10 March 2012

Hans-Werner Sinn: Fed versus ECB - How Target debts can be repaid

In February 2012, the Bundesbank had a TARGET claim of €547 billion on the Eurosystem. This column proposes a US-like system of marketable covered treasury bills that could be applied to a yearly settlement of TARGET liabilities.

Now that Bundesbank President, Jens Weidman, has expressed his concern about the rising TARGET balances within the eurozone in an official letter to Mario Draghi, the issue can no longer be swept under the carpet. In February, the Bundesbank had a TARGET claim of €547 billion on the Eurosystem, while the Dutch central bank had one of €171 billion in January. These claims constitute more than half of both countries’ net foreign wealth.

TARGET loans arose because some countries in the eurozone’s periphery borrowed the electronic money printing press, with the approval of the ECB Council, and printed money galore. That money flowed into Germany and the Netherlands to buy goods or repay debts, primarily because Dutch and German commercial banks were reluctant to renew their interbank credit at conditions that could match those under which the ECB was allowing the national central banks to provide refinancing credit. The excess liquidity building up in the Netherlands and Germany induced commercial banks to borrow less from their respective national central banks, and even to lend their excess funds to them, making both the Bundesbank and the Dutch central bank net debtors of their commercial banking systems and replacing national savings, in terms of marketable assets, with mere TARGET claims on the ECB system that cannot be called due. While TARGET balances directly measure the net amount of money that flows across borders, they also indirectly measure a public credit flow between the national central banks of the eurozone. TARGET balances resemble the public loans granted via the European Financial Stability Facility and are primarily of a fiscal nature.

The real question behind Weidmann’s letter is whether and how the TARGET loans should be repaid. Sharing the opinion expressed in this year’s Annual Report on the European Economy by the European Economic Advisory Group (2012), I opt for settling the balances in a way similar to how the US system requires of its District Feds.

In the US, there are 12 Federal Reserve districts, with TARGET-like balances (Interdistrict Settlement Account balances) arising between each of them. These balances have to be settled every April, by making those District Feds that over-used their money-printing presses cover the net outflow of money by bilaterally transferring to the corresponding other District Feds marketable assets (originally "gold-backed securities") which they cannot issue themselves. Technically, this is done by reallocating ownership shares in, and annual interest distribution of, a joint clearing portfolio run by the Fed.

To calculate the repayment rate, it is not the closing balance that is considered, but the average increase in the Interdistrict Settlement Account liability over the previous year. This implies that some balances can indeed remain after the cut-off date, but the increase in such balances is greatly reduced.

The question is how to adopt in Europe a system similar to the US one. It would certainly be no solution to allow the deficit countries to settle their balances with normal government bonds that they issue themselves. That would be akin to jumping from the frying pan into the fire.

In its just-released 11th Report on the European Economy, the EEAG proposes the introduction of a system of marketable covered treasury bills that they dub Euro Standard Bills, and that would be standardised and collateralised by each corresponding government with state-owned real estate or senior rights to future tax revenue. In the opinion of the Advisory Group, these bills could be applied to a yearly settlement of TARGET liabilities.

A simple, minimum solution that could be useful has been suggested by former Bundesbank President, Helmut Schlesinger. He would like to see the TARGET liabilities encumbered by progressively higher punitive interest rates that would be paid by the debtor to the creditor countries.

In any case, the eurozone needs a shock-absorbing system that can dampen the extreme spikes in the TARGET credits. A private banking account’s overdraft facility, after all, cannot be expanded at will either.

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