A reader alerted me to this, which apparently is not a joke. For a horrible moment, I thought there was going to be ninety five theses but mercifully, the “people who count themselves friends of the Ifo Institute” limited themselves to sixteen.
Anyway, happy Christmas to one and all, even the friends of the Ifo Institute.
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.
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.
I know we’ve devoted too much time to this already but, for the anoraks out there, here‘s a VoxEU piece that I’ve written responding to the earlier article by Tornell and Westermann.
One of the funny aspects of this debate is it tends to trigger comments from German residents that say something like “phooey to you and your technical details, you know that Sinn is right that we’re getting ripped off”. Forget the facts, feel the truthiness.
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.