Repeating a wrong argument endlessly does not turn it into a right one. Unfortunately, this lesson has not been learned by German economist Hans-Werner Sinn.
For more than half a year Sinn has been claiming that the European Central Bank and the Bundesbank in particular give secret credits to the crisis countries in the Euro zone periphery.
According to Sinn these alleged hidden loans are necessary to finance the current account deficits of the periphery. He also argues that this so called “stealth bailout” crowds out credit growth in Germany and hence comes at the expense of the German economy.
If all this was really happening, it would be outrageous to say the least. In fact, however, Sinn’s points are utterly fallacious. His points are based on a misconception of monetary institutions within the Euro zone and some of his claims are just factually wrong.
For several months an amazing coalition of economists, who usually are completely at odds with each other, has been arguing against Sinn. The opposition stretches from Jürgen Stark, the ultra-conservative former chief economist of the ECB, to Gustav Horn, a Keynesian economist leading the economic think tank of the German labour unions.
A number of leading academics, among them the former LSE professor and today’s Citi’s chief economist Willem Buiter (numerous times) as well as Karl Whelan (University College Dublin) contradict Sinn’s arguments. The Wall Street Journal, FT Alphaville and the almighty Economist as well as an amazing number of bloggers (including me) argued against him.
Amazingly Sinn carries on regardless and stubbornly repeats his factually inaccurate claims.
He tries to thwart off criticism by frequently denying accusations his critics never made and by slandering their reputation. For instance in an academic paper Sinn claimed that I mistranslated him from German into English although I only cited his English papers. (A fact that Sinn later acknowledged.) In a letter to Willem Buiter Sinn claimed that I
“masterly twisted [his]arguments, trying to excite as many journalists and commentators who had no time or capacity to read [him] in German.”
Recently Sinn even suggested that the German constitutional court should take care of the alleged “stealth bailout”. In a new piece he published on Voxeu.org he repeated his erroneous and misleading claims. Sinn wrote:
“the mechanics of the Eurosystem implied that the Bundesbank gave credit to other euro countries at the expense of German banks to the tune of €390 billion (by August 2011) to allow them to crank up the money-printing press to finance their balance of payment deficits.”
However, this claim is much closer to fiction than to science. The Bundesbank neither gave credit to other euro countries nor to the ECB and it is not at all clear that the ECB financed the balance of payment deficits of the crisis countries.
Since Sinn endlessly repeats his highly misleading claims, I think it is necessary to recall the facts that I already described in my initial blogpost in June.
At the core of the debate is the intrabank payment system of the Euro area, the so-called “Target 2” system. Private banks use Target2 for the settlement of electronic payments from one country to the other. Since Target2 is run by the ECB and the national central banks, every cross border money transfer from one private actor to another one in the Euro area has several implications for the balance sheet of the ECB and the central banks as the following example points out:
Imagine a customer of Alpha Bank in Athens who pays 10.000 Euro to a bank account with Deutsche Bank in Germany.
This transaction involves several steps that all affect the balance sheets of central banks, as the Bundesbank describes in its Monthly Bulletin (March 2011, p. 34):
“If, for example, foreign funds are transferred to a bank that participates in Target2 via the Bundesbank [in my example: Deutsche Bank], this results in a liability of the Bundesbank to this bank (such as in the form of a credit to this amount on the banks current account).
In return, the transaction generates a Bundesbank claim for the same sum against the sending central bank. This central bank then in turn debits the account of the originating commercial bank.”
A good explanation of the system is available in a Bundesbank press release and the March 2011 edition of the Bundesbank Monthly Report (pp 24/25) as well as in this text by Clemens Jobst, an Economist with the National Bank.
In the twisted logic of Hans-Werner Sinn, this operation resembles a loan from the Bundesbank to the Greek national bank and “forced capital export” on the expense of the German economy.
Central Bank money
A pivotal point in the whole debate is that the private banks need central bank money when they want to carry out any Target 2 operation. If they do not have sufficient deposits at their local central bank, they will either borrow the liquidity on the money market from other private financial institutions or use an ordinary refinancing operation at their local central bank.
Since private banks in the periphery find it almost impossible to borrow on the money market, the latter alternative became the norm in the crisis. Hence, thanks to private money transfers in the Euro zone and the “Target 2” system, central bank money that is created in the periphery flows to the core.
This becomes clear when you imagine that the customer of the Greek bank does not transfer his money from one bank to another electronically but usea cash instead. The Euro notes he withdraws from his Greek bank account constitute central bank money as well. If he puts them into a suitcase, flies to Germany and pays them to a bank account in Frankfurt, economically the whole operation will be completely identical: central bank money is being transferred from the periphery to the core. However, there is no “Target 2″ balance and no loan from the Bundesbank to Greece.
Where Sinn is wrong
The undisputed fact is that since the outbreak of the crisis the Bundesbank has accumulated “Target 2″ claims worth 390 billion Euro. However, Sinn gets almost everything else significantly wrong.
First of all, the “Target 2” claims do not resemble German “loans” to the periphery. They are mere accounting positions reflecting private money flow. Even if the “Target 2″ claims were “loans”, they were given to the ECB, not to the central banks of the individual countries . Hence Sinn’s claim (“the Bundesbank gave credit to other euro countries”) is factually wrong.
Money creation in Germany
The “Target 2” operations do not come “at the expense of German banks”, as Sinn writes.
This is utter nonsense. The deposits of private banks in the core grow thanks to the money flows within the Euro zone. The “Target 2″ claims of the Bundesbank indicate that there is more central bank money flowing from the periphery to the core than vice versa.
German banks receive central bank money that was created in Greece and other countries with “Target 2″ liabilities, or, as Sinn puts it, “the Bundesbank converts the ‘GIPS euros’ into ‘German euros’”. However, the economic characteristics of those Euros “Made in Greece” are absolutely identical to Euros “Made in Germany”. Hence, it does not matter at all if the German banks get their central bank money through refinancing operations at the Bundesbank or through “Target 2″.
Sinn’s argument would only make sense if the amount of central bank money that German banks can get from the Bundesbank or ECB was limited. This is not the case. In the refinancing operations of the ECB, every bank can get as much money as it wishes, provided they hand over the necessary collateral to the central bank. After several critics made this point, Sinn acknowledged that this is not the case and that private banks in the Euro zone can get every amount of central bank money from the ECB.
Additionally, big banks in the Euro zone have accounts with almost all central banks in the Euro area, as people familiar to the matter pointed out to me. Big financial institutions like Deutsche Bank, Citi and ABN are able to get credit, make deposits and use the “Target 2″ system on similar terms and techniques everywhere they have a subsidiary or branch.
Most large banks consolidate their central bank relationships in one country. This significantly influences the pattern of the “Target 2″ balances. Imagine, for example, that the three biggest German banks decided tomorrow to use the Central Bank of Luxemburg instead of the Bundesbank for their “Target 2″ operations. The terms of conditions for the banks would be identical. However, the German “Target 2″ account would turn negative immediately.
Target 2 balances and the current account
Sinn claims that the Bundesbank and the ECB finance the current account deficits of the countries in the periphery via “Target 2″.
This is highly questionable as well.
In accounting terms, “Target 2″ liabilities are indeed treated as capital import in the capital account. Additionally, as every student in economics learns, with regard to the balance of payments, the current account balance always equals the negative capital account. However, these accounting identities do not automatically imply that every “Target 2″ liability is a capital import that finances the a current account deficit. It is also possible that this capital import just mirrors a capital export that happens at the same time. For instance, this would be the case when a customer of a Greek bank moves his money from Athens to Frankfurt.
I inquired at the Bundesbank about the relationship between the current account balance. They pointed out to me that “the relationship between the current account balance of a country and the variation of its Target-2-balances is not clearcut.” Current account deficits can co-exist with rising, shrinking or constant “Target 2″ balances. On the other hand, according to the Bundesbank, even with a balanced current account the “Target 2″ balances can vary if there are capital flows triggering this development.
So what does the empirical evidence look like? Sinn points to the fact that the aggregated current account deficits of the PIGS countries (Greece, Ireland, Spain and Portugal) are more or less of the same size than their aggregated current account deficits: Between 2008 and 2010, the joint current account deficit of the PIGS countries totaled 365 billion Euro while the “Target 2″ liabilities of the ECB for the same period equaled 340 billion Euro. However, in itself this correlation does not say anything about cause and effect. It is very likely that it is just a coincident hat both numbers are quite similar.
An aggregation of the balances over the four countries hides important differences, as an easy thought experiment shows. Imagine that the financial crisis would not have happened in Ireland. From 2008 to 2010, the aggregated current account deficits of Greece, Portugal and Spain equal 348 billion Euro while their “Target 2″ liabilities only sum up to 198 billion Euro.
Two economists, Ulrich Bindseil (EZB) and Philipp Johann König (TU Berlin) looked at the empirical facts in closer detail:
“If Sinn’s hypothesis, that the current account deficits are financed by the Eurosystem, were true, one would observe a systematic pattern in changes of Target 2 liabilities of approximately the same order of magnitude as the current account deficits. According to the data, this is not the case.”
Sinn acknowledges that the Target 2 and the current account balances only match each other in aggregate and that they are only similar in Greece and Portugal. However, in a research paper co-authored by Timo Wollmershäuser, he states:
“This does not mean, of course, that there is a correlation of the values in a statistical sense”
The explanation is rather opaque:
“When the deficits had to be financed, private credit was available temporarily just to dry out again later on, and the central banks had to help out. Later there were loans from the community of countries. There was a permanent to and fro, an interplay between the bull-headed capital markets and the NBCs that helped out whenever the capital flows were insufficient. Only in the sum of the three years can it be said that the increase in Target liabilities created by the additional creation of money in these countries was of a magnitude that financed the current account deficits.”
I find this completely unconvincing and rather unscientific. Sinn makes a claim without any solid evidence and disregards the counter-arguments of his critics without any valid evidence as well.
Sinn probably makes another fundamental error of reasoning. He does not acknowledge that the monetary flows within the Euro zone are detached from the physical cross border flows in the monetary union because Europeans can freely bank with any financial institution in the currency area.
On top of this comes the fact that Frankfurt is the most important financial center of the Euro zone. Hence it attracts a lot of international banks hailing from countries outside the monetary union. They use the Bundesbank for their “Target 2″ operations as well. As people familiar with the matter point out: “The payment volumes and balances observed currently in Frankfurt relate therefore also to many other countries and not just to Germany. “
Sinn’s highly explosive policy advice
Sinn reccommends that there should be a cap on “Target 2″ claims and liabilities. He writes:
“The credit given by the Bundesbank (Target) to the GIPS is not to increase further.”
This sound harmless but is highly dangerous. If policy makers follow this piece of advise, this would be the end of the Euro because citizens would not be able to smoothly move their savings around within the currency union, as Karl Whelan has pointed out:
“Understand what a limit on Target 2 balances would imply. It’s September 2012 and I’m writing a cheque to a German economics journal to pay my submission fee. However, the cheque bounces. Even though I have sufficient money in my account, I’m told that Ireland has reached its limit on its Target 2 balance, so the ECB is refusing to transfer my money. In other words, the euros in my bank account can’t do the same things that a euro in a German bank account can do. This kind of suspension of transfers would mean the end of the Euro as a single currency.”
Additionally, restrictions on “Target 2″ balances would hit Germany first, as Clemens Jobst with the Austrian Central Bank explains in a very good piece on Voxeu.org:
”First, restrictions on electronic transfers through TARGET could be easily circumvented by sending cash. Secondly, claims and liabilities within the Eurosystem will arise for various reasons, many of which are benign or even welcome, e.g. when banks within an integrated monetary union specialise and financial centres emerge. The sums involved are large. Annual settlement of intra-system debts (as in Prof. Sinn’s latest proposal) would have required the Bundesbank in 2006 to pay close to €80 billion, equivalent to its entire gold and foreign exchange holdings (€81 billion). Short of selling all its gold, the Bundesbank would have had to prevent German banks from playing an intermediating role in the Eurozone. This can neither be in Germany’s best interest nor consistent with the idea of an integrated monetary union.”
When I was criticising Hans-Werner Sinn’s misleading “Target 2″ arguments in May and June this year, several high-ranking German economists told me that I should not expect too much of Sinn. “You managed to show that he made a serious error of judgement. Do you really expect that he publicly apologises?”
I thought that this bloke had a point and expected that Sinn will just silently stop making his highly misleading claims. However, almost three months later Sinn still endlessly repeats his “Target 2″ fallacies. From my point of view, this is where the whole thing becomes disingenuous and unscientific.
Hans-Werner Sinn fritters away his reputation as a serious academic and has entered the domain of populists that make biased and flawed arguments.