The Target imbalances issue exploded into the public discussion early this year, igniting a heated debate in some corners of the blogosphere and in the press, before the data now published by Sinn and Wollmershäuser became available. Since the subject is rather difficult to understand (many bright minds have tripped up over some of its intricacies), here is a primer.
Target is – for the still uninitiated – the Eurozone’s system for settling intra-Eurozone transactions. Every time money flows from the banks of one euro member country to the banks of another, it does so through the Target system (unless, of course, the money flows across the border as cash in a suitcase). Thus, Target is a kind of financial plumbing underlying the European System of Central Banks.
Now imagine you have a credit card. If your cash flow is healthy, it is best to pay it off at the end of the month; if your cash flow is impaired, you can pay the minimum and roll over the rest. If you do the latter and keep maxing out your credit card, after a few months you will have accumulated a sizable debt. If you keep at it for some three years, your debt will be humongous. This is, in essence, what happened with the Target balances of the GIPS (Greece, Ireland, Portugal and Spain) and, lately, of Italy, stretching the acronym to GIIPS—only that they did not use a credit card but the money-printing press. In terms of indebtedness, the result is the same.
For many years, until the financial crisis hit, the balances in the Target accounts were virtually zero. But when private capital flows dried up, first the periphery and then the GIIPS started to face an acute balance of payments crisis, so they resorted to drawing credit from the ECB system by having their respective national central banks (NCBs) print money: it was a lot cheaper than paying the high yields demanded by the capital markets.
The money flowed via the commercial banks to either (or both) the public and the private sectors of the economy to replace the now nonexistent private capital imports. From there it flowed to the core euro countries, mostly to Germany and the Netherlands, as payment for goods and assets purchased there, with the result that the NCBs of these recipient countries saw their own money creation crowded out by the inflowing money.
In essence, what happened was akin to the GIIPS NCBs having “borrowed” the money-printing presses from the core NCBs, so that the former are now creating the money, while the latter end up mopping up the excess liquidity by borrowing it from their commercial banks—to then destroy it.
The European Central Bank (ECB) tolerated this (it was a crisis, after all). In this way, by now the NCBs of the GIIPS have accumulated at least 465 billion euros in Target debts, i.e. in liabilities to the ECB, while the core central banks have accumulated a corresponding claim. The Bundesbank alone holds around 500 billion euros in claims on the ECB.
So, it looks like the state of the “plumbing” might be signaling that something is amiss. And, as you know, when something keeps building up on one side of the plumbing, the outcome can be very smelly indeed.
But, countered the Bundesbank initially, these are purely accounting numbers in a settlement system. Within the Eurozone, you see, it all balances out to zero. No need to lose sleep over it.
This is, to say the least, disingenuous. Let’s think of it this way: you are part of a family. You lend 100 to your brother, who is having, well, yes, balance of payments difficulties. Within the family we have +100 for one of the members, and -100 for another. Nets out to zero within the group. But that does not make you sleep any better. What if your brother cannot surmount his balance of payments difficulties and simply defaults on paying you back? Purely accounting numbers, indeed.
Do the Target imbalances have any kind of other effects? More to the point, does this lending of the money-printing press lead to a credit squeeze in Germany, as some commentators claim? No, definitely no. The thing is, the core countries, and Germany in particular, are swimming in liquidity. For one thing, money is flowing from abroad. For another, and most crucially, German banks are now reluctant to continue lending their money abroad.
So, if Germany’s economy is not suffering from a dearth of credit, what is the problem? Does it matter whether the money comes from here or from there? Well, there are actually two reasons to be concerned.
First, by lending the money-printing press, the ECB system forces the reluctant capital that no longer wants to flow to the GIIPS to flow nevertheless. It thus artificially keeps a capital flow alive that private markets no longer find useful. Before the crisis Germans were lending money to the GIPS rather than investing it at home, with the result that Germany underwent a prolonged slump with extremely low growth, mass unemployment and the lowest net investment share of all the OECD countries. As we saw above, when the crisis hit, the country’s banks no longer wanted to send their money abroad, but were lending it to other Germans instead, so that these could use the money to buy German goods, investment goods in particular. This is the reason why Germany has been booming so strongly after the crisis. The ECB’s stance now forces some of the reluctant capital to flow to the GIPS (now GIIPS) nevertheless. In essence, this process is identical to a public credit flow through the existing rescue mechanisms, except that it has neither sought nor required prior parliamentary approval.
Second, the capital flow forced through the ECB system does involve risks. If any over-indebted Eurozone country should collapse but the euro survive, the rest of the NCBs would share in the loss in proportion to their capital shares in the ECB. But if the euro itself should go under, Germany, for one, would find itself the owner of 500 billion euros in claims on a system that no longer exists. The whole half-trillion, half of Germany’s external net wealth, would be at risk.
The whole thing could not have happened had the Eurozone had adopted the US system. There, the equivalent of Target balances have to be settled once a year with interest-bearing assets, gold-backed securities to be precise. If the US system were applied in Europe, the Bundesbank would have the right to claim from other NCBs in the Eurozone such gold-backed securities in exchange for its 500-billion-euro claims.
This is, in essence, what Hans-Werner Sinn brought to public attention with his various articles in the press and VOX, and what he explains in detail in the paper he wrote with Timo Wollmershäuser.
The ECB then finally deigned to make a statement regarding the economic crux of the Target balances issue in its October 2011 Monthly Bulletin. It confirms the facts that the above CESifo paper presented back in June. Interestingly, the ECB revealed that it does not have its own reporting system for such balances. It followed the CESifo approach, namely drawing some of the data from the statistics of the International Monetary Fund (IMF); it arrived at the same figures as CESifo.
And, true to form, some commentators gleefully reported that it denied the assertions of the CESifo paper, which was no surprise. But, in fact, it did not. In particular, the ECB did not deny that the Target balances measure a true credit between the NCBs (the credit from lending the printing press). And it could not possibly deny it: the balance of payment statistics officially call the Target credit a “capital flow through the ECB system”.
Peter Coy has recently summarised the story in a tight, well-written article in Bloomberg Businessweek. But well, for the real McCoy, just go ahead and read the CESifo paper or, better still, the NBER version that has just come out, which is an abridged, updated version of the CESifo paper.
Note: This text is the responsibility of the writer (Julio C. Saavedra) and does not necessarily reflect the opinion of either the person(s) cited or of the CESifo Group Munich.Copyright © CESifo GmbH 2004-2011. All rights reserved.