The aim of this concluding comment on the Hans Werner Sinn versus the rest on the subject of Target2 stealth bail-outs is a simple one. It is to persuade the reader who has made it thus far to go and read the “OriginalSinn-target-rebuttal” paper by Citibank chief economist Willem Buiter and his two colleagues, Ebrahim Rahbari and Jurgen Michels. The paper is not light reading but it is thorough and detailed and sets out the argument against Sinn in 24 pages of very logical prose.
If you are not a deeply experienced central banker to begin with, you will emerge from a reading of this paper with a much clearer idea of how the euro system works – or you might well decide that watching Wimbledon is a lot more fun and the hell with Sinn and the whole debate. That’s your privilege.
Lets begin at the beginning - again. A good part of why Sinn’s lecture and follow up blog on the theme of why Target2 imbalances in the euro system constitute a looming crisis for the euro is this: he suggests that in judging how much money is flowing from the core to the periphery of the EU we should (probably) take all the bail-out funds and add to them the Target2 imbalances, which are up in the hundreds of billions. This produces a frighteningly large figure and generates a shock horror response. Nothing involving that much money is sustainable.
This annoys Buiter and his colleagues no end.
“The sovereigns and the banking systems in the euro area periphery (EAP), notably in Greece, Portugal and Ireland, are under stress. In order to avoid needlessly aggravating the situation in these countries, it is imperative to avoid jumping to gloomy conclusions when confronted with potentially worrying data. Careful scrutiny of the data to achieve a full understanding of what they mean should come first.”
In other words, they see Sinn, one of Germany’s most respected economists, as engaging in polemics in a realm where there is already rioting in the street and where the spectacle of economists chucking buckets of petrol on the fire cannot be viewed as edifying. This point has been taken up with far less delicacy by a Wall Street Journal columnist who argues that Sinn, who has some form in opposing the bail-out of “lazy Greeks” by prudent German taxpayers, is deliberately stirring things up. (A note of thanks here to Handelsbatt Editor Olaf for the link to the WSJ piece.)
Others, who have followed the whole debate, argue that Sinn has performed at least one valuable service in that he has highlighted, quite spectacularly, the fact that huge imbalances exist in the Target2 settlement system. These imbalances cannot be found on the ECB’s balance sheet since the total of borrowings and lendings among Eurozone national central banks cancels out to zero. They have to be ferreted out. So knowing that they are there is something. What they mean, is something else…
The potential repercussions
Buiter and colleagues concede that these imbalances should not be viewed as benign. They are worrying. For Buiter they probably point to the fact that very few investors other than the ECB will lend to the peripheral countries any more – which is also not sustainable (gulp!). This is not the reading of Target2 imbalances given by ECB chief economist Jurgen Stark, who really should know, or what the devil is he doing in that position anyway? For Stark, these are purely accounting numbers in a settlement system (and therefore not something the rest of us should be losing any sleep over, despite the fact that accounting systems are supposed to be designed to apply measurement to real world events) – unless an EAP country leaves the Eurozone. (Stark’s reaction to the Sinn debate was given to Handelsblatt, Germany’s business daily, and featured in a blog by Olaf Storbeck, who has been at the forefront of publicising the Sinn debate).
Quite what Stark means by adding that dark little conditional clause ("unless they leave the Eurozone...") is unclear. Presumably what he is hinting at is that if a peripheral state suddenly bolts for the Eurozone exit door, the Target2 debt instantly becomes a matter to be settled purely by the NCB concerned. The point is interesting because if an NCB was to default on its Target2 obligation the debt as stands would be borne by all the central banks in the Eurozone in proportion to the ratio of their capitalisation of the ECB, not merely by the sovereign of the defaulting NCB. Now there’s an incentive for an EAP squirming under much austerity pain to sit tight and suffer. It sounds as if the message from the ECB would be "Can you settle your Target2 balance before departing, please?"
In fact, such a default under the present system is hugely unlikely since the NCB concerned is not being asked by the ECB to settle the debt, which is “fully collateralized” by the NCB’s sovereign bonds. In other words, the sovereign can simply keep issuing government debt, which is “bought” by the NCB concerned and handed on to the ECB as collateral in an ever upward spiralling Target2 balance. Like Stark says, it’s just accounting… Hmmm. Sounds like a Ponzi scheme to me…
Further reading on bail-outs, sovereign debt and political economy:
- Greek bail-out rewrites rulebook for EU sovereign debt by Ian Fraser (blog)
- Why Printing Money Sometimes Works for Central Banks by Paul Kasriel
- Nothing but Painful Choices Ahead as the Global Debt Supercycle Ends by John Mauldin
Tags: bail out , bailout , Citibank , debt , Ebrahim Rahbari , ECB , EU , Greece , Greek debt , Handelsblatt , Hans Werner Sinn , Jurgen Michels , Jurgen Stark , Olaf Storbeck , sovereign debt , stealth bailouts , Target2 , Wall Street Journal , Willem Buiter , Wimbledon