My post yesterday on how the German banking sector can likely withstand a restructuring of Greek debt touched on, but did not dwell on, another important aspect of the Euro crisis: it's not just the banks in the Eurocore that own debt in the periphery, but also the governments. I wrote "The taxpayers have already loaned Greece a lot of money, either directly or via the ECB" and quoted a Der Spiegel report that said:
Taxpayers might need to step in, as might the savings banks that are owned by municipalities.
In addition, the European Central Bank (ECB) has bought up tens of billions of euros of Greek sovereign bonds. Because the Bundesbank, Germany's central bank, holds more than a quarter of the ECB's capital, it would have to take its share of losses accordingly.
This latter point is the subject of this Martin Wolf column that has made the rounds of the blogosphere (Salmon, McArdle, Krugman) and yielded the above graphs. Wolf's column is provocative -- he begins with "The eurozone, as designed, has failed." -- but makes a very important point about the centrality of the European banking system to the broader regional economy:
The role of banks is central. Almost all of the money in a contemporary economy consists of the liabilities of financial institutions. In the eurozone, for example, currency in circulation is just 9 per cent of broad money (M3). If this is a true currency union, a deposit in any eurozone bank must be the equivalent of a deposit in any other bank. But what happens if the banks in a given country are on the verge of collapse? The answer is that this presumption of equal value no longer holds. A euro in a Greek bank is today no longer the same as a euro in a German bank. In this situation, there is not only the risk of a run on a bank but also the risk of a run on a national banking system. This is, of course, what the federal government has prevented in the US.
The ECB doesn't technically have legal authority as a lender of last resort (although it's taken on part of that function since 2007), so domestic central banks as well as the US Federal Reserve have had to fill that role. The upshot? Central banks in the Eurocore, such as the German Bundesbank, are now heavily exposed to debt from the periphery. At current rates of lending they're likely to run out of cash by 2013, and unlike the US Fed, they can't just print more. This is becoming a slow-moving liquidity crisis, in other words, and as London Banker wrote a few days ago, liquidity crises (such as occurred in the Fall of 2008) are really nasty. As Wolf notes, this is serious business:
Government insolvencies would now also threaten the solvency of debtor country central banks. This would then impose large losses on creditor country central banks, which national taxpayers would have to make good. This would be a fiscal transfer by the back door.
In a sense this is already a fiscal transfer, since debtor countries are spending the funds on financing the state, and the creditor central banks don't have a printing press. So why, given that a fiscal transfer was needed, was it done in a way that risks the solvency and credibility of Eurocore central banks? Because they are unelected. Such a large transfer plan on top of the EFSF is unlikely to have been approved by voters in the Eurocore, as my post from yesterday indicates. And as Hans-Warner Sinn notes (via Henry Farrell's Twitter), the size of these hidden transfers "dwarfs the parliament-approved bailouts extended to Greece, Ireland and Portugal." It's easy to see why European leaders would opt for a bailout mechanism that was less transparent, and that involved non-elected actors pulling the strings: it allows bailout financing to continue, but with plausible deniability.
Sinn draws an analogy between the situation in the Europeriphery and Britain in 1992, when Soros sank the pound by selling it off. Eventually, the British Treasury ran out of marks and francs to exchange for pounds, and was forced to devalue. Soon, writes Sinn, there won't be enough funds in Bundesbank to cover the borrowing in the periphery. At that point, the Euro will collapse like the pound. If Sinn is right, then the Euro has two years. I've been saying for awhile now that 2013 was key to the Euro's future. 2013 is officially when haircuts begin, and when new bailout lending ends. It's also when the "stealth bailout", through the central banking system in the EU, can no longer sustain itself. At that point, either the peripheral economies have righted the ship by balancing the budget and/or regaining access to private credit markets, or they exit the Euro.
So right now it's a waiting game. The Eurocore doesn't want a restructuring, which would cost taxpayers (and banks) billions, if it can avoid it. The Europeriphery doesn't want the economic collapse that would accompany a Euro-exit. But both of them want the other to pick up more of the tab. But there's not much more the periphery can pick up, with unemployment above 11% in Portugal, 14% in each of Greece and Ireland, and 20% in Spain. And there's not much more the core can pick up without risky the solvency of their domestic central banks. More direct fiscal funding mechanisms look to be politically impossible. Maybe one of those things changes by 2013, but I wouldn't bet on it.
4 comments:
In a sense this is already a fiscal transfer, since debtor countries are spending the funds on financing the state
No, there is no such sense - this bit is one where Felix and Martin Wolf are just wrong. The intra-ESCB exposures are all related to the banking system and all collateralised - the money absolutely is not available to the fiscal sector. The counterpart to the Bundesbank's large credit balance with respect to the Eurosystem is a debit balance with respect to the German domestic banking system. The regional Feds have similar imbalances (they settle up every April with a transfer of gold certificates) and they are clearly unrelated to fiscal transfers within the USA.
Sinn is also wrong about there "not being enough funds in the Bundesbank". The credit item in the Bundesbank is created by an increase in the Eurosystem money supply when a German bank decides to park its excess deposits in the central bank deposit facility rather than recycling them in the interbank market. This is just a misunderstanding of the mechanics of central banking.
Before EMU, these were genuine credit exposures between central banks and Peter Garber wrote a series of good papers about how they could form the locus of a speculative attack on the stage 3 EMS. But post-EMU they're no more meaningful than intra-Federal Reserve System exposures - the only way that they can turn into credit exposures is if the Eurosystem fails to act as a currency union - ie, what we're saying here is that if the Euro breaks up, it will break up.
What we're seeing here is that the Euro is a single currency (albeit a badly designed one). The Irish and Greek banks have a liquidity problem, which is financed by the ECSB. That's it. Drawing lines inside the ECSB is only meaningful if you understand exactly what the balancing items are and what they're meant to balance. And the fact that Germany picks up a lot of losses proportionately in the Euro zone is just the same as the fact that New York and California pay a lot of the bills in the USA - it's the biggest single piece of the Euro economy.
Your actual point about 2013 being the key date has a lot to be said for it IMO, but if you're going to publish on this, show it to a *really* good central bank economist first would be my advice.
DD -
Thanks for the clarifications. A lot in there that I'll need time to fully digest, but a few things.
"The Irish and Greek banks have a liquidity problem, which is financed by the ECSB. ... the fact that Germany picks up a lot of losses proportionately in the Euro zone is just the same as the fact that New York and California pay a lot of the bills in the USA - it's the biggest single piece of the Euro economy."
Right, but isn't that the main point? The shifting of exposures through the ECSB is shifting losses from Ireland and Greece to Germany. Eventually, Germany can't/won't pay anymore, just as California and NY can't/won't pay any more of the US federal budget. If/when that happens, Arkansas (Greece) gets screwed. I thought that was the mechanism we're talking about, but maybe I've misunderstood something. Perhaps it's just a liquidity problem and time will smooth it out, or perhaps it's a solvency problem and this is a stealth bailout. Of course, liquidity problems that go on long enough tend to become solvency problems, so it could be a distinction with little difference.
"The intra-ESCB exposures are all related to the banking system and all collateralised - the money absolutely is not available to the fiscal sector."
Not directly. But if cash is being funneled from Germany into Irish and Greek banks, and those banks are increasing lending as a result, than in practice it's operating as a form of indirect quasi-fiscal stimulus, no? A different form of QE? That's not to say that the Irish or Greek governments have access to those funds necessarily, although in practice if any non-EFSF/IMF party is going to buy Irish and Greek debt it will likely as not be Irish and Greek banks, but if the Bundesbank is pumping cash into Irish banks, then that's money the Irish government doesn't have to pony up. That functions as a fiscal move, done by monetary authorities.
My understanding of Sinn's point is that the Bundesbank (or other central banks) can create an increase in euro supply, but because they don't actually control the press those actions have to be backed up, and there's a limit to how much they can back up. Eventually the liquidity crunch gets passed from the banks to the central banks, which then face their own liquidity crunch. Is that wrong? If not, the fear is that they're approaching that limit.
Of course the ECB can fix all this fairly easily, but they don't seem to have given any indication that they will.
I have no plans to publish any of this beyond blog posts, but I wish someone would. It's interesting, and confusing, stuff.
The shifting of exposures through the ECSB is shifting losses from Ireland and Greece to Germany
Remember that these are collateralised exposures, with repo haircuts and a lot of them will be against good quality collateral. And the exposures are all to the central ECB counterparty, not directly from the Bundesbank to the Bank of Greece. The only situation in which the BuBa takes a loss is in which a) Greek banks default b) in enough size to bankrupt the BoG and c) the collateral is worthless d) to such an extent that it bankrupts the ECB. In other words, a eurozone breakdown.
But if cash is being funneled from Germany into Irish and Greek banks, and those banks are increasing lending as a result, than in practice it's operating as a form of indirect quasi-fiscal stimulus, no?
"Quasi" here would better be replaced by "not". The fact that the Irish and Greek banking systems are able to function is good for Ireland and Greece, yes. And this fact is underwritten by the fact that the German deposits they would ordinarily acquire from the interbank market are being provided via the ECB, yes. But this isn't a fiscal matter, and it isn't really a stimulus. It's the normal operation of monetary policy by normal means, in abnormal conditions. It doesn't change the government's budget constraint - all it is, is that the European Central Bank is operating as a central bank. In particular, there is *absolutely no* monetisation of either the Greek or Irish fiscal deficits and I don't understand why Martin Wolf and Felix think there is (HW Sinn doesn't AFAICS).
if the Bundesbank is pumping cash into Irish banks, then that's money the Irish government doesn't have to pony up. That functions as a fiscal move, done by monetary authorities
No this is bass-ackward. Providing short term collateralised finance for the banking system is a monetary operation not a fiscal one. The unusual thing would be if the ECB didn't do this - in that circumstance, as a desperate last-gasp, the Irish goverment might try to make the fiscal deficit do the job of the monetary authority, but that's not the normal way of the world.
My understanding of Sinn's point is that the Bundesbank (or other central banks) can create an increase in euro supply, but because they don't actually control the press those actions have to be backed up, and there's a limit to how much they can back up.
Sinn's point is just wrong, as Oscar points out with reference to the Bundesbank's own publications. There would only be such a limit if the ECB decided to set a hard limit on the amount of the euro money supply. Which, to put it mildly, is not current policy. The Bundesbank doesn't have to back anything up - it's just intermediating the German banking system's placing of excess liquidity with the ECB, as the Irish Central Bank is intermediating the Irish banking system's funding deficit.
Thanks for the clarifications. I think I understand what's happening.
Well, if the Germans *aren't* funneling euros into Greece and Ireland via the central banking system, then they're bloody idiots. Right now, if I'm a German politician, and I've got kids on the streets of every European capital protesting austerity/bailouts, and I want to keep EMU together for at least another 18 months, then I do everything I can to get the ECB to lend to Irish and Greek banks, and then let those banks either lend it to the government, or to the private sector.
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