The Bundesbank has always been producing a lot of noise regarding the way in which policy makers are dealing with the ongoing economic crisis. At times their objections are legitimate and well-grounded, at others they exaggerate by stubbornly maintaining a disproportionately hard line on rather insignificant issues. The last in the series of such over-emphasized concerns is the “discovery” that intra-eurozone current account imbalances are a risk to the Bundesbank that could presently cost it some €500 billion. This was found through the amount of claims made by the Bundesbank on the inter-central-bank payment system known as Target 2, which measures payments made within the Eurosystem (ECB + national central banks of EU17) – a quite technical issue that should only concern central bankers and mostly their statistical bureaus. The alarms started ringing when they realized that the claims through Target 2 were close to zero prior to the crisis, whereas now they have climbed to about half a trillion euro. What the economic intelligentsia of Germany had just realized was how problematic current account imbalances are, but it did so in a rather peculiar way. To explain why allow me to first outline the issue.
The Target 2 is a payment system between the central banks of the Eurosystem that allows for the smooth operation of the monetary union, by facilitating transactions between banks and/or national central banks. It serves as a platform that allows for the creation of money that are needed for local transactions that involve imported goods. This is necessary in modern economies, since due to the Fractional Reserve Banking System, private banks only keep a fraction of their reserves, while the rest is lent out to the economy. Thus private banks do not actually have in their vaults the money needed to carry out a transaction, but have to make a claim to the Central Bank to create that money. This process is normal under the current monetary system. When the transactions involve payments to other eurozone countries, in other words when they concern imported products, then the process will also involve the central bank of the state that exported the product. As such a German product bought in Greece would create the following chain of events in the eurosystem (Germany and Greece are just used as an example):
- The local bank would bring a claim to the Greek central bank (Bank of Greece) asking for the amount of money necessary to carry out the transaction,
- Since the issue concerns a German product the Greek central bank would create the necessary money, but would send the claim to the central bank of Germany (Bundesbank),
- The Bundesbank, would then record the amount of the transaction as a claim against the eurosystem.
*the picture below depicts what was just described above, under normal economic conditions (click to enlarge).
|Target 2 payment System. Image Source: ECB|
All the above are done through the Target 2 payment system, which of course is monitored by the statistical offices of central banks. The reason that suddenly the Bundsbank reacted to this, through its chairman Mr. Weidmann, is because before the crisis the figure measuring Target 2 claims of the Bundesbank, was close to zero, whereas now it shows around €500 bn worth of claims against the eurosystem. Given that the crisis has practically disrupted the credit line and after considering how deep in the hole European banks are, it is quite normal to witness such a rise, since central banks step in to avoid a credit crunch and an eventual collapse of the monetary system (and consequently the monetary union). The noise that the Bundesbank has produced around the issue and the collateral they now ask for to cover this exposure, is worth observing since it implies a few things about the countries within the eurozone.
First of all the rise of the Target 2 index shows to the German economic intelligentsia that current account imbalances are problematic even for (or perhaps more for) the country that runs a surplus. The increase in the amount of Target 2 claims, shows how exposed Germany and the Bundesbank are to a disruption of trade with other eurozone countries. This exposure would ultimately prove to be disastrous, if the eurozone collapsed, or even if the countries that produce the largest amount of claims via Target 2 – the countries that have the largest current account deficit vis a vis Germany – were to exit, or be forced out of the eurozone. In short the interconnections that are created through Target 2, are such that no part of the eurozone can be severed without immense pain for all the rest, especially for Germany that is a surplus country and thus its exposure is greater.
What does this tell us? The obvious: That no country will ever be forced out of the eurozone for as long as it affects the overall current account balance – even Greece -, thus I am again proven correct when insisting that such “threats” were groundless and could only be used rhetorically. The cost of forcing a country out of the eurozone would mostly be felt by Germany, therefore the German government that pretty much shapes the European agenda, will never allow that to happen, ultimately for their own good.
Moreover the Bundesbank has brought to the surface a debate that only makes sense if there is a high chance that the eurozone will disintegrate in the near future. At least that is what it directly implies since collaterals would only make sense in such an event. But there really is no chance of a eurozone collapse within the next few months (maybe there is over the medium-term), so why does Mr. Weidmann maintain such a hard line on this issue? But of course to satisfy the conservative German economic elite that still wants to believe that the crisis is all about the fiscal finances of certain (irresponsible) states. Well Target 2 itself should open their eyes to make them see that the crisis might be more intense in Greece or Portugal or elsewhere, but Germany and other surplus countries are equally involved in it – again a proof that the crisis is systemic and not a series of “sovereign debt crises”.
By posing objections to the increase in the claims made through Target 2, the Bundesbank has actually fell into a trap of its own making, as it has unwillingly undermined its own interpretation of the ongoing crisis and its overall view of the political economy. By saying that Target 2 is a risk to the Bundesbank, its chairman Mr. Weidmann, has indirectly admitted that (a) current account imbalances are also problematic for Germany, not just the deficit countries, (b) the cost of forcing a country out of the eurozone will be immense for Germany – thus it will not be allowed to happen, (c) the interconnections measured through Target 2 alone are enough to prove that the crisis in the eurozone is systemic and is not only about the unsustainable finances of certain states.
It finally becomes crystal clear that being tough in your decisions is good, but having a sense of proportion and realism is better.
**UPDATE December 19, 2012 at 9.30 CET:** Target2 imbalances are also due to the massive capital flight from peripheral countries. Ever since the beginning of the eurocrisis we have been witnessing the reversal of the erratic capital outflows from the core to the periphery, which fed into all sorts of bubbles and produced unsustainable capital structures. For more on this issue I recommend my articles:
- Money illusion as a solution to the eurocrisis?
- Quo vadis Jens Weidmann
- Has the European Central Bank lost its independence?
Also to avoid any misunderstandings and to stress my opposition and alertness to the exuberant Germanophobia of our times, I suggest reading these three posts, among others:
- Is Merkel preventing the solution to the eurocrisis?
- Merkel, European austerity and the scurrilous metaphysics of a Harvard historian
- A failure of ideology not of Germany