"GIPS Euros" vs. "German Euros" – Debunking Hans-Werner Sinn, Vol. II

Hans-Werner Sinn, sitzend

Hans-Werner Sinn (Image: Jan Roeder, via Wikipedia)

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.

The facts

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.


Filed under Financial Crisis, Monetary Policy, Target 2

41 Responses to "GIPS Euros" vs. "German Euros" – Debunking Hans-Werner Sinn, Vol. II

  1. I’ve read the article by Prof. Sinn and your answer, and must say I find your opinion more convincing. Thanks for clearing some things.
    However, Mr Sinn made nine other advices towards solving the crisis. And I see nothing wrong with these. Maybe you should add a paragraph, stating that – given all the errors regarding Target2 – he is right about the other things. That would be, well, scientific of you :-)

    • Benjamin, I’m not discussing Sinn’s policy advise but his Target2 arguements (which are thorny enough). Since you asked: I also strongly disagree with his “commandments” No. 1, 3, 4, 5, 6 and 7. He has a point a No. 8 to 10.

  2. Pingback: Handelsblatt.com - Target2-Unsinn ist nicht zu stoppen « Handelsblog

  3. Erich

    I understand that the account deficits and surpluses are only a factor for the target2 balances. But isn’t it true that the deficits in the end are financed by printing new money via the target2 system? As far as I understand in America they have a different system to balance inequalities between the regions, the deficit regions have to give some kind of bonds to balance. And if You only print new money to compensate the deficits, of course that would result in a real transfer of assets from the surplus countries to the deficit countries.

    How else could trade deficits/surpluses get balanced, if no corresponding capital flow from the private sector compensate for these? And for me these deficits/surpluses are the real problem behind this. There were some suggestions in germany to reduce the surpluses by rizing wages considerable, but this might result in an export of work to asian countries only, which does not really help.

    I think it is necessary for the deficit countries in Europe to improve their standing on the world market (like Agenda 2010 in germany). As far as I understood Hans-Werner Sinn’s fear is that without a compensation mechanism for the deficits the position of the deficit countries is too comfortable to really try to change their situation.

    • Erich, the money isn’t printed “via the Target2 system”. The money is printed via the refinancing operations of the ECB that are carried out by the national central banks. In a second step, the money might be shifted electronically to a bank account in another European country using Target2.

      I’m not familiar with the details of the American system but a number of people who are dispute HWS’s arguments. For example, Clemens Jobst, an Economist with the National Bank of Austria, writes:

      Operations in the US are mainly executed through a centralised account (System Open Market Account), not through the individual balance sheets of the reserve banks (equivalent to the national central banks in the Eurozone). SOMA-assets are allocated across reserve banks in rough proportion to the capital paid. That is why similar imbalances due to monetary policy operations cannot arise in the US.

      In his piece, Clemens also points out that Target2 imbalances can also arise without any imbalance in the current account.

  4. Pingback: Ökonomen lernen nichts über die Finanzkrise « eurogate101

  5. Ralph

    Olaf, You point out, that “central bank money that is created in the periphery flows to the core”. You disribe the creation of central bank money as a mere tecnical process, “provided they (every bank) hand over the necessary collateral to the central bank”. But the ECB accepts collaterals like bonds (obligations) of Greece or Potugal. In case of a default of Greece the member states of the ECB bear the full liability for this createt central bank money, since (part of) the collaterals become worthless and since the bank, that has handed over the collaterals, will most certainly not be able to bear this loss itself.
    The ECB has given around 400 bill. of central bank money to banks within the GIPS-states, backed with doubtful collaterals.
    The TARGET-2 liabilities are the result of this “tecnical process” that makes the amount of money at stake visible.
    In fact Germany bears via its share in the ECB at least 28 % of the risk, that the banks, that received the central bank money in the GIPS-states, will not pay back their liabilities and that the collaterals will not cover the full amount.

    Personally I am convinced, that, in case of a default of Greece and maybe Portugal, has to claim insolvency. Furthermore I am convinced, that our European “partners” will not recapitalize the ECB to the extend needed, to set the claim of our Bundesbank, amounting to 390 bill. by end of August, even. In this case I expect lots of political pressure on Germany to dispense with at least 70 % of this amount – or do You imagine italian, maltesian, slowakian or spanish tax payers to transfer money to Germany via recapitalising the ECB? Never ever!!!

    HWS might have unscientificly exxagerated the meaning of the TARGET-2 liabilities. Nevertheless I am very grateful to Prof. Sinn, that he has pointed out this risk, that is disguised behind “a tecnical process” in the TARGET-2 system.

    • Ralph,
      thanks for you comment.
      You’re absolutely right: the collateral in the refi-operations is key, and the ECB lowered its standards during the crisis. This is a well known fact, however, and it is not related at all to Target2.
      However, please keep in mind that the basic point of HWS NOT AT ALL related to the collaterall the ECB demands in its refi operations. He claims that the Bundesbank gives loans to the periphery and that is comes at the expense of German banks. Both claims are barmy, but he has been repeating them since February 2011 although he really should know better by now.

      • Erich

        So the Bundesbank gives Credit to the ECB, so that the GIPS countries can Pay their Bills. And when the ECB has nö more Capital, it prints New Money, because nobody is going to replace the Lost Capital. It doesn’t look too much different from HWS claims. the end.

        • No, this is a biased description of what’s going on, I’m afraid. The Bundesbank, the ECB and all the other central banks are just carrying out the payments of the private sector. This does not involve giving credit to the ECB. Imaginge that the electronic payment system would not be existent and all cross boarder payments would be carried out using cash.

  6. Stefan

    Probably I’m making a mistake here, but I couldn’t figure it out, so I’m asking you: In your example transaction, step 1, you write “Alpha Banks transfers the 10.000 Euro to the National Bank of Greece. In terms of the balance sheet the central bank now has a claim of 10.000 Euro against Alpha Bank, and Alpha Bank has a liability of the same amount.”. If I transfer money to any bank, shouldn’t this result in me having a claim and the bank a liability? Even if this bank ist the National Bank of Greece? Perhaps you could elaborate a little on the exact technicality of step 1?
    Thank you

    • Stefan, it looks like I messed things up. At the moment, I’m completely confused. Hence I replaced my example with the Bundesbank explanation taken from their Monthly report. Apologies – and thanks for the pointer.

  7. Erich

    Ok, before the Euro was introduced, deficits (Leistungsbilanz) had to Be compensated by capital imports, right? So After the Introduction of the Euro this was nö more necessary, since now we have the target2 system for this.
    At the beginning Germany had a target2 deficit, since in One Hand it was Not yet competitve like today, and in the other Hand a Lot of money Went to the Gips countries to buy Bonds and other assets,
    Now the Capital givers realized, that there was more risk

  8. Erich

    Sorry for the interrupt
    More Risk then expected, and they returned their Money As fast As possible. At least at the current interest rate, which döes Not Seem to Be enough compensation for them for the risk.
    Obviously the ECB does Not want such high interest rates, because that could lead to further problems.

  9. Erich

    So the ECB buys the bonds at lower interest rate than the market considers As approppriate.
    But is this really sustainable?
    So how are permanent deficits or surpluses dealt within the Euro system, is their anything beside the target2 system?

    • Eric, first of all the Target2 balances at not related to the ECB’s purchases of sovereign bonds whatsover.

      Secondly, is is by no means clear that the Target2 deficits finance the current account deficits of the deficit countries as I point out in my blog post. I discussed this issue in an article for Handelsblatt a few month ago: “Die Griechen und das ‘Extrageld’”

  10. Erich

    I fully agree with what You wrote in that article, You pointed to. But Let’s assume a country permanently exports Capital and at the same time has permanently deficits. For a limited Time this is ok, of course. But Not forever, how is this avoided in our current system?

  11. You are forgetting, Olaf, how my article ( http://reservedplace.blogspot.com/2011/07/right-on-target.html ) explained why Sinn is basically correct. In order to settle cross-border payments, whether these arise from capital or trade flows, banks need central bank money. The banks ultimately obtain this central bank money by selling their debt to the ECB (ie by participating in the refis), and central banks normally ensure that this debt is so well-collateralised as to be practically credit risk free. The problem in the eurozone is that, if it is honest, the ECB is buying debt from the GIPS banks that is not credit risk free, because the collateral that the GIPS banks are allowed to post (ie GIPS government bonds) simply does not cover their credit risk. While, the same offer is theoretically open to, say German, banks, in practice it is irrelevant since they do not hold much of this kind of collateral. The result therefore is that ECB operations do disadvantage German banks, while the risk arising from the inadequate collateralisation is shared between ECB shareholders according to the capital key (ie German bears the most risk). Sinn is basically correct, although he appears to be such an inflexible character that he refuses to modify his argument in the light of discussion to make it more convincing, rather than simply reasserting it from time to time.

    From what original information I was able to find, it is not clear how the Fed’s inter-regional settlement system works over time, but I doubt whether it matters as much as in the eurozone, because the Fed is not under pressure to go easy on any particular type of collateral, and especially on any type that is predominantly held in a certain region. Provided that refi loans are so strongly collateralised that they really are credit-risk free, it does not really matter whether inter-regional settlement balances are reset annually or not.

  12. Stefan-2

    Sinn’s basic argument that Target2 balances reflect current account deficits and/or capital exports is correct by definition: If a country runs a current account deficit and/or exports capital, the sum of the current account and the capital account must equal the Target2 balance. This follows directly from the definition of a balance of payments.

    Therefore, if a country runs a current account deficit without importing a corresponding amount of private capital, that current account deficit is financed via Target2 in general and via German taxpayers in particular.

    I do not see any flaw in Sinn’s arguments. Neither do I think that people like Stark, Horn (!) or Citigroup-Buiter are good witnesses to prove the opposite. Moreover, the article disguises the fact that numerous scholars favour Sinn’s analysis. Cf. ifo Schnelldienst 16/2011, for instance.

    • As I wrote in the article:

      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.

      The fact that Target2 liablities are treated as capital imports in the balance of payment does not say anything wrt to cause and effect. The T2 liablities of those countries are most likely not caused by current account deficits. They are probably CAUSED by capital exports (people who move their Euros from a bank account in the periphery to the core). According to Sinn, however, the T2 liabilities are caused by the current account deficits. That’s a fundamentally different argument (and NOT correct by definition). (As I wrote and the Bundesbank explained, T2 liabilities can co-exist with current account deficits and surpluses as well as with a balanced current account.

      • Stefan-2

        Perhaps you should read Sinn more carefully, Olaf. Sinn does not argue that Target2 liabilities are always caused by current account deficits. Quite on the contrary, Sinn observes that i) Greece’s Target2 liabilities are accompanied by current account deficits whereas ii) Ireland’s Target2 liabilities go hand in hand with capital exports. In the first instance, taxpayers finance foreign consumption whereas in the second instance, they finance foreigh capital flight.

        • Perhaps you should read my blog more carefully. I cite the section where Sinn discusses the situation for individual countries. However, his basis point centers on the argument that the aggregate sums for the PIGS countries for the current account and Target 2 are very similar. Additionally, the does not bother to give any evidence that the Target 2 flows really finance the current account deficits, he just asserts this. As you may have learned from my blog, Target 2 liabilities can exist in situations with current account deficits, surpluses and a balanced current account. Hence, the mere observation that a country has a current account deficit as well as Target 2 liabilities does not say anything about cause and effect.

          BTW, taxpayers do not finance anything when it comes to Target 2.

  13. Perhaps the GIPS’ immediate problem is capital outflows, but these may well represent the reversal of the capital inflows that funded the current account deficits in the first place – ie the marginal destination of the capital inflows may have been bank deposits. As this recently widely referred to blog post explains, the financial crisis is most strongly associated with current account deficits in most of the countries affected: http://streetlightblog.blogspot.com/2011/09/what-really-caused-eurozone-crisis-part.html

    • I suspect that the streetlightblogpost is wrong, and there is a higher correlation with inflation rates than current account deficits.

      Now who is responsible for the control of inflation in the Euroarea: The ECB!

      Second, even if it were current account deficits which were a cause of the crisis, who did have the responsiblilty that current account deficits would not get out of line? Surely it was irresponsible bankers who gave out loans to periphery countries, when they should have known better.

      Either way, it is a design fault of the Euro area, and we are all responsible for that – not just the Greeks or the Irish.

      Thirdly, I have read your rather lengthy post, and you propose to use market rates when valuing collateral such as sovereign bonds the ECB accepts to finance banks. There is of course no reason for the ECB to do so. The ECB effectively sets market bond rates for the periphery, as it can at any time enter the market and drive market yields down and bond prices up. So the ECB controls the bond market, especially for tiny countries like Greece with miniscule trading volumes on the secondary market. And of course, the ECB can always ensure a country’s solvency by monetizing all their debt in the secondary market in exchange for promises of higher taxes.

      Now, the fact that you support Sinn’s call for limiting Target 2 exposure to countries (by some arbitrary formula, no doubt) which would undoubtedly change a liquidity crisis into an insolvency crisis is irresponsible.

      What you, and Sinn are actually saying is that Greece should be driven into insolvency by some arbitrary formula – I am afraid you are as wrong as Sinn about that – this is just a ludicrous suggestion. Greece should pay for design faults of the Euro? Why the weakest and one of the poorest countries? Also, people are moving their money from Greece (leading to the Target 2 imbalances) exactly because economists like Sinn have been advocating the insolvency of the country for months now! Whether he only wants to restrict Target 2 balances in order to say “I was right” afterwards or if there are other reasons, is anybody’s guess! But billions are bet on Greece’s default with CDS, just a little reminder! Sinn plays into the hands of speculators who wish for a default of Greece – that is extremely irresponsible!

      Sinn (and perhaps you) seems to cling onto your beliefs in the markets, when everybody can seen they are not working – it’s typical of German economists – more so than any others. Its a political crisis, and markets (and most economists) should stay out of it, until the crisis has been resolved, politically!

  14. Another thought that occurred to me this morning is that it could be argued that the ECB collateral policy contributed to the demise of Dexia. As long as the ECB accepts high yield bonds as loan collateral, even banks outside the GIPS countries are encouraged to own some to access ECB liquidity in the cheapest possible way.

  15. Whether Sinn’s argument is correct or not is apparently debatable. What is not is that it is pretty difficult to demonstrate that the German economy is actually suffering from this stealth bailout of the periphery. Through q2 2011, investment in logistic and warehouse space (can we think of a better measure of business activity?) reached all-time record levels. Personally, I’m a little tired of his ilk and their constant demands that Germany be recognized as the main victim here.

    It’s like Michael Schumacher staging a fit from the centre of the podium.

    Reb – Your approach that these funding programs are de facto subsidizing peripheral nations is sound. But at the risk of tangling with a specialist, I’d suggest that a more comprehensive approach would include the subsidy being provided to German government finances by the periphery via the intimately related safe haven trade. In recent weeks, the bund has yielded as low as 1.7 percent and a 1-year was issued at 0.24.

    Cheers to all

  16. Where Sinn is and always will be right is that open Target2 balances allow countries to absorb more than they otherwise could, and therefore to run more negative external balances than they otherwise could. Specifically, without open Target2 balances Greece and Portugal could hardly run a CA deficit as noone would finance it. At the same time, external deficits to the tune of 8 percent of GDP two years into the crisis suggest an underlying structural inability to adjust as long as there is free access to ECB credit.

    This is the key point. The rest is much ado about nothing.

  17. wilhkohler

    You make much fuss about whether one may say that changes in TARGET2 balances
    a) mirror current account imbalances,
    b) are causal for GIPS current account deficits, and
    c) reflect financing of current deficits of GIPS countries
    To my knowledge, nobody has ever claimed that a) holds for each point in time and space. Nor is it of any relevance for what Hans-Werner Sinn has correctly been arguing about the economic significance of the TARGET2 balances as they have developed since 2007.

    The same holds true for b). Indeed, it seems futile to indulge in empirical analysis in order to establish – or refute – causality, if one realizes that a current account deficit by definition has to be financed either through a normal capital import or a TARGET credit, i.e. a capital import through the ECB system stemming from the reshuffling of refinancing credit. Sinn simply demonstrates that over the last three years 88% of the joint current account deficits of the GIPS was TARGET-financed, and he carefully breaks down that number between the four countries. This is an undeniable empirical fact, not a causality statement.

    There is evident confusion here between two different questions: i) What causes a balance of payments crisis? ii) Is there a well-functioning adjustment mechanism that deals with the crisis? If the answer to ii) is negative, it would be silly to say that this was causal for the crisis. This seems all too obvious, but apparently it needs to be stated.

    Point c) seems somewhat less obvious at first sight, but it becomes quite clear once we acknowledge that a positive TARGET2 balance of a country’s central bank indicates the amount of central bank money circulating in that country that was originally created in some other Eurozone country. It is true, as indeed Hans-Werner Sinn and Timo Wollmershäuser have laboriously shown, that in the GIPS countries capital exports (or capital flight) were sometimes present as well, particularly in the case of Ireland. In that case one may say that TARGET2 credits have primarily financed capital flight, as Sinn has stressed many times.

    Generally, I am astonished to see how much heat and emotion has flared up, on your blog and elsewhere, in response to Hans-Werner Sinn’s writings and statements about the TARGET2 balances. You acknowledge that the TARGET2 balances reflect central bank money created in the periphery flowing to the core. This is a non-trivial insight that Sinn deserves credit for. While true, the way you formulate your statement creates the impression that this is what the TARGET2 system was designed for, whatever the size of this flow. And this is grossly misleading. To the contrary, the TARGET2 balances were meant to be close to zero, as they were until the summer of 2007. The ECB TARGET credit system was not meant to provide for long-term capital flows, as it has done since that time.

    I cannot help getting the impression that some of this heat reflects limited understanding of economic theory. Applying the logic of how a fixed-rate system works, one realizes that in recent years TARGET2 has been turned into something akin to the adjustment mechanism present in the Bretton Woods system, with the GIPS countries de facto playing a role similar to that of the reserve currency country, i.e. the US back then. In other words, this flow of central bank money is equivalent to dollars printed by the US and flowing to other countries in the final years of the Bretton Woods system. Even though this was perfectly in line with how that system was supposed to work, it finally caused the system to break down. In the present case, one cannot possibly say that the TARGET2 balances that have accumulated over the past 4 years are in line with what TARGET2 was designed for. If we want the Eurosystem to survive, we are definitely well advised to heed Hans-Werner Sinn’s warning about the use that the TARGET2 system has been put to of late.

    Wilhelm Kohler, University of Tübingen

    • we are definitely well advised to heed Hans-Werner Sinn’s warning about the use that the TARGET2 system has been put to of late.

      If we would follow Sinn’s advise on Target2 , this would be the end of the Euro through the backdoor, as the ECB points out in its latest monthly bulletin:

      The TARGET2 balances of euro area NCBs reflect the uneven distribution of central bank liquidity within the Eurosystem. As there can be no upper limit on the value of payment flows within a single currency area, there can be no upper limit on the TARGET2 balances of NCBs. Limiting the size of TARGET2 balances would be inconsistent with the concept of a currency union.

      The comparison with Bretton Woods is beyond me. The Bretton Woods system was a system of multiple currencies pegged together to a fixed exchange rate. The Euro, however, is just a single currency. There are no “GIPS Euros” or “German Euros”, there are just Euros. And I don’t see why it should economically matter if a Euro was created by the Bundesbank or the National Bank of Greece.

      If your worry is that the money creation in the periphery gets out of hand and becomes inflationary the ECB can easily neutralize the monetary growth, can’t they?

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  20. wilhkohler

    It is all too obvious that during the past three years TARGET2 balances have started to play a fundamentally different role from what they did before. How could anybody seeing the numbers deny this? One way or another, the TARGET2 system must be brought back to fulfilling its designated role, and this must include bringing the balances down and preventing them to explode again in the future. I do not see that this undermines the Euro. After all, the Euro has flourished for nearly 10 years with TARGET2 balances a tiny fraction of what they are now. The details of this turnaround have yet to be worked out. Indeed, I would hope that the ECB has something in the making by this time. True, quantitative restrictions are not what economists would generally rush for. But this may well be an exception to that rule.

    As to the Bretton Woods system, note that the issue is one of economics rather than semantics. Your response ridicules my argument by reminding me of the obvious. But the obvious (no “German Euros”) is irrelevant. The fundamental economic significance of the TARGET2 balances and my parallel to a fixed-rates system in no way hinge on whether we have a common currency or think of a fixed rate 1:1 between different currencies. As long as we have different countries involved, it does matter economically, as we know from the logic of the specie-flow mechanism, whether a country persistently creates more central bank money than is needed domestically.

    Your final statement is true only up to a point. What you suggest is the equivalent of surplus countries in a fixed-rates system sterilizing their foreign exchange market interventions. Reading Sinn and Wollmershäuser, you will find out that this is indeed what the ECB appears to have done so far. But as we know, all sterilization eventually hits a wall. In the present case this will happen when the entire central bank money circulating in non-GIPS countries is of GIPS origin. Again, this is elaborated upon in great detail in Sinn and Wollmershäuser. I trust it won’t come that far. However, I might add that if it comes to that point and if the underlying imbalances have not been corrected by that time, then the Euro faces a Krugman-like speculative attack.

    Reading your comments on the recent ECB statement, I am surprised to see that you repeating to misrepresent Sinn’s arguments.

    Wilhelm Kohler

    • “It is all too obvious that during the past three years TARGET2 balances have started to play a fundamentally different role from what they did before. How could anybody seeing the numbers deny this? One way or another, the TARGET2 system must be brought back to fulfilling its designated role, and this must include bringing the balances down and preventing them to explode again in the future”

      I think that current Target2 imbalances reflect the European Banking crisis. From my point of view, the huge liabilities and claims are a symptom of the difficulties of the financial industry. As the ECB puts it in its October 2011 monthly bulletin:

      “banking communities in some countries that face net payment outflows need more central bank liquidity than those in other countries where commercial bank money is flowing in.”

      We’re in the midst of the most significant financial and economic crisis since the Great Depression. From my point of view this explains why the Euro was able to flourish for nearly 10 years without any significant Target2 imbalances – in the good old days prior to 2008, things were just fine. The banks in the periphery were able to borrow on the interbank market anymore and did not face a significant outflow of deposits.

      “As to the Bretton Woods system, note that the issue is one of economics rather than semantics. Your response ridicules my argument by reminding me of the obvious. But the obvious (no “German Euros”) is irrelevant. “

      I did not want to offend you and did not want to ridicule your arguments. Apologies if you got this impression. I was just referring to a claim that I think is central for Hans-Werner Sinn’s way of reasoning. In his “10 Commandments” piece on Voxeu.org, he recently discussed the alleged parallels to Bretton Woods and stated:

      “Today, the Bundesbank converts the “GIPS euros” into “German euros”, which then crowd out the “refinancing-credit-euros” issued by the Bundesbank, and instead of foreign currency or foreign assets, the Bundesbank just receives claims on the Eurosystem that it will not be able to convert into anything.”

      Where precisely do I misrepresent Sinn’s arguments? Here’s a table that compares central claims made by Sinn and by the ECB.

      What really drives me crazy is Sinn’s “crowding out of credit” argument. At least in his popular writings he suggests that the Target2 balances do inhibit credit growth by German banks. An example can be found in this “10 commandments” piece published on 3/10/2011. There, he argues

      “that the Bundesbank gave credit to other euro countries at the expense of German banks”.

      This, as a number of people have been arguing for months, is not the case. The ECB makes the same point in its monthly bulletin:

      “It would be wrong to believe that TARGET2 liabilities that result from the provision of relatively large amounts of liquidity to banks in some countries have a negative impact on bank lending in other countries.”

      If you press Sinn hard on this topic, he argues that he never claimed that private credit growth was hampered by Target2 and accuses you of misrepresenting his views. He then acknowledges that German banks can get as much central bank money as they want. At the moment, German banks get the bulk of their central bank money through Target2 operations rather than through refi operations with the Bundesbank.
      However, I can’t really see how this comes “at the expense” of German banks. From the banks’ perspective, it does not matter at all if their central bank money was created in Athens or in Frankfurt. A Euro is a Euro is a Euro.

      I increasingly ask myself if Sinn deliberately argues disingenuously and ambiguously with regard to the crowding out issue. On the one hand side, the constantly makes public claims that sound very scary for people (“this comes to the expense of credit growth in Germany”) who are not familiar with the details of the monetary system.
      For everyone involved, including the ECB, it is clear what his arguments imply (that Target2 liabilities have a negative impact on bank lending in other countries). This, however, is not the case. When someone correctes him, he says that the never made this claim and comes up with a diferrent explanation ( “GIPS euros” are converted into “German euros”, which then crowd out the “refinancing-credit-euros” issued by the Bundesbank”) that does not justify the fuss he makes about the issue in public. (And, as there are just Euros, does not make much sense…)

      Everyone makes mistakes (here’s a recent example where I got it wrong), and we all are occasionally misunderstood. However, Sinn has been making his claims for several months now. He should have realised how people interpret his arguments (in a way that is completely wrong). However, he carries on regardless and repeats his highly ambiguous (misleading?) claims time and again.

  21. wilhkohler

    I think we should not just view the TARGET2 balances as somehow reflecting “abnormal times”, vaguely referring to financial and economic crisis. Instead, we should view them more specifically as reflecting balance of payments crises of the GIPS countries which can no longer finance their expenditure (not just its public portion) through private capital imports. My point is that the Eurosystem responds to such crises by letting TARGET2 balances explode. Hence the comparison with the Bretton Woods system in my earlier comment. I have just written a little comment on this point on VoxEU that ought to be posted after moderation.
    That this is coupled with a banking crisis, inasmuch as that the banks involved do not have sufficient capital to back the risks involved, is an additional, and conceptually different, aspect.

    On the crowding out issue, it should be beyond doubt that that with the positive German TARGET2 balances “Greek euros” are being converted into “German euros”. This is an empirical fact. But given that the demand for liquidity is limited, this logically implies that it also crowds out refinancing euros in Germany. Since we have no reason to assume that liquidity demand changes in this context, it follows that that there is crowding out of refinancing credit in Germany. You seem to misinterpret the crowding-out argument. German refinancing credit is crowded out because liquidity demand is limited, not because supply is limited. And please do not confuse liquidity with credit. Liquidity can come without credit and credit can be given without liquidity.

    The economic significance of any central bank accumulating foreign exchange reserves is that it orchestrates a capital export because private investors do not want to send their capital abroad; otherwise, private capital exports would still occur and there would be no balance of payments crisis in the first place. Thus, the fact that the TARGET credit flows does not at all mean that Germany is credit-constrained, since at the moment German private capital does not dare leave the country. Some of the capital that does not dare leave is exported through the ECB system. Nevertheless, enough capital remains. Sinn pointed that out very clearly.

  22. Isabel Wein

    I would like to draw your attention to a press release on the ECB Bulletin issued by the Ifo Institute. It arrives at a radically different interpretation from yours. I just wonder whether you are on the right track here at all.


    • Thanks for you comment.

      I’m discussing the ECB bulletin on Target 2 (and, briefly, Ifo’s response to this ) in another blog post. (klick). From my point of view, the ECB contradicts Sinn’s main points. The Ifo press release is twisting the facts. A table which compares Sinn’s main points to the ECB’s view is available here.
      Please be also aware that Jürgen Stark openly contradicted Sinn’s arguments in June in a background talk with journalists (link) and in a public debate with Sinn in Munich (German link) .
      You may also have a look at the work of Buiter, Whelan, Bindseil and all the other stuff that is linked in my blog posts.

  23. Geir H

    I dont find you convincing at all. You cant prove they dont finance other ECB branches. You dont know that and you have not proved otherwise. Just empty words. What we all know is that they get their money from somewhere. From who? From the ECB central bank money stock……

    • The private banks in the crisis countires get their money in standard refi operations with their local central bank. It’s as simple as that.

  24. Maria Dolores

    Interesting view of the situation, when we look into the key indicators.


  25. Private Money Exchange

    I agree what Geir H , said, for this topic. (private money exchange)

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