How to claim to inflate the bubblefish
The dispute over target balances
This contribution is a response to the criticism expressed in Perspectives of Economic Policy by Martin Hellwig of the work of Clemens Fuest and Hans-Werner Sinn on the target problem. It is also a reply to Isabel Schnabel, who joined Hellwig's analysis and presented it to the German Bundestag together with him. Sinn contradicts the central factual statements of these authors.
1 preliminary remark
The economic guild is divided in the political evaluation of target balances. I have argued on several occasions that the target balances are public loans of the Eurosystem, which, although they mean a short-term stabilization and calming of the capital markets, invite abuse and expose the taxpayers of the target surplus countries to a liability risk without being asked. Other economists see this as an unfounded alarmism. The most prominent proponent of this view is without a doubt Martin Hellwig. Hellwig joined the discussion about the balances very late, but all the more clearly. We already had a few opportunities to exchange ideas, also with the participation of Clemens Fuest. In a macro round organized by Carl Christian von Weizsäcker in 2018, we discussed with a number of other colleagues. In the Perspectives of Economic Policy, Hellwig (2018b) has now attempted to present his view conclusively and to uncover alleged errors in my argumentation. Above all, he claims that the Bundesbank's target claims are not a measure of credit, that their economic value is zero, and that their loss is meaningless because they do not earn interest. The target demands of the Bundesbank are proof of the success of the Frankfurt financial center.
Hellwig sees little more in my warning of the excessive interpretation of the ECB's mandate, as his title shows, than falling into an “indignation trap”. He's not just criticizing me. The Federal Constitutional Court, which suspected the mandate was exceeded in its submission decision on the OMT program, he attests (p. 351) “nonchalance to historical experience”, and he accuses Bundesbank President Weidmann of being “artefacts of accounting” when warning about the liability risks of the securities purchase programs (p. 349). The national accounts measured a “collectivist fiction” (p. 362). Anyone who sees Germany as a “lending collective” is promoting “nationalist agitation”, such as that of Der Spiegel (sic!), For example (p. 366).
The readers of this magazine will understand if I respond to Hellwig's statements. I am amazed at his rampant accusations, his attacks ad personam and his attempts to fathom the motives behind my writings, but does not want to answer on this level. Only the insinuation of scandalous terms that I don't use and statements I haven't made I have to reject it.
The target problem has become more topical due to the recent increase in the German target demand in the course of the quantitative easing program (QE) up to almost 1,000 billion euros. Politics has also dealt with it lately. Not only 43 members of the AfD parliamentary group have expressed concern, but also the Secretary General of the Economic Council of the Union, various members of the Bundestag the CDU and CSU as well as a large number of members of the FDP parliamentary group. The hearings of the Bundestag in June 2019, at which various domestic and foreign economists commented on the target issue (German Bundestag 2019), represent a high point of political attention in Germany.
Among them was Isabel Schnabel, a member of the Advisory Council, who submitted a text written together with Hellwig (Hellwig and Schnabel 2019), the content of which is congruent with Hellwig (2018b). I will try to convince the reader that the key economic statements of the texts and statements by Hellwig and Schnabel are scientifically unsustainable. My text, however, is not a plea for the abolition of the target system, and it does not develop any reform proposals, although I believe that reform is urgently necessary. I have omitted this elsewhere. My only concern here is to correctly inform the public and the German Bundestag about the economic situation and the dangers associated with the target system.
2 Why target balances measure public lending between central banks
I will start with the core question of whether target balances measure credit relationships, because this interpretation is not accessible to the intuition of many viewers. Hellwig contests the credit quality of the balances with verve (p. 345 f., 373 ff., 380, especially p. 366 ff.). Schnabel (2019) made a similar statement before the Bundestag:
"In our joint statement, we repeated in great detail that Target2 balances are not loans."
But what is it really like now?
2.1 Transfers and credit transactions
Target balances arise from net transfers in the Eurosystem, in which the national central banks and the ECB pass on payment orders to one another. The balances are listed as claims and liabilities vis-à-vis the Eurosystem as a whole in the balance sheets of the national central banks and, if one includes the ECB, i.e. the headquarters of the Eurosystem, the sum is zero.
Transfers between banks, be they commercial banks or central banks, can or do not have to go hand in hand with lending between these banks. This is not a matter of lending in the sense of providing means of payment through a specific contract, but, as can be shown, a credit relationship that is similar to an overdraft.
To explain the basic problem, consider two private banks in the United States in the 19th century. At that time there was (apart from a brief interlude) no central bank, but the dollar did. Dollar coins were produced decentrally according to well-defined standards for the silver content. The state had also issued banknotes. When the customer of a bank B in Detroit wanted to transfer money to the supplier of goods in Chicago, B debited her customer's account and asked the supplier's bank A in Chicago to pay out dollars. With that, Bank A (in Chicago) gave Bank B (in Detroit) a loan. The hope was that there would soon be payment orders in the opposite direction. If this was not the case and there was a balance remaining within a previously agreed period of time, Bank B had to send gold, silver or banknotes to Chicago in order to repay the loan received. It was a risky endeavor because it attracted robbers. The robbers' attacks later became the subject of many Wild West films.
The United States decided to create a central bank with 12 district banks in 1913. In the case of transfers between the districts, the credit relationships that initially developed between the district central banks were repaid by the annual transfer of ownership of a jointly managed gold treasure, which the robbers could no longer get at. This system lasted until 1975 and was then replaced by the repayment of the credit relationships arising during the year by transferring shares in the jointly managed portfolio of assets that had come into the possession of the district central banks through open market transactions.
If a transfer takes place between banks within Germany, there is usually no credit flowing between the banks, because they only transfer existing deposits at the Bundesbank that were granted to the banks in their entirety in exchange for valuable assets in the broadest sense. There is usually no credit relationship between these banks either.
Either way, a transfer is always associated with an opposing transfer of an asset. Either bank A, which credits the transfer, gives the other bank B a loan and receives a corresponding credit claim against it, or it receives an already existing asset such as gold or a deposit at a higher-level clearing institution such as the Bundesbank. In foreign trade theory, the transfer of the asset from B to A in compensation for the transfer is called a "capital export" from A to B if an area border is exceeded, because the transfer serves to export goods from area A or to import other capital this area to pay.
How do the transfers between the national central banks of the Eurosystem take place?
2.2 Opting for Public International Loans
When the Eurosystem was created and the aim of the Maastricht Treaty was to be fulfilled, according to which the European Central Bank (ECB) had the task of promoting the smooth functioning of the payment systems, Theoretically, the following options were available for designing a European payment system:
Private: International payments flow directly between private banks or via private clearing institutions (with the option of lending banknotes to one another to compensate for cash outflows).
European public, central account management at the ECB: National central banks are only branches owned by the ECB. All assets created through money creation belong to the ECB, which in turn belongs to the EU. The Eurosystem commercial banks have direct accounts with the ECB and can transfer funds to one another by transferring deposits.
Nationally public, with a transfer of money creation assets: The money creation assets that a national central bank acquires in exchange for central bank money belong to this central bank. The central bank can build up a target balance at the ECB by transferring part of these money creation assets to the Eurosystem, and this balance can then be used for net transfers. Alternatively, it assigns a corresponding part of its money creation assets to the other central bank or to the Eurosystem when it makes the transfers.
Nationally public, without transfer of money creation assets: A national central bank that issues a payment order to another remains the owner of the money creation assets that came into its possession through the lending of central bank money. The central banks therefore grant each other unsecured loans.
Variant A) corresponds to the example described at the beginning of payment transactions between the bank in Detroit and Chicago in the period before the Federal Reserve Bank was founded in the United States. It would have been easily possible under the Maastricht Treaty. The wording chosen in Article 127, Paragraph 2 of the Union Treaty that the ECB “must promote the smooth functioning of the payment systems” was so general that it would have been compatible with a purely private organization of the European payment system. “Funding” really does not mean “doing it yourself”, and even the use of the plural for the word “payment systems” suggests that the fathers and mothers of the Maastricht Treaty had something else in mind than what the unified state target system then created has been. Incidentally, that is a point of view that the former Bundesbank President Helmut Schlesinger, who himself took part in drafting the contract, also took.
Variant B) corresponds at the European level to the regulations that exist within the individual countries with regard to the respective central bank. It was not chosen because the participating states and national banks attached great importance to their independence. Under no circumstances did they want to pool the assets of the Eurosystem central banks and transfer them to the EU. That was the business basis for the introduction of the euro from the start.
As far as I know, variant C) was excluded by the Governing Council itself. You probably weren't even aware of the problem because you weren't expecting larger balances anyway. They didn't exist until the Lehman crisis. This variant comes close to the American system described, as it was introduced in 1913 with the Federal Reserve System, only that initially gold and now ownership shares in the pool of assets acquired during the creation of money are transferred between the district central banks. It is also similar to the treatment of external countries connected to the Eurosystem, such as Norway or Switzerland. The central banks of these countries can build up target credit accounts that they can dispose of by issuing assets or carrying out net transfers for central banks of the Eurosystem. These accounts cannot be overdrawn.
The Governing Council agreed on variant D). International transfers therefore take place in the euro zone between the national central banks, and they lead to open positions because neither deposits at the ECB nor any other assets are transferred between the central banks. Not even the money creation assets of the national central banks are transferred to the Eurosystem as collateral - a topic that Bundesbank President Weidmann had raised in a letter to ECB President Draghi at the beginning of the crisis year 2012. In the Frankfurter Allgemeine Zeitung, which reported on the letter, it was said at the time that Weidmann was “expressly referring to the growing Target demands. He suggests securing these claims of the ECB against the financially weak central banks of the Eurosystem, which would have reached a value of more than EUR 800 billion. The proposals on collateral policy could lead to renewed disputes in the ECB [...] ”.
Regardless of the national central bank, the Eurosystem itself has no access to the securities that a national central bank has acquired with money it created itself; it has no way of enforcing claims from refinancing loans against commercial banks itself; and it has no access to the pledges that the commercial banks have given their respective national central banks to secure such loans. The national central banks of the Eurosystem are not just subordinate branches of the overall system, but, as the ECB itself writes, "financially independent institutions that, in addition to monetary policy tasks in connection with the Eurosystem's primary goal of ensuring price stability, also perform national tasks."
It is therefore in Europe as in the example of the private transfer between the bank in Detroit and Chicago in the time before the establishment of the Federal Reserve Bank, which was explained at the beginning. Because and as long as the transfer does not include the transfer of other assets between the banks, credit relationships arise between the national central banks. The only difference is that in Europe these are public credit relationships, while in the example they were private ones. The credit quality of the target balances cannot therefore be shaken.
These are of course not bilateral loans between the national central banks, but between a central bank and the ECB, whose owners - the national central banks - must collectively pay for defaults on the target debtors. In the case of a transfer, a bilateral credit relationship initially arises between the central banks involved, but at the end of each day it is transformed into corresponding relationships with the ECB, and thus indirectly with the Eurosystem as a whole.
A single executing central bank such as the Bundesbank, which has by far the largest claims in the euro area, cannot actively influence or even refuse the loans through its decisions. This aspect is important because otherwise the impression could arise that the Bundesbank was actively involved in building up the balances and behaved incorrectly. She doesn't.
Of course, this also applies to a limited extent to the central banks, which have built up a debt relationship in the form of negative target balances. If, for example, Banca d’Italia carried out transfers from Commerzbank's debtors to Germany because Commerzbank did not want to extend its loans and the debtors had to pay, it also didn't have any immediate Had choices. If an Italian debtor instructed his bank to repay his loan and the bank had sufficient credit at the Banca d'Italia, the Banca d'Italia had to replace the private international debt by transferring its own target debt and help, Exculpate the debtor and save Commerzbank, whether it wanted to or not.However, it has indirectly had options by reacting more or less flexibly to the resulting shortage of liquidity in Italy with new money creation credits and thus preventing or stimulating compensatory private capital flows. I turn to this topic in the following sections.
The target loans are undoubtedly loans, albeit of an unusual type, because although they are redeemable, the Bundesbank cannot call them, as is normally the case with loans. The question of the due date is not decisive for the credit quality, because consols, i.e. interest-bearing government bonds without a fixed repayment date, also establish credit relationships. Even normal government bonds do not lose their credit quality simply because they are usually never actually redeemed, but are replaced by new bonds on a revolving basis when they mature.
Hellwig presents the situation very differently. He points out that transfers within Germany do not give rise to any “debt-related liabilities” between the banks because the banks have accounts with the Deutsche Bundesbank, and then generalizes his statements to that in one breath Relationship between central banks. On page 359 of his text he writes:
“If a German commercial bank wants to transfer money to a French bank, it gives the order to the Bundesbank; the latter instructs the ECB to transfer the amount of the transfer from its account at the ECB to the account of the Banque de France at the ECB; the Banque de France, in turn, credits the amount to the French commercial bank. At the end of the entire process, the account balances of the German commercial bank with the Bundesbank and the Bundesbank with the ECB are lower by the amount of the transfer; the account balances of the Banque de France at the ECB and the French commercial bank at the Banque de France are correspondingly higher. " (My emphasis)
For readers in a hurry, this formulation suggests that there are account balances at the ECB that the national central bank making the transfer can dispose of. In truth, this statement is only a somewhat subtle algebraic description of the target balances, which can be positive and negative and are zero in sum. In the target system, the national central banks do not have an initial supply of deposits in accounts at the ECB that they could transfer elsewhere with the transfer. Rather, they are unlimited and uncovered overdraft accounts that are negative if a national central bank has made net transfers to other national central banks or to the ECB itself. That is exactly why these are overdrafts.
I refer here to the official definition of overdrafts according to Eurostat:
"Transferable deposit accounts may have overdraft facilities. If the account is overdrawn, the withdrawal to zero is the withdrawal of a deposit, and the amount of the overdraft is the granting of a loan. "
According to this definition, overdrafting an account creates a loan, a term that Timo Wollmershäuser and I used in the title of our base paper.
The correctness of our definition does not change even if Hellwig (p. 361) points out that the Bundesbank carries out the transfers got tobecause that is one of the monetary policy tasks in the central bank system. If I have agreed a framework agreement with my bank with an overdraft option for my account and they have to carry out my transfer order even if my account goes into negative territory, I am using an overdraft from them. The obligation to make a transfer does not contradict the creation of a credit relationship.
Unlike Hellwig with the reference to Karl Whelan and Adam Tooze would like to lead you to believe, who gave disparaging comments on my interpretation of the target balances, the credit interpretation is not a quirk of mine, but is now understood and accepted by leading figures in our discipline. I reluctantly quote here, and only because Hellwig came up with Schopenhauer's trick No. 30 (quoting awe-inspiring authorities), Carmen Reinhart (2017), who is considered to be one of the most outstanding experts in the field of international macroeconomics:
"Target2 balances are an external liability of the central bank and in orders of magnitude that are meaningful. Therefore, when we consider public sector debt, rather than general government debt, for Italy, Spain, Portugal, or Greece, those substantial Target2 balances have to be added to that picture. "
The economist Aaron Tornell (2018, fn. 1), who specializes in balance of payments crises, also calls target liabilities “automatic loans from the Eurosystem to a national central bank”. Tornell and Westermann (2011) also speak of “Eurosystem loans”. Steinkamp and Westermann (2014) interpret Target as public, multilateral credit. Aizenman, Cheung and Quian (2019) speak of "credit lines" that the Bundesbank grants to the euro crisis countries:
"TARGET2 balances are akin to swap line arrangements implemented via the ECB, where creditor Eurozone countries (mostly Germany and other core countries) provide access to credit lines to the indebted countries (mostly to the Eurozone countries affected the most by the Euro crisis - Italy , Ireland, Greece, Portugal, and Spain). "
Of the experts I have quoted, four are in RePEc's top 100 list for the field of international finance. And even Whelan (2014, p. 101), named by Hellwig as a key witness, concedes that it is a reasonable analogy, albeit imperfect, to speak of “target loans”.
After explaining the credit characteristics of target balances, I will now turn to their importance for the balance of payments of a euro area, because it is the basis for understanding their economic effects and the risks associated with a possible default.
3 Current account, capital flight and target balances
The target liability of a national central bank measures the net stock of transfer orders that this central bank has issued to other central banks of the Eurosystem and the ECB headquarters. In principle, such transfer orders come about to pay for a current account deficit and a capital export. The payment of the current account deficit includes the acquisition of a net flow of goods and services from abroad after deducting that part that was financed by transfers (gifts) from abroad, as well as the payment of interest and similar capital services. The payment of the capital export, in turn, includes the acquisition of foreign assets including possible sight deposits at banks, lending abroad and the repayment of old loans that were previously drawn from abroad. The latter explains the essential part of what is known as capital flight, because repayment is forced when a loan becomes due if the creditors do not grant follow-up loans. However, capital flight can also occur when residents acquire assets abroad in order to avoid losses at home.
International capital flows are mostly of a private nature, but they can also affect public authorities. If the lenders or capital exporters are public entities, I am speaking of a fiscal flow of capital. In general, my considerations in this text are algebraic and relate to net sizes. This means, for example, that a current account deficit is a negative current account surplus, a liability is a negative claim, a capital import is a negative capital export and a deficit is a negative surplus. With these definitions in mind, it follows:
Target deficit + fiscal capital import (1)
= Current account deficit + private capital export.
The target deficit is the year-on-year decrease in the target balance, which in turn is defined as the net receivables. In a country like Greece, the target balance is negative, and it has become increasingly negative in the first few years after the Lehman crisis because of a persistent target deficit. There was a fiscal capital import through the rescue packages, and at the same time the country had a current account deficit and suffered from capital flight, thus realized a private capital export. In Germany it was exactly the opposite. This is why equation (1) applies in reverse with a different sign for countries that are on the creditor side of the target loans.
Equation (1) represents the official posting of the change in the target balances in the European and international balance of payments statistics. The target balance itself is treated there as part of the foreign assets of an economy and is accordingly included in the calculation of the so-called net foreign position, which is the algebraic sum of all foreign claims and property titles of a country minus the domestic claims and property titles of foreigners is defined. Interest that a central bank receives from other central banks based on its target balance, as well as other profit flows between the central banks of the Eurosystem, are recorded in the current accounts of the participating countries in a similar way to international capital income flows between the other sectors of the national economy.
It should be noted that the target balance is equivalent to
the special drawing rights of the central banks at the IMF,
the artificial currency Bancor, which Keynes proposed for a fixed exchange rate system,
the transfer ruble balances in the Soviet Union,
the foreign exchange holdings in the Bretton Woods fixed rate system of the post-war period
and to a certain extent also the portfolio of assets that the Swiss central bank has invested through foreign exchange market interventions.
Equation (1) shows two important aspects: firstly, the target loan is on a similar level to a fiscal loan granted by the community of states to an economy, and secondly the target loan and the fiscal loan are used together to finance the current account deficit and private capital exports in the form of a Investment that residents make abroad and the repayment of foreign loans by residents. The latter was the more important item in most of the crisis countries in the first phase of the crisis until 2012. The foreign investors were not prepared to roll on maturing loans and demanded repayment. In view of the negative current account balances at the time, this could only be done by replacing the Eurosystem's public overdrafts with private foreign loans.
Note that the equation describes a definitional relationship from the balance of payments statistics and not causalities. When the capital markets were no longer ready to finance the current account deficits of some euro countries, which were already high before the Lehman crisis, this financing came about through the target system. And when there was a real flight of capital in individual countries, the target system provided the replacement financing. As private capital fled from the crisis countries to Germany and other countries considered safe, the Eurosystem turned public capital in the opposite direction. The private capital export of the crisis countries was compensated and made possible by a public capital import from the Eurosystem.
Without the target system, there could not have been the implicit public capital import from the Eurosystem, as it takes place automatically via the transfer via the target accounts. If a private payment system had been set up, as described under A) above, the private capital flight of investors would have required a compensating private inflow of capital on the part of banks or private clearing institutions that grant each other credit. In this respect, calculated on a net basis, a private movement of capital across the borders could not have occurred on the transfer route, unless the flight of capital had been made possible by a collapse in imports of goods. Specifically, the clearing institutions would have charged sufficiently high fees or interest for their services in order to reconcile their willingness to direct capital in the opposite direction of the original capital flight with the wishes of the refugees, and on balance there would only be so much private capital move in one direction, just as banks and clearing institutions were willing to move other private capital in the opposite direction. There would have been a system of extremely tough national budget constraints that should not have been put in place. Even so, it would have been compatible with the free movement of capital in Europe.
4 The cash balance
Private capital can also be brought across borders in the form of physical cash transports if this is not prevented by capital controls - as in the case of Greece or Cyprus. This creates balances and liabilities similar to those for transfers between central banks. The Bundesbank has a liability because it traditionally spends more cash than other central banks. It is recorded on the balance sheet under the name “Liabilities arising from the distribution of euro banknotes in circulation within the Eurosystem”, or “negative cash balance” for short.
Hellwig accuses me of suppressing the cash balance in my analysis because it is “more effective in the media” (p. 368, fn. 82). I reject this accusation. The cash liability of the Bundesbank from a disproportionate cash issue by the Bundesbank is mentioned again and again in my books and discussed in detail, also in the article to which Hellwig refers in this statement.
As I will show later, the cash balance is very important for the controversial question of interest on the target balances, because both balances have the same implications in this regard. The cash balance is defined as the difference between the amount of cash circulating in a country and the amount of cash issued. While the latter is known, the Eurosystem uses an estimate of the amount of cash in circulation (“banknotes in circulation”) by assuming that it constitutes a fixed proportion of the total amount of cash, which is itself determined by the relative size of the country. Specifically, the share is determined by the share of the deposited equity of the ECB, which is determined as the mean value between the population share and the GDP share of the country and is only recalculated every five years.
The measurement specification for the cash balance is based on the assumption that a small amount of cash issued compared to the size of the economy was caused by physical inflows from other countries. A central bank that has a positive cash balance can post a claim against the Eurosystem because it is assumed that part of the cash circulating in its territory was created elsewhere through lending and migrated domestically in exchange for goods or assets. Accordingly, a national central bank must accept a liability to the Eurosystem if its cash outflow is greater than its share of the total cash supply in the Eurosystem, because it is assumed that the excess cash for such purchases has flowed to other countries.
Germany had a cash balance of –408 billion euros in mid-2019, and the algebraic sum of the Target and cash balance was +545 billion euros. Because of the foreign employees who bring cash home, the proportion of the money supply issued by the Bundesbank that flows abroad is traditionally quite high. In this respect, this number is not unusual. The fact that physical cash actually flowed across the borders in the amount of the arithmetical cash balance is of course a mere fiction, the sense of which is debatable. In the absence of other information, however, this fiction has its justification and is assumed in further analysis.
The International Monetary Fund has also recommended a methodology to the European statistical offices that corresponds precisely to this interpretation. Here's how the IMF explains:
"For CU balance of payments and IIP statistics, transactions and positions in banknotes should be treated according to the same principles as for national data, with nonresident purchases recorded as an increase in external liabilities (credit) [...]. From a national perspective, holdings of the CU banknotes issued by a CUNCB in another member economy are external assets at the same time, even though the currency is classified as a domestic currency. "Jupiter sr 53g is how many cups
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