Stealth Bailout: "The Economist" and Gavyn Davies raise their voices – plus: A word on Sinn's merits

When it comes to press coverage about current economics research, the “Economics Focus” of  “The Economist” is something like the global gold standard. This section was my  big role model when I started a section about current economics research in Germany’s business daily “Handelsblatt” in 2005.

Now, the “Economics Focus” has joined the “wonkiest web debate ever” about an “alleged stealth bailout” by the ECB. In an excellent piece  entitled  “Pride or profit”, the Economist discusses what the ECB has done to help the Greece, Ireland and other crisis countries and what risks the central bank has accumulated while doing that.

As Karl Whelan, the Wall Street Journal and myself, they come to the conclusion that a “stealth bailout” does not happen:

“As for the third form of support, identified by Mr Sinn, this is essentially just a way of describing the ECB’s refinancing operations by highlighting the positions being built up by the NCBs. As Greg Fuzesi, an economist at J.P. Morgan, points out, the Bundesbank loans reflect the fact that the peripheral economies are starved of private-capital inflows and reliant on ECB funding. The ECB insists that the intra-euro debts incurred by the central banks of countries like Greece and Ireland are simply book-keeping entries so long as the countries remain in the euro area. Any losses would again be shared among the NCBs of the Eurosystem.”

Gavyn Davies has also published a piece on the Target2 debate on his blog at the Financial Times. His conclusion is balanced:

“Professor Sinn is partly right and partly wrong. Here’s why. (…)

Prior to the crisis, the current account deficits of the GIPS were funded largely by the banking sectors of Germany and France via short term capital flows; since the crisis, the current accounts of the GIPS have stayed in deficit, but the short term capital flows have entirely reversed direction, leaving the GIPS to look elsewhere for funding.

This is where Professor Sinn has made a valid and valuable point. The only place where the GIPS have been able to find funding has been within the arcane activities of the ECB’s Target2 payment system. As money has flowed out of the commercial banks in the GIPS, their central banks have been obliged to go into the red at Target2. Meanwhile, as money has flowed into the German commercial banks, the Bundesbank has acquired credits in Target2. Consequently – and this is an absolutely key point – the activities of the ECB have provided the net capital flows which have allowed large scale balance of payments imbalances within the EMU area to persist.

Professor Sinn claims that these flows have been equivalent to direct loans from the Buba to the GIPS central banks. This claim is clearly wrong. In fact, the Buba has claims on the ECB system as a whole, not on individual national central banks. And these debts are collateralised by holdings of government bonds issued by the GIPS.”

Davies also discusses Sinn’s hypothesis that the Target2 operations hamper crowd out credits for German banks and companies:

“Separately, Professor Sinn claims that the provision of credit within Germany could be curtailed because the Buba is in effect lending central bank money to the GIPS. This is very far fetched. There is no restriction on the availability of central bank liquidity by the ECB to Germany or any other economy at present. And anyway the German banks have more than enough cash, much of it flowing in directly from the GIPS. That is why there are no signs whatsoever of any credit crunch within Germany today.”

I don’t want to sound like a daft know-it-all… But that’s exactly the point I made one week ago.

A word on Sinn’s merits

However, what I particularly like about Davies’s piece is his paragraph on Sinn’s merits:

“Despite these shortcomings, Professor Sinn’s writings have highlighted one very important point which I at least had not appreciated until now. The central banks within the EMU zone have in fact been operating in a way which is remarkably similar to what would have happened if they had still been operating an old-fashioned fixed exchange rate regime such as the ERM. But because their activities have been conducted in a single currency, they have been far more readily disguised than they would have been in the old days, and have therefore been politically much easier to sustain.”

Davies is absolutely head on.  Sinn in fact deserves respect with regard to the fact that he was the first economist who pointed towards those massive imbalances in the Target2 system. He meticulously hand-collected the numbers from the individual central banks because the ECB does not publish a consolidated statistics on the claims and liabilities of the Target2 system. The numbers are important because they reveal a lot about the formidable problems of the private banking sector in the Euro area.

This was what I had in mind when I wrote in a German version of my thoughts (“Traktoren, Targetsalden, Trugschlüsse”) that  Sinn had a  ”scoop” with regards to Target2. I really mean it and I want to stress this.

I take issue with his interpretation of the  Target2 balances and his policy recommendations. Sinn thinks the Target2 claims should be limited and cleared once a year. I think this would be highly dangerous. As Karl Whelan rightly points out, this probably would trigger a breakup of the Euro area:

“Consider what a limit on Target2 balances would imply. Imagine 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 Target2 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. In other words, this kind of suspension of transfers would mean the end of the euro as a single currency.”

It might be possible that it becomes reasonable to stop the big European experiment called “single currency”. At the moment I’m not convinced but I do not rule this out completely, anymore. However, if this would be the case, the Euro should be dissolved in an orderly manner (as far as this is possible, at all…). If the Euro area follows the advise given by Sinn, I feat that complete and utter chaos would be the consequence.

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One Response to Stealth Bailout: "The Economist" and Gavyn Davies raise their voices – plus: A word on Sinn's merits

  1. Pingback: Stealth-Bailout: Why Sinn is Only Partially Right, But Things Might Be Even Worse « Verlorene Generation