John Whittaker is an economist at Lancaster University, specializing in monetary policy. After an earlier career in business, he obtained a doctorate in nuclear physics before joining the academic world in the 1980s. His research and teaching experience include money and banking, macroeconomics, and financial economics, and he has published papers on alternative monetary regimes and mathematical economics. His current interests are sovereign debt problems in the eurozone, and the response of policy and regulation to the financial crisis and the recession. From 2004 to 2009 he was a Member of the European Parliament for the North West of England, representing the UK Independence Party.
In June 2011 Hans-Werner Sinn, a leading German economist, picked up the subject of intra-eurosystem debts that you had written about in March, seeing these debts as a stealth bailout of enormous proportions. That in turn gave rise to an intense debate over the significance of these debts. Were you surprised?
Yes, because Professor Sinn made some fundamental errors in his analysis. My paper sets out the nature of the financial flows between the national central banks (NCBs) and between the NCBs and the European Central Bank (ECB), which are reflected in the eurozone settlement mechanism, called TARGET2. However, in his argument he miscasts the role of the TARGET2 mechanism. He makes two major claims: first, that the TARGET2 figures—which show that by December 2010 the Bundesbank had lent €325 billion to other NCBs—somehow provide evidence that the Bundesbank’s lending to NCBs in the peripheral euro countries is “crowding out” its lending to German banks, starving them of credit. That claim is wrong. The Bundesbank’s claim on the eurosystem does not imply a shortage of credit in Germany.
Second, he claims that the increases in the TARGET2 liabilities of the NCBs in countries on the euro area periphery (EAP) are financing EAP current account deficits. But cross-border trade is only one cause of financial flows—they are also caused by bank transfers that are unrelated to trade, and there is in fact little correlation between changes in TARGET2 debt and the balance of payments for a particular country. Whatever the cause, it is hard to characterize TARGET2 debts as a “stealth bailout” conducted by Germany via the Bundesbank.
What is the status of the TARGET2 debts? Do they have real-world implications or are they “merely” accounting figures?
The TARGET2 debts of the EAP countries are just as real as the debts to the European Union/IMF that these countries have taken on under their official “bailouts.” But they are cheaper. In the Irish case, for example, TARGET2 debts currently carry an interest rate of 1.5%, whereas the rate for the official bailout of €67 billion is about 5.8%—a point we will pick up later.
Hence, Sinn is on the right track in recognizing that the TARGET2 debt that is being run up by Ireland and other EAP countries exposes the Bundesbank, and therefore Germany, to a nontrivial risk of losses, together with all the other countries that fund the ECB. However, it is important to realize that TARGET2 flows are an essential mechanism in the operation of the eurosystem. There is no way of arbitrarily “controlling” TARGET2 balances by, say, placing a debt ceiling on any one country’s TARGET2 balance—which, incidentally, is one of Sinn’s suggestions.