Saturday, April 7, 2012

Germany's Hidden Support of Greece, Spain and Portugal (Wonkish)

Bob Engilsh emails:
Just got to this in my reading stack and it supports your post(s).  It's pretty interesting.  The gist of the 40+ page paper is that Germany has been stealth printing with TARGET loans to make up for the capital flight from the periphery: 
It shows up on the balance sheets of the individual NCBs, but is hidden in the ECB's balance sheet.  By August, 2011, Germany had printed nearly 400 billion euros--much more than the EFSF purchases.

From the paper's conclusions:
This paper has tried to shed light on the European balance-of-payments crisis by drawing on a hitherto little known accounting system embedded in a non-transparent way in the balance sheets of the Eurozone’s National Central Banks (NCBs): the Target balances. While Target balances at first glance seem to be inconsequential technicalities of an interbank settlement system, we demonstrate that they indeed measure the Eurozone’s internal balance-of payments surpluses and deficits, and hence capital flows and credit shifts through the ECB system. In our opinion the Target statistics provide the most accurate seismograph of the shockwaves that were sent through the Eurozone during the global financial crisis...

 We showed that the current account deficits of Greece and Portugal were almost entirely financed by Target credits in the years 2008 – 2010, and Ireland in addition accommodated a major capital flight that way, a policy that Italy copied in the summer of 2011. Germany, on the other hand, in the period 2008 – 2010, was paid for its 264-billion euro current account surplus with the rest of the Eurozone almost entirely (96%) with Bundesbank Target claims on the ECB. No marketable assets were returned. Currently, there is a huge capital flight from Italy to Germany that even results in swapping German marketable assets for Target claims.

These are all symptoms of a deep balance-of-payments crisis that resembles in many respects the fatal crisis of the Bretton Woods system. The cheap credit that the euro made possible for the periphery countries led to inflationary bubbles and huge current account deficits, as in the USA during the Sixties....

The European system may not collapse as quickly as the Bretton Woods system did, given that the Bundesbank, which has accumulated Target claims instead of dollar claims, will be unable to follow General De Gaulles’s example and convert its claims into gold. After all, its Target claims are intangible assets that cannot be converted into anything without a fundamental change in the ECB’s policy.Thus, year after year, the periphery’s current account deficit and capital flight may continue to be financed with the printing press, and the core can continue to shred the money flowing in as payment for goods and assets sold to the periphery. The peripheral countries and the core countries, above all Germany, can just go on swapping Target claims for real marketable assets that the inhabitants of the periphery buy in the core.
 However, one can doubt whether such a solution would really be sustainable. There
are too many cumbersome aspects that would undermine its economic and political feasibility...

The Target imbalances show that a system with idiosyncratic country risks and international interest spreads for public and private bonds is incompatible with a monetary system that allows countries to finance their balance-of-payments deficits with the printing press, without having to pay for the extra money-printing with marketable assets as is the case in the USA. Such a system will always induce the less-solid countries to draw Target credit to avoid the risk premium that the market demands, leading them eventually to a balance-of- payments crisis. To avoid this problem, Europe has only two options. Either it socializes national debts in order to eliminate the international differences in interest rates (by creating a uniform default risk for all countries), limiting excessive borrowing through the imposition of politically mandated constraints. Or it ensures that the Target balances are paid annually with marketable assets, keeping the debt burdens within the national responsibility and allowing for country defaults and interest differentials...

In our opinion, the reason why Europe is drifting in the direction of Eurobonds lies in the path-dependence resulting from the prior decision to set up a Eurosystem that provides the right to settle balance-of-payments deficits by creating money without having to pay for the extra money creation with marketable assets... Arguably, the potential threat with the printing press in the basement has made it easier for them to convince their European partners to solve their balance-of-payments crises with generous public rescue operations rather than undergoing the hardship of solving such crises by lowering the bubble-driven prices of labor,goods and assets to their equilibrium levels.
Bottom line: Germany is funding the PIIGS and getting air in return.

On the hidden target loans:

The Target imbalances went unnoticed for a long time, because they are not shown on the ECB’s balance sheet, given that they net out to zero within the Eurosystem. They can be found, however, if somewhat laboriously, in the NCBs’ balance sheets under the “IntraEurosystem Claims and Liabilities” position. Furthermore, they can be found in the balanceof-payments statistics, where they are shown as a flow in the financial account under the “Other Financial Transactions with Non-residents” position of the respective NCBs and as a stock in the external position of the respective NCBs as “Assets/Liabilities within the


  1. This debate has been raging for nearly a year now. Check out Olaf Storbeck's blog (among many)to get an idea of how wrong some of the conclusions the HW Sinn has drawn in his assessment of the TARGET2 system.

    The link to Olaf's blog is here where he goes through the ECBs response to Sinn's ridiculous interpretation. (search the blog for TARGET2 to see more on the debate)

    I'm sorry, but "Bottom line: Germany is funding the PIIGS and getting air in return." is just plain wrong.

  2. Does this all mean that the ECB through the NCBs (here the german) continue to buy greek assets in order to inject money into the southern countries? Thus the interest rates stay low and encourages further consumption and not savings. In addition the southern governments finance their deficits with money created out of thin air. Am I correct?

  3. I am sure the they are Rolling On The Floor Laughing at the ECB after reading this news.

  4. "The Target imbalances went unnoticed for a long time, because they are not shown on the ECB’s balance sheet, given that they net out to zero within the Eurosystem."

    These don't appear to net to zero from the chart, as the totals don't equal in the chart. Does it not account for printing by ECB (not even sure it can or does do this)? 28 Billion+ is missing in the graph.

  5. These are all symptoms of a deep balance-of-payments crisis that resembles in many respects the fatal crisis of the Bretton Woods system.

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