Wolfgang Münchau has it right in his article in the SPIEGEL. A legend is created on one end of the political spectrum about Germans getting ripped off in the financial markets by evil foreigners. That legend is spun on the same day that ECB president Mario Draghi visits the German Bundestag (federal parliament) to explain his proposals. Hans-Werner Sinn and his TARGET-2 nonsense hits exactly the same chord. Grexit is the plan, and it will be sold as betrayal. The preparations in Germany for returning to nationalism are gaining speed, driven by the unwillingness of both politicians and the financial sector to tell the truth about the German Exportweltmeister system. Net exports led to a portfolio with more and more non-performing loans from the periphery, and this – together with the birth defects of the euro – is what led us into the crisis.
A Grexit and then an exit of more euro zone members would lead to high unemployment in Germany. The export sector would find itself priced out of markets as the new currencies will all devalue against the euro (or the deutschmark). Once again, international finance would be the scapegoat for German mass unemployment after a financial crisis.
econoblog101
Golddämmerung in Germany
Dirk Ehnts | Berlin School for Economics and Law
22 comments:
"Why does a central bank hold gold reserves in a world where the ECB creates the monetary unit by keystroke I do not understand."
In 1991, when India had a balance of payments crisis, the IMF demanded that India keep Gold as collateral and a plane full of gold was transported to the IMF.
In the case of the Euro Area, the Bundesbank is not the ECB.
"Hans-Werner Sinn and his TARGET-2 nonsense"
It is his opponents who have been speaking nonsense no end.
It is true that Sinn has his own mistakes. He is however quite right on his point that the central bank claims on foreigners matter and that the creditor nations in the Euro Area are exposed to a risk of default by nations leaving the Euro Area and defaulting on their obligations.
Ramanan,
the central bank claims on foreigners matter and that the creditor nations in the Euro Area are exposed to a risk of default by nations leaving the Euro Area and defaulting on their obligations
Not so fast, please.
Most of these supposed "obligations" from southerners to Germany arise not from the financing of net imports of the periphery (where you could indeed argue there is a corresponding, legitimate German claim) but from massive deposit flight from Spain and Italy into Germany.
Say I'm a Spaniard worried about the possibility of my country dropping the euro. I transfer my savings to Germany to get protection from this risk. There is no way the credits arising on the Bundesbank's books as a result of this operation can be described as an "obligation" of Spain to Germany. These were savings earned in Spain by Spanish citizens, remember?
In fact, the deposit flight that has taken place in periphery countries would probably help German industry in case the euro collapses. Here's why.
It's likely that a new DM would rise substantially vis à vis the other European currencies, creating a huge headache for German exporters. But the Mediterranean savings now deposited in German banks could then be used by the owners to keep buying all those BMWs that would otherwise become virtually unsaleable everywhere in Europe.
Instead of complaining like a spoiled child, Mr. Sinn should instead be thankful that a well-designed system such as TARGET2 is in place to guarantee smooth payments throughout the eurozone. Because it's quite likely that whatever scenario turns out to be the end game in the eurozone Germany will emerge as the ultimate victor - as usual (Gary Lineker dixit).
"The export sector would find itself priced out of markets as the new currencies will all devalue against the euro (or the deutschmark)"
Except that export nations hold the key in the currency markets. They simply 'convert' the earnings of their exporters into domestic currency. Foreign currency goes in the vault and new domestic currency is distributed.
Because of neo-liberal policies in place, the competitor will not retaliate by simply offsetting that drain in the opposite direction. It is sacrilege to convert currency that hasn't been 'earned'.
Switzerland have done it. That Chinese do it daily and Japan is always trying to do it even though it clearly feels guilty when it does.
Those with a 'strong' currency can always weaken it if they realise that their counterpart is too wrapped up in religious belief to counteract the move.
Jose,
The biggest criticism of Sinn's analysis has been that Target2 claims of central banks on other central banks does not matter if there is a breakup. This is quite wrong.
Claims on foreigners plus nonfinancial assets is the wealth of a nation.
To your specific points, if you are a Spaniard and shift funds from Spain to Germany, then the Spanish public sector owes the German public sector after the transaction - whichever way you earned it initially.
If this claim goes down, Germany's wealth reduces.
In your argument, the person transferring deposits isn't necessarily going to buy a BMW. In fact unlikely. Then what?
To claim that the new claims of foreigners on Germany doesn't matter is to claim that net indebtedness of a nation to the rest of the world does not matter.
Sinn is not behaving like a child. It is true that TARGET2 is nicely designed and has done good for the Euro Area during the crisis. It is also true he has been saying some wrong things. But his opponents have behaved to downplay future risks and say really silly things to downplay the risks.
Here's JKH analysis on this:
http://monetaryrealism.com/target2-window-on-eurozone-risk/
Ramanan,
if you are a Spaniard and shift funds from Spain to Germany, then the Spanish public sector owes the German public sector after the transaction - whichever way you earned it initially
Take the extreme scenario: all Spaniards transfer their deposits to Germany.
Then Spain exits the euro and refuses to honour her debts incurred under TARGET2.
The German public sector takes a loss.
But the deposits are still in Germany. When they are used to buy German goods and services German firms scora a gain: sales and profits. And German households score jobs.
I argue that real gains are much more relevant than accounting losses. And more so when said losses are predicated on Spain eventually defaulting on her obligations if she exits the euro - an implicit assumption made by Sinn that btw says much about his prejudices.
Jose,
Yes Sinn has his prejudices but his opponents' arguments are silly.
On this very point however, his arguments are not prejudiced. From Germany's point of view there is no strong reason why if Spain leaves, its government won't default on the TARGET2 liabilities. It is too much of a strong assumption and goes against simple risk management judgement.
His opponents' arguments however doesn't take issue with this. For them it simply does not matter if Spain defaults or not.
Also, you are taking a case where Spaniards transfer all deposits. It is too extreme a scenario. A crash would happen before such a scenario happens. It will leave Germany will extra indebtedness to foreigners without a counterpart asset when the foreign country's government defaults.
Also, your arguments are highly dependent on the assumption that a nation's indebtedness does not matter and the creditors are benign and can only do good by purchasing goods and services from the domestic economy. But that isn't true. Creditors keep earning interest payments.
Ramanan,
My example may be "extreme" but it could perfectly happen under TARGET2.
In fact, if Spanish and Italian depositors are neoclassical, Rational Economic Agents it should happen: they've got nothing to lose and much to gain by placing their assets in Germany.
And the Spanish banks would post gains as well. They would pay 0.75% a year for the funds automatically advanced to them by the Bank of Spain as a replacement for deposit flight - instead of the higher rates they are presently offering to their depositors and other creditors.
Of course, they would also lose all their clients in the process. This would be indeed an ironic application of the Law of Unintended Consequences - the neoliberal eurozone having to accept the banking sector of a major member being transformed into a farcical copy of Soviet-style financing.
No doubt it could happen, though.
But back to Mr. Sinn. Let's sum up his argument.
1. Germany is accumulating enormous creditor balances under TARGET2 (True)
2. Most of these are a direct result of massive deposit flight from the periphery (True)
3. So, the periphery should "settle" those balances annually (False conclusion)
What Sinn should be proposing, in order to be fully coherent in his argument, is the (retroactive) introduction of capital controls within the eurozone. That would eliminate the possibility of Germany accumulating such balances.
Of course, said controls would mean the end of the EMU. So Sinn is really complaining against the EMU, but doesn't dare to say so explicitly because it would be politically incorrect and might place him outside of the circles of "respectable opinion".
The euro implies a clearing and settlement mechanism such as TARGET2. And yes, the euro cannot eliminate the risk of exit by a member (even if not allowed under the Treaties) and consequent losses to creditors.If Sinn thinks this risk is not worth bearing by Germany he should state it explicitly. Otherwise all the fuss he has created will only serve to throw more wood into an already intense and dangerous fire.
Jose,
Good summary. Yes false conclusion.
But at least he recognizes there is a loss to creditor nations in case nations leave the Euro Area. Others (and by that I mean his opponents who have publicly criticized him in academic papers) do not even recognize it.
If a nation's banks start losing deposits, it will have issues with collateral to be posted at the home NCB. But at any rate - to survive it has to attract funds from abroad and can't simply pay 0.75%.
I don't know about deposit rates in Spain, but thought it is high in Italy.
On your point about transferring deposits - at any rate, the higher Germany gets deposits from nonresidents, the greater will be its loss of wealth if the other country leaves.
The article linked in this post has the attitude that the German Bundesbank shouldn't worry about risks at all!
Ramanan,
My point is essentially about how far Germany can legitmately complain about the risk of losses in the majority of cases where her TARGET2 (positive) balances arise from deposit flight.
Example: I'm an Italian consumer and I buy a Ferrari today for 1 million euros.
The manufacturer sees her bank account being credited for 1 million. However, being afraid of a possible Italian exit from the euro, Ferrari transfers those euros to Germany.
At the end of the process, via TARGET2 the Bundesbank will have a credit balance of 1 million euros, while the Bank of Italy gets a 1 million euro debit balance.
Say Italy exits the eurozone the next day and refuses to honour the obligations arising from her TARGET2 balances.
The Bundesbank will post a "loss",
But who created this 1 million euro wealth in the first place? An Italian consumer and an Italian manufacturer.
Germany cannot complain about "losing" something it never created.
I agree that in those cases where positive balances result from the financing of trade and current account deficits Germany has reason to worry.
But this represents only a small amount of Germany's 700 billion euros or so in positive balances. The majority of claims is a direct function of deposit flights that represent wealth created in the periphery of Europe.
We may thus conclude that Sinn's argument simply doesn't stand.
Jose,
Who created the credit in the first place is irrelevant if we are talking about losses.
"Germany cannot complain about "losing" something it never created."
Well, it is a loss to Germany because its net wealth has reduced.
It is now left with an extra liability to Italy without there being a counterpart asset.
Ramanan, I think that José is arguing that Germany's "loss" of net worth is like the slave holders loss of net worth when their slaves were freed due to the American Civil War.
Ramanan,
The Bundesbank will only take a minority part in the "loss" - the rest would be spread among the rump eurozone NCBs.
And the liability to Italy will be in the form of a deposit at a German commercial bank that will likely be quite glad to have it.
Also, it is not at all clear that a loss in central bank equity represents a drop in the country's net wealth. Will the loss affect the ability of German to order goods from Italy in the future? Not clear it does - and this would be the only relevant loss in real economic terms.
In any case there is no way to escape the risk of losses should the euro crumble. It is part of the very decision of creating a EMU - if you build something it may collapse and the consequences will be unpleasant for all concerned parties.
Sinn should have taken this inconvenience into account before, not after, the adoption of the euro. His idea of having the countries with TARGET2 debits "pay" the balances at the end of each year is pure delusion. And he was silent when said balances had a minus side on the German side (in 2007/8). He is an extremely biased thinker, not a detached economist in pursuit of knowledge.
Tom,
Exactly what I meant.
Jose,
"The Bundesbank will only take a minority part in the "loss" - the rest would be spread among the rump eurozone NCBs."
Same old argument. At least accepts that there is a loss instead of saying there is no loss at all!
More generally, the creditor nations as a whole lose the whole amount whatever the distribution of losses is according to the capital key formula.
Also in case of a breakup, Germany will be left with a few nations. Spain will be out, Italy also out. So the capital key formula changes accordingly. It will no longer be 27.06%.
"And the liability to Italy will be in the form of a deposit at a German commercial bank that will likely be quite glad to have it."
Glad? Why would anyone want to simply have more debt to foreigners? Not relevant.
"Also, it is not at all clear that a loss in central bank equity represents a drop in the country's net wealth. Will the loss affect the ability of German to order goods from Italy in the future? Not clear it does - and this would be the only relevant loss in real economic terms."
The economic definition of wealth of a nation is the sum of nonfinancial assets of residents plus the net claim on nonresidents. Very simple.
Very sound too.
Bundesbank loses the claims, it is a loss to Germany.
If I am a billionaire and I lose $200m, it is a loss for me?
Answer: yes.
More importantly the amount of capital flight that can occur in case there is a major expectation of a collapse can turn Germany into a nation with net indebtedness to the rest of the world.
"In any case there is no way to escape the risk of losses should the euro crumble"
A slightly different point. It is a loss rather than not a loss.
"He is an extremely biased thinker, not a detached economist in pursuit of knowledge."
Yes he is but not really relevant on the discussion of risks and losses. The fact that he is not good doesn't automatically make his specific claim bad. His advice is bad of course.
Ramanan,
You keep focusing on the accounting side of the story only - and ignoring the real life economic processes behind the numbers.
If Germany has a TARGET2 claim on the periphery of 700 billion euros this means - in economic terms - that she is entitled to be paid back in the future to the tune of 700 billion euros of goods and services (or physical assets) from the periphery.
IMO, Germany has a legitimate claim on the portion of that amount corresponding to the net exports she has sent to the periphery, in the past.
She does NOT have a legitimate claim on the portion resulting from capital/bank deposit flight.
This is the meaningful part of the argument.
You say the origins of the claims don't count; I say it's all that matters.
If I own a one million euro Ferrari and it is destroyed in a hurricane, I'll post a loss of 1 million.
If a thief steals my Ferrari and it is destroyed in a hurricane,the thief will also post a 1 million euro loss.
From an accounting point of view, the situations are alike.
They're totally different, however, from an economic (and ethical) point of view.
Anyway, since L. Randall Wray has just written a new piece on eurozone imbalances, perhaps we may proceed with this conversation in the comments section of his article.
Jose,
Galileo said by denying scientific principles, one may maintain any paradox. Something similar holds for Macroeconomics: by denying accounting principles, one may maintain any paradox.
Germany has about €700 TARGET2 claims. However, in case of a further bigger panic, a flight to quality will lead to this amount increasing to a high unknown value.
"She does NOT have a legitimate claim on the portion resulting from capital/bank deposit flight."
That is your personal opinion. As far as Germany and others are concerned, Germany will try to get others to settle this claim.
If there is a flight of about another €1tn, the creditor nations have the risk of losing another €1tn.
Whichever way - if Germany loses its TARGET2 claims, it is a loss. Please everyone stop denying it is a loss.
There is a very self-consistent way in which national accounts is defined the way it is.
"If I own a one million euro Ferrari and it is destroyed in a hurricane, I'll post a loss of 1 million."
Irrelevant here as far as I can see. Plus the whole economy is not about stealing. It happens in small scale but I don't know why it is relevant here.
Wray continues to miss the point. First it is clear from the data which nations have troubles and which do not. He presents a case of German banks having blown up real estate in Germany. He forgets it would have deteriorated the German balance of payments because of huge rises in domestic demand compared to demand abroad!
Ramanan,
If you have a system imposed upon a whole continent where bank deposits are being sucked into a single country, then this may not be "stealing" but it surely is a highly unusual phenomenon that would not take place in the absence of a EMU.
IMO, the periphery should have started "gaming" the system a long time ago by financing her government deficits via state-owned banks. TARGET2 would be able to accommodate all payments of foreign-held public debt, as we have concluded in a previous discussion.
In fact, it's arguable that a state-owned bank could even be used for financing new deficit-spending inside a periphery country (as opposed to simply paying off maturing debt held abroad).
The periphery government would issue bonds and sell them to the commercial bank in order to finance its new spending. If the NCB could keep providing advances to the domestic banking system, the process would be self-sustainable and the government would recover 100% of the monetary sovereignty it lost by entering the EMU. (This process of deficit-financing in eurozone member states is carefully described by Marc Lavoie on page 22 of its November 2011 paper on neo-chartalism)
My criticism of Wray would go in a different direction from yours.
Marx once said that the point of philosophy is to change the world. Yet MMT thinkers haven't paid sufficient attention to possibilities for change that have been opened by the complex clearing and settlement systems of the eurozone.
There is perhaps a chance for periphery governments to recover currency issuance without leaving the euro. Non neoclassical economists should be following this issue closely in order to provide sound political and technical advice to said governments. That they haven't done so speaks against their wisdom and political acumen.
MMT economists may be losing a historic opportunity for becoming relevant - simply because they've failed to study the details of the clearing and settlement mechanisms of euroland and their implications for finding a solution to the crisis while preserving the euro.
Jose,
The proposal of banks buying all debt is not acceptable - even if it were possible in the circumstances.
Nein Nein Nein.
In a monetary union, governments cannot have unlimited credit creating ability. For that a central government is needed.
This is because it gives the government the power to finance the current account indefinitely without paying anything in return. Have you read Graziani's concept of money?
About Wray, I just happened to mention one part of my criticism.
His arguments are the same as those in 1991 who said that since there is no currency to defend, there won't be a balance-of-payments crisis.
Others rightly argued that the balance-of-payments crisis if it happens will manifest itself as a deflationary spiral.
Again just another aspect of so many of the criticisms.
Ramanan,
Show me the article in the European Treaties that forbid a government-owned bank from buying its Treasury bonds.
That's the only thing that might block the procedure within the eurozone.
The euro implies TARGET2. TARGET2 implies no limit to balances. No limit to balances implies governments may pay off debt held abroad by "dumping it" deep inside TARGET2 balances.
I think we both agree up to this point, right?
From this we have only a further step to take and presto the governments of the periphery recover full monetary sovereignty by issuing bonds to their own commercial banks, instead of going to the "markets" or the Troikas to get financing.
You may object this would be tantamount to transforming the eurozone, via a stealthy procedure, into a full-fledged transfer union.
And you would be right of course. I admit it would be politically hard to swallow for Germany, buy certainly not "illegal".
And it would be the only way to make the EMU viable, by becoming a copy of the U.S. transfer union - with very different institutions, of course.
Jose,
I thought we discussed that.
There is nobody controlling the prices of government bonds and hence everyone except the "state bank" can bring it down - resulting in NCB margin calls from the state bank which it cannot meet.
Second, ELA procedures also require approvals from the ECB.
Ramanan,
As you know, economic reality prevents the ECB from making much fuss over the ELAs of member countries.
If NCBs fail to provide liquidity to their banking systems, under one form or another, payments will not be made, cross-border flows will cease and the eurozone will be toast.
In practice, NCBs will have to accept anything as "collateral" from banks and the ECB will have no choice but to go along, however reluctantly.
The important distinction to make here is between:
a) a government using TARGET2 to pay off maturing bonds held abroad. This procedure would slowly but surely extinguish the portion of the debt held by foreigners and it would abide by all the rules, in letter as well as spirit.
b) a government using its own commercial bank to directly finance new expenditures inside the country. This would not involve TARGET2 and could arguably be defined as against the "spirit" of the EMU. But it would not be strictly "illegal" and could be presented as a temporary, self-defense measure against the economic depredation brought by the Troikas.
In fact, some economists in France, of all countries, are already admitting the necessity of the government adopting an even more extreme measure, one day: "requisitioning" the Banque de France to directly finance the state budget.
But this would be both needless and wrong: using a government-owned commercial bank would have the advantage of maintaining the facade that everything is being done through "normal" banks without involving the NCB in a direct way.
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