pointless exercise)
    In a closed system what goes around comes around -Somethings got to give.

    As a side issue what happens to German banks credit deposits if they decide to leave ?
    As far as I know they have not deleveraged , unlike the Irish to some extent although at our own expense.
    Will the Bundesbank have to defecit spend on a huge scale if they eject ?
    We took the meat out of the fridge & found it rotten but at least we can feed it to the dog.
    But the German stuff may be going straight to landfill.

  14. JKH Says:

    My quick impression is that both RebelEconomist and Ramanan have a similar point, from slightly different perspectives.

    Yes, the hole in the Bundesbank balance sheet can easily be filled in an accounting sense.

    But there is an opportunity cost in the sense that the Bundesbank will lose revenue permanently that otherwise would have flowed from the collective EZ capital and profit share of the ECB, as interest paid on the TARGET credit balance. That’s real external revenue, and it would have floated according to policy rates in the future, including potential future increases in policy rates.

    Basically, if you capitalize that expected future revenue, you get the value of the asset. So it is a real loss (except for Germany’s existing share of ECB participation).

    The fact that both Rebel and Ramanan have a similar point that’s joined at the hip leads me to believe they’re right, although that’s just a first impression.

  15. Karl Whelan Says:

    I can see I’m never going to convince the various anonymous commenters here but let’s have one last go.

    @ Ramanan

    Between “This is incorrect Karl” and “I believe most of what I quoted from you” I’m not sure what you’re objecting to or agreeing with.

    @ Ramanan\JKH

    Fine, write off the €500 billion and call it a hit the German IIP position if you want. All this entry corresponds to is a claim on a central bank which can print money. I’ve pointed out that the new Buba can write out a new piece of paper that’s worth the same amount, add interest to it every year, and keep it in a vault somewhere. This exactly offsets any perceived loss.

    I think what people are missing here is that central bank assets are not a good way to think about the wealth of a nation.

    A central bank can have as many assets as it wants by printing money and acquiring them. And it can send the revenues from these assets back to the fiscal authority if it wants. However to do so in a big way tends to lead to inflation.

    In this example, the central bank loses one asset and replaces it with a piece of paper with a face value and interest pattern that mimics the original asset. No loss in wealth for the Bundesbank and no new money circulating in the private sector (deposits have not changed) so no inflation either.

    Ok, that’s more than enough for now.

  16. Ramanan Says:

    My point was that Karl Whalen unnecessarily nitpicked a point made by Bloomberg. The Bloomberg point

    “If the euro zone breaks into sorry little pieces, Germany could possibly lose its entire €495 billion claim. That’s more than $650 billion. It is 60 percent bigger than Germany’s annual federal budget.”

    Karl Whalen is correct in one sense, though ultimately wrong.

    This can be seen by construction a hypothetical scenario:

    Let us assume that for some reason Germany has to pay a fine as decided by international courts for some reason which has nothing to do with a breakup. It is decided Bundesbank foots the bill (€500bn) and the German government is supposed to pay this back over time to Bundesbank. The fine is paid equally to all governments except the German.

    Initially Buba’s TARGET2 assets is reduced by €500bn

    Nothing much happens to Germany’s demand here. No recession.

    It can lead to an increase in demand in the rest of the Euro Area since it will increase demand there (if the foreign governments decide to relax their fiscal stance as a result of gaining from this huge inflow) and can be beneficial to demand in Germany since its exports increase.

    At any rate, it is misleading to suggest that Germany did not lose anything.

    What is hidden in my scenario is that the German public debt increases and it reduces the “fiscal space” Germany’s government has.

    And yes, as JKH suggest, it is the loss of future income for Germany as a whole since it is losing an interest earning asset.

  17. Ramanan Says:

    “@ Ramanan

    Between “This is incorrect Karl” and “I believe most of what I quoted from you” I’m not sure what you’re objecting to or agreeing with.”

    Karl (with apologies for misspelling your surname earlier),

    I agree with most of your writings on TARGET2 mechanics.

    I disagree with your stand that it isn’t a loss to Germany.

  18. Ramanan Says:

    “I think what people are missing here is that central bank assets are not a good way to think about the wealth of a nation.”

    That’s a key point/opinion around which the debate can be won.

    The People Bank of China’s foreign exchange reserves is a lot of wealth for China. It reduces external risks for China by a considerable amount.

    Similarly, Buba’s external assets is part of wealth for Germany.

  19. Karl Whelan Says:

    “Buba’s external assets is part of wealth for Germany.”

    The target 2 credit is not foreign-currency denominated assets. It does not play the same role as the large accumulation of foreign assets that some Asian central banks have run up. Replacement of one domestic currency asset (the euro asset that is the Target 2 credit) with another (the D-mark check in the magic vault after euro breakup) will keep things exactly as they were before and won’t affect Germany’s holdings of foreign-currency denominated assets.

    But look, you guys can believe what you want. Hopefully, the breakup thing will never happen, so this turns out to be irrelevant.

  20. Ramanan Says:

    “The target 2 credit is not foreign-currency denominated assets.”

    Does not matter which currency it is denominated in.

    The German Bundesbank counts both Euro-denominated external assets and non-Euro denominated external assets in Germany’s net asset position.

    “won’t affect Germany’s holdings of foreign-currency denominated assets.”

    No because Bundesbank will suffer impairment of assets and it reduces the rest of the world’s indebtedness to Germany. Germany’s net asset position reduces if Bundesbank’s TARGET2 assets suddenly becomes zero.

    “But look, you guys can believe what you want.

    If a breakup does not happen, then what you say is partly true. A domestic resident moves his/her/its assets abroad to Germany and it does not change Germany’s net asset position. However, if a default occurs, it reduces Germany’s net assets.

  21. Johan Says:

    LHE,

    Between 1999 and 2010 German prices rose less than 1% per annum (accumulated inflation 10%), when they shoud have risen by 2%. France has stayed almost exactly on target and has seen it’s prices rise by 25%. Southern Europe has seen it’s prices rise by 35%. In other words Germany has deviated the most from the 2% inflation target. This is in almost spooky correlation with Unit Labour costs. Arguably this is gaming the Eurosystem by playing a beggar thy Euroneighbours policy. Even France, which has been a model of correct behavior, is now suffering from a trade deficit. This is no doubt why Merkel insists budget deficits are the illness, rather than a symptom of economies that can’t compete with Northern Europe.

    If Germany still had the D-mark it would be considerably stronger than the Euro, whereas under the Euro the averages means it’s kept artificially low by the weaker economies. This means an excess of money flow to Germany, which according to classical theory leads to inflationary pressures as in a currency union no automatic adjustment is possible through appreciation. If Germany left the Eurozone the D-mark would automatically appreciate, lessening inflation pressures, on top of which cheaper imports and greater competition provides an additional disinflationary impulse. So I’d say from a German inflation perspective it’s safe to write a ginormous cheque for a bank vault.

  22. JKH Says:

    “A central bank can have as many assets as it wants by printing money and acquiring them. And it can send the revenues from these assets back to the fiscal authority if it wants. However to do so in a big way tends to lead to inflation.

    In this example, the central bank loses one asset and replaces it with a piece of paper with a face value and interest pattern that mimics the original asset. No loss in wealth for the Bundesbank and no new money circulating in the private sector (deposits have not changed) so no inflation either.”

    That’s not correct.

    You’re confusing the effect of central bank assets swaps in the domestic currency (which has zero net effect on wealth) with a central bank loss on a foreign asset (which does have a net loss effect on weath, because the Euro has the financial characteristics of a foreign currency for the Bundesbank, and this effect will be galvanized if the Euro collapses.)

    It’s analogous to the US defaulting outright on Chinese holdings of its treasuries - i.e. no US dollar credit whatsover to the PBOC account at the Fed when they come to deliver their treasuries. That’s a net wealth loss to China, and no amount of domestic Yuan monetization can change that marginal effect on Chinese wealth.

    The point is that the monetization of domestic currency assets is always an option for a central bank, so there must be a marginal effect relative to any such domestic monetization opportunity when one starts to write off foreign currency assets.

  23. Karl Whelan Says:

    @ Ramanan\JKH

    Sorry guys, I’ve much better things to be doing. Let’s just say I don’t agree with the various arguments and have explained why.

    Hopefully we can agree we will have far more to worry about if a Euro breakup actually happens than what the poor Bundesbank has to do about its Target 2 credit.

  24. colm brazel Says:

    @ JKH

    RE “It’s analogous to the US defaulting outright on Chinese holdings of its treasuries - i.e. no US dollar credit whatsover to the PBOC account at the Fed when they come to deliver their treasuries. That’s a net wealth loss to China, and no amount of domestic Yuan monetization can change that marginal effect on Chinese wealth.”

    Nope, false comparison.

    Difference is Central Bank of China is not one of the FED Central Banks in the USA. China is not a US state; whereas Germany is part of the EMU.

    Buba is part of the euro and the EMU. Losses will have to be shared as part of a currency writedown. In one sense, Buba already has a share in these losses and so ’so-called’ external assets do not exist, external liabilities because of the failure of the euro exist.

    I think there is confusion above on what exactly an asset is. In one sense, a breakup of the euro will be a liability for all concerned. Buba is part of the ECB as the other CB’s are. My own limited understanding of this is, best to look at this in terms of a writedown of loss for all concerned.

    The so-called external assets on Bubas books are toxic in the real sense of the word. They have as much value as some of the US OTC’s based on subprime and are worth virtually nothing.

    When Buba returns to the DM this will be a new beginning. I’m not at all knowledgeable in these matters, but my understanding is, it can print any amount of money it likes and float that currency on world currency markets.

    So-called €495 bn claim of Germany on a currency that is history is like a claim in a game of monopoly; if that currency ceases to exist. Especially if that currency ceases to exist because of default on outstanding debt.

    It could even peg its currency to gold, which would be very interesting. Some International Court of Settlement would have to examine these issues and make a judgement. Thanks for making matters even more confusing :-)

  25. Bond. Eoin Bond... Says:

    @ Karl

    Who are the New Kids on the Block? Something smells here. Sinn has directed his minions?

  26. The Dork of Cork Says:

    @Colm
    Not a good idea to peg your currency to Gold or anything else if you have little control of it.
    Germany might have more Gold then anybody else bar the US but I suspect the German goverment & German citizens combined have very much less then Half the worlds Gold.
    As for Euro countries / citizen subjects as a collective - well thats a different matter - but we just don’t really know.
    But the CBs have a good Idea I am sure.

    Only dominant countries such as Britain pre Great war or US post war can do the Gold standard thingy half properly.
    However bidding up the price of the shiny stuff does not mean its a standard - it can become a new range , from a low 4 digit figure to a low 5 digit figure sounds about right for a Dork.
    Anyway - “Sondervermögen Ersetzen Vermögensverwaltung Früher als Target2 Kreditkarten Bekannte“ (“Special Fund Replacing Asset Formerly Known As Target2 Credit” - does not have much Gravitas.

    When you get a crisis of confidence in claims on wealth in a fractional system then Gold is the simplest solution if you hold the majority of it.
    Its partly a psycological thingy but also you can’t just make the stuff up , unless the CBs are lying about their holdings which is a possibility I am afraid.

    Its looking more likely that the dollar will win this one if the Euroclub cannot agree to produce credible money to pay the debt.
    The wealth remains but the debt is killing the organism.

  27. David O'Donnell Says:

    bulldog had to pop in: CARTOON OF THE DAY

    United Kingdom
    Bulldog spirit
    15 December 2011 The Guardian London

    http://www.presseurop.eu/en/content/cartoon/1294501-bulldog-spirit

  28. David O'Donnell Says:

    @Johan

    ‘So I’d say from a German inflation perspective it’s safe to write a ginormous cheque for a bank vault.

    May I quote you on that one? No shortage of vaults …

  29. hoganmahew Says:

    Best thing to do, then, to avoid the risk of hyperinflation in Germany would be for Germany to buy tangible assets in the countries that ‘owe’ then the target2 balances. Given the risk of breakup, they’d better spend quickly.

    I have a couple of bridges and an Anglo shell building I’d like to sell them. I’ve a fishing village in Roscommon that I’m sure they’d love too…

  30. Nick Rowe Says:

    Well, quite a gathering in the comments here!

    Finally, with the help of Karl, and Bloomberg, I think I am maybe starting to understand this Target 2 business. But I’m not satisfied with Karl’s final answer. And it has nothing to do with hyperinflation.

    Let me re-phrase the question this way:

    Originally, in the Bloomberg piece, a German-produced truck went from Germany to Greece. Then a lot of bits of paper (IOUs) flowed the other way, from Greece to Germany, via the ECB.

    If the ECB goes bust, when do the Germans get their truck back? (Or, when do the Germans get back some real good or service, not just a bit of paper, in exchange for the truck?)

  31. Kevin Donoghue Says:

    Nick, the simplest case is where the Greek truck-buyer borrowed the money from Commerzbank. Assume this truck is the last straw which breaks the Euro’s back. The loan goes bad, Commerzbank goes bust, angry depositors who have lost money start a revolution and restore the Bundesbank to its former glory. ECB HQ is looted and destroyed. The site becomes a memorial to the losses suffered by hardworking Germans and an inscription proclaims that Germany will never again enter a monetary union with anyone, not even Austria.

    If the Germans want the truck as compensation for the loss of Commerzbank they are going to have to send the Wehrmacht I think. More realistically, they are just going to have to swallow the loss. But what’s that got to do with Target2? Why bring in all this drivel about settlement systems into a simple story of default?

  32. Kevin Donoghue Says:

    Whoops, I believe it’s called the Bundeswehr now. My apologies to all members.

  33. RebelEconomist Says:

    Don’t forget Nick, that although Sinn originally emphasised TARGET2 imbalances as funding for the, say Greek, trade deficit, more recently the flows have been associated with capital flight, in which case Germany swaps a claim on the eurosystem (matched by a Greek eurosystem liability) for a deposit liability to a Greek. At that point, no real good or service has been supplied by Germany. However, the German TARGET2 claim bears interest, which effectively entitles Germany to a net flow of goods and services from the rest of the eurosystem as long as the claim exists. The made-up Buba asset that Karl postulates would not. And if the imbalance exists only between Germany and Greece, all of that net flow of goods and services must come from Greece.

    Karl seems to be getting confused about gross and net flows, imbalances and risk (ie the involvement of the eurosystem makes no difference to the net flows, but essentially provides Germany with a CDS on Greece), and states and currency areas.

    If I have not done so to you already, Nick, may I suggest that if you want a detailed account of the mechanics of TARGET2 in one place, you read my blog post: http://reservedplace.blogspot.com/2011/07/right-on-target.html

  34. hoganmahew Says:

    @RebelEconomist
    “the German TARGET2 claim bears interest”

    :? I think you are making this bit up.

  35. Kevin Donoghue Says:

    Dunno, maybe it’s included in verschiedene posten, die nicht anderswo specied ;)

  36. Karl Whelan Says:

    @ Rebel

    “Karl seems to be getting confused about”

    Feel free to come on here and tell me I’m confused — I’m used to getting stick for various things.

    At the same time, I still think you’re spouting nonsense (”essentially provides Germany with a CDS on Greece …”)

    You may have thought about this a lot. That doesn’t mean you’ve got it right.

    We’ll have to agree to disagree.

  37. Karl Whelan Says:

    @ Nick

    “Originally, in the Bloomberg piece, a German-produced truck went from Germany to Greece. Then a lot of bits of paper (IOUs) flowed the other way, from Greece to Germany, via the ECB.

    If the ECB goes bust, when do the Germans get their truck back? (Or, when do the Germans get back some real good or service, not just a bit of paper, in exchange for the truck?)”

    I assume by ECB goes bust, you mean the end of the Eurosystem and the return of a system of national currencies.

    Pretty clearly the Germans wont’ want the now-dirty-and-smelly truck back. So what have they got instead? They received euros, which then got redenominated into new D-Marks, which will likely rapidly appreciate relative to the weighted average of the currencies of the other 16 euro members. The end of the euro is not a return to barter or the end of fiat currency systems.

    The Germans can likely go back to Greece and buy two trucks with their new D-Marks, so don’t feel too sorry for them.

  38. Nick Rowe Says:

    Karl: thanks.

    When I first read Hans-Werner Sinn’s piece on Target 2, and the various responses, I really couldn’t get my head around it all. Now I feel I am getting my head around it. So, from my point of view, this whole debate between Karl and Hans-Werner has been a good one, eventually.

    Back to the truck. The way international trade and finance is supposed to work is like this: A German gives a truck to a Greek. Then many years later the Greek gives some olive oil to the German. (Or, the Greek gives some olive oil to a Canadian, who gives some maple syrup to the German, etc.)

    If the ECB goes bust, how does the Greek end up giving olive oil to the German? Following Karl’s response, this is the only way I can see it happening: the Greek wants to hold New Deutschmarks. The German government gives the German some New Deutschmarks, which the German uses to buy the olive oil from the Greek, and the Greek holds onto the New DMs.

    As far as I can see, Karl’s story works if and only if, post ECB going bust, the Greeks want to permanently hold a stock of New DMs equal in value to the Target 2 balances. That will probably be partly true, but I wonder if the magnitudes will be big enough?

    (Of course, if the ECB goes bust, and the whole Euro thing goes belly up, Target 2 balances probably won’t be the biggest thing on anyone’s mind.)

  39. Kevin Donoghue Says:

    …Karl’s story works if and only if, post ECB going bust, the Greeks want to permanently hold a stock of New DMs equal in value to the Target 2 balances.

    Is that an equilibrium condition of some sort? Supposing it is, why should Greek demand be considered in isolation? And if all that’s required is that the market value of the stock of New DMs must equal something-or-other, shouldn’t the FX market be capable of ensuring that it does?

  40. RebelEconomist Says:

    @hoganmahew

    You can work out that TARGET2 balances are remunerated at the ECB’s refi rate from this document http://www.ecb.europa.eu/ecb/legal/pdf/l_03520110209en00170025.pdf by reading recital 8 (which specifies the remuneration rate) and Annexes I and II which include TARGET2 liabilities and assets respectively. Alternatively, you can just believe John Whittaker’s paper http://eprints.lancs.ac.uk/51933/4/eurosystem.pdf (bottom of page 1).

  41. RebelEconomist Says:

    Karl, simply stating your opposition to what I (or others) write is not going to get either of us much further. What do you disagree with in my explanation to Nick Rowe?

    The reason why I make the CDS point is that you seem to believe that because Germany stands to lose only its capital key share of its TARGET2 claim if Greece defaulted (assuming the simple one creditor one debtor example), it is not the case that Germany did not lend the amount of its TARGET2 claim to Greece. Germany has indeed lent that amount of money to Greece, but the risk is shared by other members of the eurosystem. A CDS allows the unbundling of the amount of debt and the risk.

    Where I think you err in your explanation to Nick is that you seem to think that the Germans have received euros for their truck. That is not really the case. The truck seller received euros in their bank account and their bank received euro reserves in their Buba settlement account, but the Buba received an interest-bearing claim on the eurosystem. The problem is that this claim may cease to exist if the eurosystem ceases to exist, whereas the Buba will probably still honour its euro reserves liabilities converted to New DMs. The hole in the Buba balance sheet is a hole in the German national balance sheet.

  42. RebelEconomist Says:

    For “risk” in paragraph 2 above, I mean credit risk only of course.

  43. hoganmahew Says:

    @RebelEconomist
    “The net balance of the intra-Eurosystem claims and liabilities on euro banknotes in circulation should be remunerated by applying an objective criterion defining the cost of money. In this context, the main refinancing operations rate used by the Eurosystem in its tenders for main refinancing operations is regarded as appropriate.”
    That recital 8?

    It specifically mentions banknotes, but not Target2 claims. Mr. Whittaker appears to have expanded this to all claims, but I do not see where that is supported by the ECB document. While Target2 liabilities/assets are included in the liability base as are banknotes in circulation, it appears to me that it is seignorage that this document is talking about, not the overall liability base.

    No?

  44. hoganmahew Says:

    PS I accept that you didn’t make it up and sorry for saying so.

  45. Kevin Donoghue Says:

    But the hole is plugged with the Sondervermögen Ersetzen Vermögensverwaltung Früher als Target2 Kreditkarten Bekannte. Problem solved.

  46. Ramanan Says:

    “The hole in the Buba balance sheet is a hole in the German national balance sheet.”

    Good point RebelE.

    The fundamental error of the main post is the implicit assumption that “Germany” is made of just individuals and not institutions.

  47. Ramanan Says:

    “But the hole is plugged with the Sondervermögen Ersetzen Vermögensverwaltung Früher als Target2 Kreditkarten Bekannte. Problem solved.”

    Nothing net has been created. It increases Buba’s assets and increases the German government’s liabilities.

    It doesn’t put the Net Asset Position of Germany to the level back to where it was before Buba’s external assets vanished.

  48. Kevin Donoghue Says:

    No, Karl’s proposal doesn’t increase the German government’s liabilities. Not that it would matter if it did. The Buba can treat the asset in its books as a loan which it has granted to God, to be repaid by Him on the Day of Judgement.

  49. Kevin Donoghue Says:

    How long before someone brings the fiscal theory of the price level into this?

  50. hoganmahew Says:

    @Rebel Economist
    http://www.bundesbank.de/download/volkswirtschaft/jahresberichte/2010gb_bbk_en.pdf
    p.170 (as referenced by Mr. Storkbeck)
    “Sub-item 9.3 “Claims related to the allocation of euro banknotes within the Eurosystem (net)” shows the claims which arise from applying the euro banknote allocation key. Like at the end of 2009, the Bundesbank again had no claims at the end of 2010 but, instead, liabilities, which are shown in liability sub-item 9.2 “Liabilities related to the allocation of euro banknotes within the Eurosystem (net)”.

    A daily net balance vis-à-vis the ECB is derived from the TARGET2 settlement balances between the central banks of the ESCB. This balance is generally remunerated at the respective interest rate for the main refinancing operations. At the end of the year, the Bundesbank had net claims amounting to e325,556 million (2009: e177,723 million), which are shown under sub-item 9.4 “Other claims within the Eurosystem (net)”. On a daily average, the interest-bearing net claims arising from TARGET2 settlement balances amounted to e244,921 million (2009: e177,498 million).”

    I disagree, though, that the flow is necessarily from liability holder to asset holder. It appears that there are two claims. One by the ECB on, say, the Irish NCB and one by the Bundesbank on the ECB. Only in the case that the ECB disappears does the Bundesbank lose out. This, presumably, would be the case if the euro collapses. Would the ECB repudiate what it owes to the Buba if Germany left the euro? Would it repay in depreciated euros?

  51. hoganmahew Says:

    Does anyone know what the starting Target2 balances were? (Yes, I’m asking the same question again).

  52. Karl Whelan Says:

    @ Rebel

    I’ve spent more time explaining this issue than almost anyone. I’ve explained my position to you in detail, You don’t want to agree with it and you keep repeating basic mistakes such as confusing Eurosystem lending with the Target balances (”Germany has indeed lent that amount of money to Greece ….” — No, really, no.)

    At this point, I don’t owe you any more of my time. Feel free to declare victory if you want.

    As I’ve said, I suspect you’ll have a lot more to worry about if the euro breaks up than the Buba’s dear old Target balance.

  53. RebelEconomist Says:

    @hoganmahew,

    Yes, you have it; that’s a good reference. The TARGET2 balances are monetary, because they offset a change in reserves, so they bear interest at the refi rate. Ideally, they would have started at zero all round, but perhaps there were some legacy balances assigned from TARGET1.

    I agree that there is no net flow of euros. The Buba accepts a claim on the eurosystem and credits the reserve account of the bank receiving a euro payment “from Greece”. The Bank of Greece does the opposite, so the Buba is effectively lending the outward payment back to Greece. In normal times, the private sector could be expected to do that.

    As you say, Germany might lose its TARGET2 claim if the eurosystem vanished, but note that it would also lose according to its capital key if just Greece defaulted on its debt to the eurosystem. If Germany left the eurosystem, then presumably the eurosystem’s other members would have to either pay Germany off, or negotiate gradual repayment of its TARGET2 claim.

  54. Ramanan Says:

    “(”Germany has indeed lent that amount of money to Greece ….” — No, really, no.)”

    Yes, really, yes.

    “The ECB and each of the NCBs shall open an inter-
    NCB account on their books for each of the other
    NCBs and for the ECB. In support of entries made
    on any inter-NCB account, each NCB and the ECB
    shall grant one another an unlimited and uncollateralised
    credit facility.”

    “To effect a cross-border payment, the sending NCB/
    ECB shall credit the inter-NCB account of the
    receiving NCB/ECB held at the sending NCB/ECB;
    the receiving NCB/ECB shall debit the inter-NCB
    account of the sending NCB/ECB held at the
    receiving NCB/ECB”

    from http://www.ecb.int/ecb/legal/pdf/l_01820060123en00010017.pdf

    notice:

    “grant one another … credit facility”

    and from the ECB Annual Report,

    “These bilateral balances are then assigned to the ECB on a daily basis, leaving each NCB with a single net bilateral position vis-à-vis the ECB only. ”

    Etc.

    It is misleading to say “The Bundesbank is not lending money to GIIPS central banks”

    The NCBs lend each other bilaterally and settle it at the ECB at the end of the day.

    I understand that in the original article Sinn made a lot of mistakes but I believe those who have taken him to task have been incorrect themselves on various points.

  55. Kevin Donoghue Says:

    Have we reached the point where a credit balance for the Dallas Fed in the books of the Cleveland Fed is to be regarded as a loan from Texas to Ohio?

  56. Karl Whelan Says:

    @ Ramanan

    Even the quotes you provide undermine the case you’re making. Let’s look at the quote you provided in relation to the relevant transaction.

    “To effect a cross-border payment, the sending NCB/ECB shall credit the inter-NCB account of the receiving NCB/ECB held at the sending NCB/ECB”

    It is a credit that the Bundesbank receives via the ECB, to pass on to German banks. It is not a loan from the Bundesbank to Greece or Ireland or wherever.

    Anyway, I’m not wasting any more time on you either. You may think this is great academic fun but people like you are contributing to stirring up intra-Eurosystem resentments by presenting credit flows from the periphery to Germany as if they are the going in the opposite direction. I hope you’re getting a kick out of it because I sure am not.

  57. hoganmahew Says:

    @Rebel
    “Ideally, they would have started at zero all round, but perhaps there were some legacy balances assigned from TARGET1.”
    If this is the case, then it is clearly wrong to say that Ireland ‘owes’ Germany. All we are seeing then is negative numbers that correspond to previous positive numbers. The money had to ‘flow’ to Ireland originally and now it has ‘flowed’ out. Net effect, zero…

    “note that it would also lose according to its capital key if just Greece defaulted on its debt to the eurosystem. ”
    The ECB is the central clearing house, it is the clearing house that owes and owns. Germany, like any remaining members might have to stump up to recapitalise the ECB, but that is about it. Think of it like a credit card - when you buy something on your Mastercard (other cards exist), you don’t owe money to the retailer, you owe money to Mastercard and they in turn own money to the retailer.

  58. Karl Whelan Says:

    As a closing thought, what’s with all these anonymous bloggers?

    People know who I am and where I’ve worked and published and my personal reputation is at risk when I get attacked on this site. These guys get to come on here, with no public reputation, proclaim themselves self-appointed experts and starting throwing spears at whomever they like.

    Anyway, I’m not a big fan of this kind of asymmetric exchange of views.

  59. Ramanan Says:

    Karl,

    “It is a credit that the Bundesbank receives via the ECB, to pass on to German banks. It is not a loan from the Bundesbank to Greece or Ireland or wherever.”

    It is first a credit by Bundesbank to the Bank of Greece on its own books. They then settle at the ECB at the end of the day.

    It is clear from the quote I provided from the Annual Report.

    “Intra-ESCB transactions are cross-border transactions that occur between two EU central banks. Intra-ESCB transactions in euro are primarily processed via TARGET2 – the Trans-European Automated Real-time Gross settlement Express Transfer system (see Chapter 2 of the Annual Report) – and give rise to bilateral balances in accounts held between those EU central banks connected to TARGET2. These bilateral balances are then assigned to the ECB on a daily basis, leaving each NCB with a single net bilateral position vis-à-vis the ECB only. ”

    So there you go … bilateral basis first and then ECB at the end of the day, slightly different to what you are saying.

    Sorry to bother you, but I recommend you think about this to get this point clear, not by debating with me but figuring out yourself.

    There is a playing around with words here with innuendos that the Bank of Greece should not be treated as a debtor and the Bundesbank as a creditor and other similar innuendos.

    In fact prior to 2005 or so, the claims were directly on each other not via the ECB. Does it make a difference. Not really.

    Think of other scenarios: non-Germans shifting huge amount funds into German banks before the breakup. In huge amounts. That could make Germany be become a net debtor to the rest of the world (after its TARGET2 claims vanish because of the breakup)

    Or check http://www.bundesbank.de/download/volkswirtschaft/zahlungsbilanzstatistik/2011/balanceofpayments112011.pdf - page 138 - TARGET2 claims is counted in Germany’s International Investment Position. If what you said was true, they would not have. It is given the same status as assets held in US dollars.

    Anyway thanks for engaging.

  60. hoganmahew Says:

    @Ramanan
    “In fact prior to 2005 or so, the claims were directly on each other not via the ECB. Does it make a difference. Not really. ”
    It makes a huge difference if the reverse of the current picture happened prior to 2005 - if Target2 had been in place since the inception of the euro, we’d probably have seen Ireland (and others) as a huge net creditor and Germany as a huge net debtor to the ECB via Target2 transfers. What we are seeing now is a reverse of previous capital movements. That the balances were wrong when Target2 was set up is what has been exposed. There simply wasn’t enough domestic capital in Ireland to account for the amounts that have moved, so there has been repatriation of previous movements.

  61. RebelEconomist Says:

    @hoganmahew

    I concur with Ramanan. Much of the capital inflow into Ireland occurred before TARGET2, and so had to be offset by one or more of (1) Irish private sector capital outflows (2) Irish overseas payments on the current account or (3) a build-up in Irish foreign exchange reserves. Now that capital is flowing out, (1), (2) and (3) are not reversing enough, but Irelands’s TARGET2 balance is taking the strain, hence the negative balance. The initially zero balances, if they existed, were not wrong - you can start a new currency system with any set of NIIPs

    I remain happy to keep discussing this here, but like Ramanan, I urge you to think about this offline, and of course offer my blog post as food for thought. No doubt there will be other opportunities to revisit it in future!

  62. jmg Says:

    @hoganmahew
    “if Target2 had been in place since the inception of the euro, we’d probably have seen Ireland (and others) as a huge net creditor and Germany as a huge net debtor to the ECB via Target2 transfers.” No, this guess is not true for Germany. Look at this website of a german blogger:
    http://www.querschuesse.de/target2-salden/
    There you can find the Target2 data for Germany, France, Spain, Italy, Greece, Finland, Netherlands, Luxemburg, Belgium and Portugal. Sometimes back to 1999 (including the old Target1 data)
    The Blogger and I couldn’t find the Target2 data for Ireland on the website of the Irish Central Bank. (Something to hide?)
    The ICB has only an entry “Other liabilities” in there Financial Statement on this site:
    http://www.centralbank.ie/polstats/stats/cmab/Pages/Money%20and%20Banking.aspx
    So I can’t refute that Ireland was a “huge net creditor” before the introduction of the Target2 system, but given the data of other countries
    it’s rather improbable.

  63. hoganmahew Says:

    @jmg et al.
    “So I can’t refute that Ireland was a “huge net creditor” before the introduction of the Target2 system, but given the data of other countries
    it’s rather improbable.”
    Then I suggest you look at the composition of the liabilities of Irish banks and how they have changed over the last four years. Note, for Target2 both resident and non-resident institutions are relevant. See here example: http://www.karlwhelan.com/IrishEconomy/DepositCharts.pdf

  64. hoganmahew Says:

    @RE
    “The initially zero balances, if they existed, were not wrong - you can start a new currency system with any set of NIIPs”
    Erm, if starting from zero is not wrong, then making a fuss about the current position is wrong. Either ignoring previous movements matters, or ignoring current movements doesn’t matter, you can’t say that both are true.

  65. Karl Whelan Says:

    I don’t have time to monitor this old thread anymore and the anonymous bloggers have grown tiresome (”think about this offline and you’ll agree with me” — ugh.) So let’s leave it here for now.