Felix Salmon

How the ECB could be forced to print money

By Felix Salmon
December 6, 2011

The European Central Bank has been notoriously reluctant to print money during this crisis. But what if it had to?

Aaron Tornell and Frank Westermann have a wonky post up at VoxEU about the flows between various national central banks within the Eurozone, which includes this key chart:

Assets of the Bundesbank


The line to concentrate on, here, is the solid one in blue. It shows a key part of the Bundesbank’s assets — its loans to other institutions — falling perilously low to zero, even as its loans to other European central banks — the maroon dotted line — continue to rise inexorably. (These loans from one national central bank to another are known as the TARGET system.)

Up until now, the Bundesbank has managed to fund the latter by means of selling off the former: when it’s asked to lend money to PIIGS central banks, it just sells off some other loans and advances the cash to the Irish or Portuguese central bank instead.

But it can’t do that any more, because the Bundesbank is down to its last €21 billion in private loans. And when that hits zero, the only things left to sell are the Bundesbank’s gold and reserves. Which, it’s pretty safe to say, the Bundesbank is not going to sell.

There’s good news and bad news here. The bad news first:

Before long, the Bundesbank’s stock of domestic assets is going to hit zero, and it is highly unlikely that it will agree to sell its gold or borrow more in private capital markets. At that point, the Bundesbank will not be able to lend more funds to the Eurozone TARGET mechanism… If a critical mass of agents were to engage in capital flight away from fiscally weak countries, the TARGET system would be overwhelmed. In principle, a speculative attack could occur within a day, and the ECB would have to assume all of the marketable securities from countries that suffer the speculative attack. Since the ECB has a relatively small capital base, it would not be able to purchase a large amount of assets from countries that suffer the attack.

This is a bank run, basically, with the banks suffering the run being the central banks of euro-periphery nations. Bank runs are always about liquidity, and so long as there’s a firehose of liquidity somewhere able to give anybody who wants it all the cash they want, bank runs are non-issues. But the point here is that the network of European central banks is running out of cash, and that the Bundesbank — which has been the main provider of liquidity to date — has now pretty much run out of it.

Here’s how Izabella Kaminska reads this:

If the ECB doesn’t act to discourage the borrowing (or for that matter fails to somehow top up the Bundesbank’s assets), it could become a victim of a speculative attack not dissimilar to that experienced by the Bank of England during the ERM crisis of 1992.

There are, after all, many similarities in both situations. Most notable is the fact that both central banks seem to have under-estimated the amount of quality assets (or foreign exchange in the case of the BoE) they needed to hold to defend their monetary policy effectively.

I, on the other hand, am (uncharacteristically) a little more optimistic here. Faced with the imminent collapse of a national central bank, it seems to me that the ECB would have no choice but to print as much money as was necessary to meet that country’s demand for liquidity. The problem in 1992 was that the pound was overvalued, and that the market was demanding Deutschmarks, which the Bank of England couldn’t print. In this case, the market would be demanding euros, which the ECB can print.

Basically, there’s a constant flow of money out of the European periphery and towards the center. Up until now, that flow has been matched by an equal and opposite flow of central bank lending from the Bundesbank to the PIIGS central banks. And when the Bundesbank runs out of money to lend those central banks? The ECB will have no choice but to step in and print all the money necessary to stop those banks from going bust. And that, I think, is how we’re going to see the ECB finally take on the lender-of-last-resort role it has been so reluctant to adopt until now.

Update: Karl Whelan takes issue with Tornell and Westermann’s assumptions.

5 comments so far | RSS Comments RSS

“How” it could be forced to? The ECB SHOULD print euros. They have to stop thinking of the euro as a currency that is used by 17 nations, and accept that they are one giant economic and financial system. They will all suffer if one part of the system (i.e., one member nation’s financial system) fails. It’s a large ecosystem, and not only are all of their subsystems dependent on each other, but so are the other ecosystems that trade with them, like the U.S., Britain, China, etc.

The 17 nations want the power of a big economy, but if they want to be viewed as a unified economic and political force, they have to act as one. Just as we shouldn’t make good the enemy of perfect, bad should not be the enemy of disastrous. If nothing is done, at some point, there will be a Lehman-like default that will start the next snowball running down the hill, and the result will be far worse than the inflation caused by printing money (and given that the US has to print a lot of money, and China doesn’t float its currency, inflation wouldn’t even be a given).

Posted by KenG_CA | Report as abusive

Articles like this remind me of Municipal Loans and other non-private or -corporate debt within a country. There is a similarity to the Euro here: the euro Nation States are equivalent to Municipalities, the ECB is equivalent to the Federal Reserve/Central Bank.

If California has a debt problem, what happens? Detroit? Cleveland? Are these not analogous to Greece, Italy, Portugal? And just like in Europe, the US politicians take ages to decide anything.

The big difference of course is the Fed is charged with maintaining stable growth in the US economy; the ECB is charge with one job – keeping inflation in check. Printing money is inflationary, so some rules either need to be broken or changed. Hence the meeting on Friday.

Posted by FifthDecade | Report as abusive

FifthDecade- it seems like it’s been five decades that I’ve been reading “California=Greece.” But actually California has a Federally insured banking system, so a shortfall in CA tax collections can’t cause a nationwide banking crisis. Think about it.

Posted by johnhhaskell | Report as abusive

Isn’t it possible that Bundesbank will just accept deposits form private sector and lend it to other national central banks. After all, this is another way for the core surplus to be channeled to the periphery.

Posted by athreya | Report as abusive

The whole issue of TARGET balances as alleged loans among eurozone NCBs has been discussed for quite some time now. The problem is, the central assumption here is plainly wrong. TARGET balances are claims by the national central banks on the ECB. It’s an accounting system, NOT “loans from one national central bank to another”.

Concluding that the Bundesbank was selling off loans to fund TARGET balances is hence just not the case. Loans to banks are declining because there has been less liquidity demand by German banks. It’s a shame really that there’s still so much misconception around, in this case exaggerated by clipping the chart at 2006, as the Bundesbank was in a TARGET “deficit” prior to that.

Whelan’s response is a good one, there are more by the ECB http://www.ecb.int/pub/pdf/mobu/mb201110 en.pdf (p-35), Bundesbank http://www.bundesbank.de/download/presse  /pressenotizen/2011/20110222.target2-sa lden.en.php, and Storbeck http://economicsintelligence.com/tag/tar get2/, all explaining the system in more detail…

Posted by jushuma | Report as abusive

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