German savers should applaud the growing TARGET balances…

Turning the TARGET2 debate on its head.

It was first suggested that TARGET2 balances will lead to losses for Bundesbank as it will make losses on the TARGET2 assets claims from Greece, Ireland etc. This was undone by further research saying first these claims are against ECB not Greece/Ireland Central Banks. Second, even if there are losses at ECB’s end the whole Eurozone will share the losses with share of Germany being around 27% (their share of ECB capital).

Now, this note from Sebastian Dullien & Mark Schieritz says German savers should be happy that TARGET2 balances are growing. First target2 is a response to what otherwise would have led to huge losses for Germans:

A number of commentators, led by Hans-Werner Sinn in Germany, have argued that this is a form of expropriation of German savers, who are witnessing a transformation of the country’s external wealth. “The marketable assets of savings banks, banks and life insurance companies, which back the savings (…) were exchanged without consent of the savers into claims against the ECB” (Ifo-Institut 2012). These claims are seen as inferior to private claims as they disappear if the system collapses.

Yet on closer inspection, this argument seems to get the logic completely wrong. It implicitly assumes that private sector entities in the periphery would honour their euro debt in full if the Eurozone disintegrates, while claims against the central bank in the Eurozone periphery would need to be written down. From all the experience we have from emerging market crisis, this is clearly nonsense. An exit of a periphery country from the Eurozone and a following depreciation of the country in question would increase strongly the value of all euro liabilities in households’ and firms’ balance sheets. Given that these entities would earn their revenue in (newly issued) domestic currency, this currency mismatch would render many of them bankrupt overnight. There are only two solutions to this problem – mass defaults of households, firms, and banks in the exiting country or a redenomination of the liabilities in the new domestic currency. In both cases, creditors from the north would lose (parts of) their wealth.

Second, as it is central bank money it is much safer:

In addition, while it is true that marketable direct claims on the aggregate level have been replaced by non-marketable indirect claims through the Eurosystem, these claims can sensibly be assumed to be safer than the original assets.

  • First, Germany now has a matching claim against a periphery central bank, which in turn has a claim against a commercial bank in its territory. There is no reason why such a claim should be less secure than a direct claim on the commercial bank in the periphery.
  • Second, if the euro does not disintegrate altogether but only single countries leave, the potential losses for Germany have become smaller, not larger. According to the ECB’s statutes, losses in the Eurosystem are distributed among the central banks according to their share in the ECB. The Bundesbank’s capital share is 27%, which means that Germany would only have to take less than one-third of the total losses, compared to the full amount that private creditors would have to take. The rest would be borne by those partner countries that remain in the euro with Germany.
  • Third, the shifting of the risk of a collapse of the Eurozone from the private to the public sector also benefits the savers. As the centre central bank can be expected to always honour its obligations to the commercial banks in its territory, the commercial banks have been able to replace risky foreign assets by safe domestic assets. Thus, at least to the extent that the increase in TARGET claims stems from German banks’ repatriation of money from the periphery into Germany, this increase actually protects the savings of the German public.

Hence, Germans should be happier:

Thus, the liquidity provided by the ECB which is reflected in the TARGET system has made it possible for German banks to bring their money back home. Without the ECB’s intervention, the attempt to shed assets in the periphery would most likely have led to defaults in the banking sector and the wider economy, which would have eroded the value of these assets. German savers – whose money the banks ultimately manage –should therefore applaud the increase in the Bundesbank’s TARGET balance.

The lessons from the crisis go on..

2 Responses to “German savers should applaud the growing TARGET balances…”

  1. Kristin Ohlson Says:

    I’m a journalist and want to ask you some questions.

  2. Robert Says:

    The complete TARGET2-debate:

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