The Target2 debate goes on an and on and the academic literature on the topic is growing. The latest contribution comes from Ulrich Bindseil (European Central Bank) und Philipp Johann König (TU Berlin). Both have just published a paper entitled “The economics of TARGET2 balances”.
Some sections of the paper are highly technical but all in all the paper is a must read for anybody who follows the Target2 saga.
Here are the three most important conclusions of Bindseil and König :
1) No monetary union without unlimited Target2 liabilities
If the ECB and governments took Sinn’s recommentations serioursly and set a certain limit with regard to Target2 liabilities, this would mean nothing less than the end of the Euro are. On page 25 of their paper, Bindseil and König assert:
Sinn’s proposal to limit Target2 balances essentially implies that a euro in the form of a deposit with the central bank of a country under an EU/IMF programme is not the same as a euro held as a deposit with a core country central bank. This however contradicts the core constituting element of a monetary union – namely that one euro is equal to one euro – across the entire monetary base.(…)Hence, Sinn’s proposal is first of all tantamount to abandon the monetary union and to replace it by a hybrid system: a monetary union between the TARGET2 creditor countries to which the TARGET2 debtor countries peg their exchange rates.
This is excactly the point Karl Whelan put forward:
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.
The authors of the new paper also disregard Sinn’s recommentation to that Target2 liabilities should be settled once a year and that countries should pay for their liabilities with “gold, currency reserves, or other marketable assets that cannot be produced by the paying country itself”. Bindseil and König stress that this basically would force Target2 debtor countries to pay a significant price “to sustain their banking sector’s ability to pay” every year.
Very interesting is a remarkt towards the German Bundesbank, which was running huge Target liabilities a few years ago:
If such a rule would have been applied since the start of the common currency, the Bundesbank would have depleted almost its entire gold stock during 2000 and 2001 and other countries with only moderate net TARGET2 liabilities, e.g. Slovenia, would probably already been unable to make payments to other euro area member countries.
2) Target2 does not finance the current account deficits of the PIGS
Henry Kaspar (Kantoos Economics) erroneously thinks that this is “a secondary Sinn-hypothesis.” In fact, this claim one of the most important building blocks of his whole argument: Sinn is convinced that the Target2 system makes it possible for the PIGS (Sinn calls them GIPS) to continue living above their means and on the expense of Germany and other countries with Target2 claims.
Sinn writes with regard to Target2:
“This bailout made it possible for the GIPS to continue living beyond their means, and it saved them from a drastic reduction in credit flows.”
He also asserts that a limit to Target2 liabilities would
orce the GIPS banks to seek financing in the private market where interest rates are high, and the GIPS economies would then react by borrowing less and reducing their current-account deficits”
Bindseil and König as well as Willem Buiter et al. (“TARGETing the wrong villain: Target2 and intra-Eurosystem imbalances in credit flows”) debunk this hypothesis. They compare the current account balances of the PIGS to their Target2 liablities, because (as Bindseil and König wirte):
“if Sinn’s hypothesis, that the current account decits are financed by the Eurosystem were true, one would observe a systematic pattern in changes of TARGET2 liabilities of approximately the same order of magnitude as the current account decits. According to the data, this is not the case. “
In fact, there is a close correlation of the Target2 liabilitites and the financial crisis.
The easiest way to falsify Sinns hypothesis is a look at the numbers for Ireland. According to IMF figures (Table A11) im 2010 Ireland only had a very small current account deficit (0,7% of GDP) . In 2011 Irland probably will even have a small current account surplus (0,2% of GDP). However, the Irish national bank at the same time is by far the biggest Target2 borrower (see here). At the end of 2010 the Irish Target2 liabilities equaled 146 bn euros. (Greece came second with Target2 liabilities of 87bn euros).
However, according Bindseil und König even the accumulated Irish current account deficit over the last 10 years only equals 41bn euros.
Hence, both economists come to the conclusion that the huge Target2 liablities are by no means an indication that Ireland lives at the expense of Europe. Those figures just show that a bank run on Ireland is happening and customers withdraw their money from Irish banks:
Bindseil and König write with regard to the Irish central bank:
“The large increase in TARGET2 liabilities of around EUR 91.7 bn between the end of 2009 and the end of 2010 can be almost exclusively attributed to the ongoing difficult situation of the Irish banking system and the loss of access to private sector funding. Funding out flows of this order of magnitude could enforce massive asset fire sales of banks, if the central bank was not stepping in to close these gaps.”
Willem Buiter et. al. make excactly the same point in their ”TARGETing the wrong villain: Target2 and intra-Eurosystem imbalances in credit flows”. With regards to Greece and Portugal – two countries with significant current account deficits and huge Target2 liabilities -they assert:
“for Greece and Portugal, the largest increases in Target2 net liabilities were, again, in 2010, when the increase in Target2 net debt was much larger than the overall current account deficit. The data on current account deficits and changes in Target2 balances therefore do not provide support for the hypothesis that the current account has been the main driver of change in national net Target2 balances for the EAP countries.”
Buiter et al also come to the conclusion that:
“the driver is what could be termed ‘deposit flight’ – a movement of financial balances from Ireland to Germany which is, at least directly, unrelated to the demand for goods – it is a financial portfolio rebalancing that does not require any change in the national saving-investment balance”
3) Target2 operations do not crowd out lending in Germany
According to Sinn, Target2 operations are
”likely to crowd out normal German money creation by way of the Bundesbank’s lending to German banks. (…)
Ultimately, the credit to the Irish farmer comes from the Bundesbank at the expense of a similar credit provided to the German economy.”
There is a huge consensus among academics and economic journalists that Sinn is plainly wrong here. Hence, I will discuss this issue only very briefly.
Bindseil and König write with regard to the alleged “crowding out” of credit:
“This reasoning is the result of a misunderstanding of the relationship between central bank assets (in particular lending to banks) and central bank liabilities (reserves of banks with the central bank, banknotes, or the sum of the two, the “monetary base”).”
They also address a question that I asked in my initial post on the Target2 issue: “Does it economically matter in which country Euros were created?” I didn’t think so but I was not ultimately sure. I put it this way:
“I personally do not care if the Euro notes in my wallet are printed by the Bundesbank or the national bank of Greece.
A Euro is a Euro is a Euro, or isn’t it?
What am I missing?
(…) Does it economically matter if the central bank money which is used in Germany has been created inGermany? Is central bank money “made in Greece” of inferior quality?
I don’t think so.”
In their new Bindseil and König now stress the same point:
“it is completely irrelevant whether the reserve holdings of banks are due to a credit from its NCB or whether they are due to transfers of reserves from other banks via the payment system”