Felix Salmon

Felix Salmon smackdown watch, European central bank edition

By Felix Salmon
June 7, 2011

Martin Wolf’s column last week was not an easy read. I did my best to turn it into English, only to run into an unexpected source of pushback: not only was I wrong, Martin Wolf was wrong as well.

Enter Olaf Storbeck, the International Economics Correspondent with Handelsblatt, Germany’s business daily. He has an explanation of why Martin and I are wrong, which approaches in reading difficulty Martin’s original column.

I spoke to Olaf today, and he sent me a bunch of links in German, but since I’m having enough difficulty getting my head around these issues in English, I’m not even going to attempt to read them. (But for the record, start here, and then try here and here; Mark Schieritz here, here, and here; Thomas Strobel here and here; and finally this.)

In English, there’s also this press release from the Bundesbank, which says very clearly that “TARGET2 balances” — the things that Martin and I were worrying about — “do not pose specific risks to individual central banks”.

And if all that isn’t enough to be getting on with, Olaf has many more links within his own post.

Am I convinced that Martin was wrong? No — because a lot of this argument hinges on the idea that there’s a bright line between fiscal policy and monetary policy, and my feeling is that the distinction tends to get very blurry indeed in a crisis. If a central bank lends unlimited amounts of money into the banking system to prevent it from collapse, or a finance ministry enters into a fiscal TARP-style operation with the same goal in mind, are they so very different?

But I’ll be the first to admit that I’m no expert on any of this, and that when I blogged Martin’s piece I didn’t know how controversial his position was, and that many if not most central bankers would consider him simply factually incorrect on many counts. I thought his piece was excellent as analysis; as argument, I’m not fully persuaded.

So if there’s a central-banking wonk out there who fancies adjudicating this dispute, I’m happy to put it up for arbitration. Wessel? Ip? Is Martin on to something here, or not?

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The ECB annual accounts have this passage which should clear things up (?):

“Intra-ESCB transactions are cross-border transactions that occur between two EU central banks. Intra-ESCB transactions in euro are primarily processed via TARGET2 – the Trans- European Automated Real-time Gross settlement Express Transfer system– and give rise to bilateral balances in accounts held between those EU central banks connected to TARGET2. These bilateral balances are then assigned to the ECB on a daily basis, leaving each NCB with a single net bilateral position vis-à-vis the ECB only. This position in the books of the ECB represents the net claim or liability of each NCB against the rest of the ESCB.”

http://www.ecb.int/pub/pdf/annrep/ar2010 annualaccounts_en.pdf

Posted by guanix | Report as abusive

Felix, I think Hans Werner-Sinn has the most lucid explication of this issue. Inevitably heavy-going, but clear once you get the double-entry accounting straight in your head.

http://www.voxeu.org/index.php?q=node/65 99

Posted by Anonymous | Report as abusive

The clearest explanation is linked in Olaf’s comments

http://www.aleablog.com/2011/06/06/hoist ed-from-comments-eurosystem/

The Bundesbank TARGET balance has a counterpart in a Bundesbank liability to the German banking system – it reflects the unwillingness of German banks to lend to the interbank market as a whole, net (ie, to recycle the Sparkasse savings deposits).

[If a central bank lends unlimited amounts of money into the banking system to prevent it from collapse, or a finance ministry enters into a fiscal TARP-style operation with the same goal in mind, are they so very different?]

Collateral! If the central bank lends $10bn against $10bn of cash collateral (as the BIS in fact did to Mexico in the 1994/95 crisis), how much actual financing has it provided?

Posted by dsquared | Report as abusive

dsquared – Depends on the abiding value of the collateral. (Many people posts their homes v. mortgages in Spain and the U.S. Ask a local caja or FU how that’s working out for them.)

Now, you can claim–and I’ll agree, given no currency exposure–that $10B in cash is always worth $10B. But that leaves the BIS with $10B less in operating capital. Which is fine until it isn’t. (See LEH for the extreme example.)

What appears to have happened so far is that the German/French–er, European–Central Bank has accepted collateral to lend to Ireland, Greece, and Spain (and Portugal, iirc) so that they can repay the German and French banks that made stupid loans at full value, or at least where they were marked when the German government took them over.

So if you believe that the (remaining) German banks are all perfectly solvent and are just “[unwilling] to lend to the interbank market as a whole,” then there’s no problem at all.

In the short term, that’s a good bet. But there’s also a good reason that most of the CDS selling on those securities is being done by NON-European banks. They may not know what’s going to fall On the River, but they know the hole cards on both sides.

Posted by klhoughton | Report as abusive

Hi Felix.

I don’t know about whether I’m the right person to adjucate definitively but I think I probably do count as a central bank wonk (11 years at central banks, first the Fed, then the Irish Central Bank.)

I had written a piece criticising Sinn’s claims over the weekend prior to seeing Olaf’s excelletn article. Anyway, here it is, amended to also send people to read Olaf’s piece

http://www.iiea.com/blogosphere/professo r-sinn-misses-the-target

To be fair, Martin Wolf is perhaps not to be blamed for reporting what must have seemed very important points made by a leading academic.

Posted by KWhelan | Report as abusive

He Felix,
thanks for your post, I really appreciate that. Today, I’ve asked severel leading European economists about their view on the matter. Until tonight, Elga Bartsch (Morgan Stanley) and Holger Schmieding (Berenberg, formerly Bank of America) came back to me.
You can see their view here: http://olafstorbeck.com/2011/06/07/on-ta rget-whats-really-going-on-in-the-euro-a rea-banking-system/

Posted by OlafStorbeck | Report as abusive

Someone posted a link to this paper in a comment on my blog:
“The Mechanics of intra Euro capital flight”, by Peter Garber, Deutsche Bank, published in December 2010.

http://fincake.ru/stock/reviews/56090/do wnload/54478

I haven’t had a detailed look at it but it seems to be quite promising…

Posted by OlafStorbeck | Report as abusive

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