Global Agenda: Bang on Target

A few weeks ago, this column noted that the European financial markets are behaving very well, creating the impression that the great euro crisis is at least under control and hopefully actually improving.

The sharp rises in the hardest-hit European bourses, such as Athens, Madrid and Lisbon, are the most obvious evidence of the sharp change in sentiment – but not the most convincing, because of their inherently volatile nature.

The fall in the yields on Italian and Spanish government bonds is much stronger evidence, because the bond market is a more solid market and is also a key source of finance for national governments.

But given that the euro crisis is ultimately a crisis of confidence in the European Monetary Union and the financial system that underpins it, the most important measure of the severity of the crisis is the banking system, where firms and households deposit and hold their funds. If the citizens – corporate and individual – of a given country are scared about the viability of their banks, they will withdraw their money and thereby precipitate the collapse they feared.

This is precisely what was happening in Southern Europe in late 2011 and again in the summer of 2012. The banks in Greece, Italy and Spain suffered a loss of deposits on a scale that easily qualified as a run on the banks – the ultimate existential threat for any banking system. On both occasions, the European Central Bank was forced to do what central banks are supposed to do in these situations, but what the ECB’s charter studiously avoided making its mandatory task: to be the lender of last resort, meaning the entity that supplies credit to banks when no one else will.

In December 2011 the ECB turned the tide by turning on the monetary spigots and providing the liquidity needed to keep the banking systems afloat. But this intervention proved transitory, like its previous efforts. In August 2012, when a systemic collapse seemed nearer than ever, the ECB provided something even better than cash. It promised unlimited intervention in the government bond markets and thereby injected the critical component of confidence that the markets had so sorely lacked.

That announcement marked the turning point of that crisis. Optimists hope that it marked a much greater milestone: the turning point in the entire euro crisis that has been under way since October 2009. That, of course, remains to be seen, and it remains a matter of fierce contention between economic analysts. But on the critical front of the commercial banks’ inflows and outflows of customer deposits, the data – albeit only available through October or November – show a reversal. Money ceased pouring out of Spain et al and began to trickle back in.

(An excellent summary of the developments in the “plumbing” of the European monetary system, which is known as “Target,” appeared in Spiegel Online last Wednesday and can be found, in good English, at www.spiegel.de.) Few topics within the financial system are less well-understood than payments systems such as Target. But the central principle is very simple: Every minus (withdrawal) has to have a corresponding and offsetting plus (deposit). If you deposit a check drawn on my bank account, you get a plus and I get a minus – but the system remains in balance.

At the national level, if thousands of Greeks are transferring euros from Greece to Germany, all the money goes through the central banks of each country. The result is that the Bundesbank account at the ECB gets a plus and the National Bank of Greece gets a minus. The Target system is in overall balance, but within it, the National Bank of Greece owes the Bundesbank that number of euros. The longer the outflow from Greece continues, the greater the amount that the Greek central bank owes the German central bank – and hence the greater the internal imbalance within the Target system.

By relieving the pressure, the ECB has enabled this internal imbalance to begin to recede, as Greeks and Spaniards return their money to their local banks. This is a significant achievement. But, says Hans Werner Sinn, the German economist who first identified what was happening within the European monetary system and sounded the alarm, this sense of relief may be misplaced.

“The markets have been calmed because new ways have been found to make taxpayers in those European countries that are still healthy liable,” Spiegel quotes Sinn as saying.

His point is that the risks have not disappeared; they have merely been redistributed – from the commercial banks to the taxpayers of euro-zone countries, who are on the line for the ECB’s promises and the debts owed to their central banks, if these end up not being repaid.

Sinn puts his finger on the fatal flaw in the ECB’s supposed success: “The debt crisis is eating its way ever further into the budgets of Europe’s core countries, but policymakers are celebrating the obfuscation of this fact as a success.” The German term for obfuscation is probably very long, aptly and accurately mirroring the process it describes.

landaup@netvision.net.il