Europe's real crisis is balance of payments, not gross debt

[Beet]

Europe’s countries have established a clearing mechanism to connect their banking systems. This ‘Trans-European Automated Real-time Gross Settlement Express Transfer System’ – or in short TARGET 2 – is meant to facilitate bank transfers across all EU member states (with the notable exceptions of the UK and Sweden).

Suppose a deposit is moved from a Greek bank to a German bank, but the German bank refuses to accept payment in the form of a claim on the Greek bank, either directly or via another interbank counterparty. The debt is then settled via their central banks: the Greek bank makes up for its lost deposit by borrowing more from its NCB (the Bank of Greece, BoG); the German bank reduces its borrowing from the Bundesbank (German NCB); and the Bundesbank acquires a claim on the BoG.

These claims between the NCBs are aggregated by the EU settlement system known as TARGET2 and are considered as a net claim or liability of each NCB against the European Central Bank (ECB). In other words, a creditor NCB such as the Bundesbank has a claim on the ECB while the BoG has a debt to the ECB.
...

The greatest critic of Germany’s exposure to Target loans is Hans-Werner Sinn, president of Munich’s Ifo research institute. According to Professor Sinn, Germany is effectively financing the trade imbalances in the eurozone. His argument goes like this: countries like Greece or Italy import more than they export, without being able to borrow to make up for the difference. What they do instead is run the (virtual) printing presses and transfer the freshly printed euros to Germany. In this way, Sinn argues, the Target system is being abused to maintain trade deficits which should have been eliminated in the crisis. He also believes that this process has restricted credit availability within Germany as most of the newly created central bank money is concentrated on the euro periphery.

...

central banks from the healthier core of the eurozone are now sitting on enormous amounts of claims against the euro system. The German Bundesbank as the biggest lender has so far accumulated claims totalling more than €460 billion (approximately $615 billion). This sum is more than twice the guarantees given by the German government to the European rescue fund EFSF

...

It now looks as if for the past four years of the financial crisis, Germany has effectively kept the trade imbalances party going in the euro periphery countries. But when the party is over, Germany will be sitting on enormous claims against these other countries, which will be effectively worthless.

http://www.businessspectator.com.au/bs.nsf/Article/Euro-eurozone-debt-crisis-Germany-banks-Bundesbank-pd20111121-NSUQ9?OpenDocument&src=mp

John Whittaker of the University of Lancaster asserts:

The only way for the ECB to stop this indirect eurosystem lending to the Greek government would be by ordering other NCBs to refuse further credit to the BoG, shutting the BoG out of the TARGET2 system. But this would prevent clearance of cross-border payments out of Greece and amount to the expulsion of Greece from the euro. The free flow of credit between eurozone NCBs is an essential feature of monetary union. It is what keeps a euro in a Greek bank equal to a euro in banks elsewhere.

As long as Greece remains in the euro, it cannot be excluded from eurosystem credit, so Germany and any other euro countries that still have sound finances will keep lending, whether or not the Greek government defaults. If this is not done via an official loan facility, it will go through the eurosystem (ECB), and it will increase if uncertainty about Greece remaining in the euro accelerates the flight of capital.

http://ftalphaville.ft.com/blog/2011/11/14/745851/some-euro-banknotes-are-more-equal-than-others/

With all due respect to Prof. Whittaker, I do not follow his argument. Expulsion of BoG from TARGET2 would merely create a credit crisis in Greece and collapse of the banking sector. Technically, Greece could still remain on the euro (although whether it would want to is open to question), it could even avoid default if the EFSF and IMF continued to fund it. And while that would certainly be painful, it seems to me that there is no alternative to this if Greece is to adjust its balance of payments, which is at the root of the crisis. At the very least, political leaders must acknowledge the under-reported TARGET2 system for which there is no awareness, as the primary bailout facility which allowed Greece to continue to 'live beyond its means' since May 2010.

If BoG were expelled from TARGET2, it would finally cause Greece to no longer be able to finance its balance of payments of deficit. A the most fundamental level, foreigners' claims on Greece would cease to grow (except EFSF and IMF claims), for Greece's ability to take on these claims would end. This contrasts with the status quo, where the government taking on all of the responsibility for 'adjustment' and failing -- because the government budget is a red herring. It is not the root of the issue. The root of the issue is in the private sector. The private sector must correct until Greece runs a trade surplus. After this, Greece will become like Ireland.

[Wonkish1]

A problem that transfers risk and any inflation to European core. Still a problem, but not what is threatening all of Europe.

The problem today is still the amount of debt throughout Europe both sovereign and within their banking sector.

But you just discovered one of the key reasons why the periphery is so easy to transfer its cancer to European core so quickly.

[Wonkish1]

And look you can keep on globing onto the ever changing positions of people like Krugman, Stiglitz, etc., but my guys stuck it to them over a year ago and have been dead on right since then.

Start watching at 1:30. http://www.youtube.com/watch?v=-DN_eZHxa8Q

[CARLHAYDEN]

Beet,

Thank you for the informative and thoughtful material.

To simplify for those unfamiliar with the arcana, think of the PIIGS as small children who want their parents to get them more and more toys.  We mama says no, then instead of taking no for an answer, they simply go to papa (and don't tell him mama said no).

[Stardust]

Beet,

Thank you for the informative and thoughtful material.

To simplify for those unfamiliar with the arcana, think of the PIIGS as small children who want their parents to get them more and more toys.  We mama says no, then instead of taking no for an answer, they simply go to papa (and don't tell him mama said no).

This is a profoundly inaccurate analogy.

[Wonkish1]

Beet,

Thank you for the informative and thoughtful material.

To simplify for those unfamiliar with the arcana, think of the PIIGS as small children who want their parents to get them more and more toys.  We mama says no, then instead of taking no for an answer, they simply go to papa (and don't tell him mama said no).

This is a profoundly inaccurate analogy.

Yeah your rights its not accurate. For one Beet's post is referring to a problem within the banking sector not in sovereign governments.

The sovereign government debt is weakening their own banks and inviting systemic risk within their own financial system. A mechanism like this is actually transferring the the banking sector systemic risk throughout the whole of the Eurozone and weakening the balance sheets of core Euro central banks by adding more and more claims(worth less and less) against periphery central banks. Plus they have been defacto printing right into their banking sector for a long time(goes to show you that doesn't help a thing now doesn't it?).

[CARLHAYDEN]

Beet,

Thank you for the informative and thoughtful material.

To simplify for those unfamiliar with the arcana, think of the PIIGS as small children who want their parents to get them more and more toys.  We mama says no, then instead of taking no for an answer, they simply go to papa (and don't tell him mama said no).

This is a profoundly inaccurate analogy.

Yeah your rights its not accurate. For one Beet's post is referring to a problem within the banking sector not in sovereign governments.

The sovereign government debt is weakening their own banks and inviting systemic risk within their own financial system. A mechanism like this is actually transferring the the banking sector systemic risk throughout the whole of the Eurozone and weakening the balance sheets of core Euro central banks by adding more and more claims(worth less and less) against periphery central banks. Plus they have been defacto printing right into their banking sector for a long time(goes to show you that doesn't help a thing now doesn't it?).

Wonkish,

I really thought that would perceive what is happening.

What is occurring is a transfer of funds from Germany (principally) to sources in the PIIGS.

[Wonkish1]

Beet,

Thank you for the informative and thoughtful material.

To simplify for those unfamiliar with the arcana, think of the PIIGS as small children who want their parents to get them more and more toys.  We mama says no, then instead of taking no for an answer, they simply go to papa (and don't tell him mama said no).

This is a profoundly inaccurate analogy.

Yeah your rights its not accurate. For one Beet's post is referring to a problem within the banking sector not in sovereign governments.

The sovereign government debt is weakening their own banks and inviting systemic risk within their own financial system. A mechanism like this is actually transferring the the banking sector systemic risk throughout the whole of the Eurozone and weakening the balance sheets of core Euro central banks by adding more and more claims(worth less and less) against periphery central banks. Plus they have been defacto printing right into their banking sector for a long time(goes to show you that doesn't help a thing now doesn't it?).

Wonkish,

I really thought that would perceive what is happening.

What is occurring is a transfer of funds from Germany (principally) to sources in the PIIGS.

In regard to Beet's post maybe more like: Kids run to the their local friend the moneylender to spend and spend. The kids look like they aren't going to pay back the moneylender. So other moneylenders aren't willing to do business with that moneylender anymore. Meanwhile the adults wont bailout the kids, but are okay with a facility that takes on the risk of their moneylenders doing business with the one that lent to those reckless kids.

How's that!

[Wonkish1]

And people wonder why the European banking sector is so overlevered and undercapitalized. Well they have been trying to do everything they can to socialize risk so what do you expect. If risk isn't really risk anymore because you've socialized it to someone else than what's the point of being responsible with other people's money?

Damn politicians and bureaucrats are stupid!

[Politico]

And look you can keep on globing onto the ever changing positions of people like Krugman, Stiglitz, etc., but my guys stuck it to them over a year ago and have been dead on right since then.

Start watching at 1:30. http://www.youtube.com/watch?v=-DN_eZHxa8Q

Loved the bit about "champagne socialists." Those pompous bureaucrats need to be put in their place from time to time. There are two types of workers: Those who work in the private sector, and those who work for the taxpayers.

That video makes Stiglitz and Sachs seem like the man behind in the curtain in the Wizard of Oz.

[Wonkish1]

I mean for God sakes Krugman had the tenacity to come out with an article today saying that "Europe's Problem Is Too Little Spending". I mean what planet is he living on? I mean if that doesn't show you that he is completely irrelevant to any discussion of economics today(that and his consistent mistaken comments claiming x country or y country or z country is completely fine in debt servicing and him eating sand each time) I don't know what can.

I mean the degree of which he has been unbelievably wrong over and over and over again and continues to produce crap like this article this morning just shows you the guy should have been thrown out of the economics and economic columnist professions years ago.


Its becoming beyond absurd! These Keynesians seem intent on thrusting themselves into becoming the laughing stock of the world.

[CARLHAYDEN]

I mean for God sakes Krugman had the tenacity to come out with an article today saying that "Europe's Problem Is Too Little Spending". I mean what planet is he living on? I mean if that doesn't show you that he is completely irrelevant to any discussion of economics today(that and his consistent mistaken comments claiming x country or y country or z country is completely fine in debt servicing and him eating sand each time) I don't know what can.

I mean the degree of which he has been unbelievably wrong over and over and over again and continues to produce crap like this article this morning just shows you the guy should have been thrown out of the economics and economic columnist professions years ago.


Its becoming beyond absurd! These Keynesians seem intent on thrusting themselves into becoming the laughing stock of the world.

Krugman is the John Kenneth Galbraith of the 21st century.

[opebo]

Its becoming beyond absurd! These Keynesians seem intent on thrusting themselves into becoming the laughing stock of the world.

Not at all Wonk.  Your neo-liberal model collapsed in 2008, just as it always does (and did most famously in 1929), under the crushing weight of deflation and concentration.  It is neoliberal capitalism that should be the laughing stock of the world - it has failed over and over again.

Keynesianism by contrast works very well.

[Beet]

Thanks for all the comments guys. Wonkish I can't view your video on my work computer but I will when I get home.

On June 9, the National Bureau of Economic Research (NBER) published a Citigroup Global Markets paper coauthored with Willem Buiter rather creatively titled "Original Sinn":

http://www.nber.org/~wbuiter/originalsinn.pdf

The paper has several main points that seek to refute the thrust of my original post, primarily being that

(1) Bundesbank net loans to Target2 do not decrease credit available in Germany unless German banks are voluntarily decreasing their accounts at the Bundesbank. This could happen if a German bank receives a deposit, and uses it to pay back the Bundesbank. This would appear to be a decrease of Bundesbank credit to Germany but it could actually be happening because the German banks can find other, more attractive sources of financing than the central bank. Overall I am not sure what to make of this point, so I accept it.

(2) Bundesbank net loans to Target2 do not represent German exposures to peripheral countries. This is supposedly because all profits and losses from monetary operations are shared equally by the 17 central banks within the Euro system. Of course, if the other central banks are dropping out of the Euro system, it would seem to refute this point.

(3) Most crucially, asserts that Target2 net liabilities by Portugal, Ireland, Greece and Spain are not funding the countries' current account deficits. Presents data showing that during the crisis years since 2008, Target2 net liabilities by the Central Banks of the peripheral countries grew much faster than the countries' current account deficits. Presents an alternative narrative whereby the net liabilities are the result of depositors withdrawing money from peripheral countries' banks, and placing them in core countries' banks. Peripheral countries' banks are replacing the loans through national central banks and the national central banks are turning to Target2.

I am not really convinced that this 'alternative' scenario is really alternative at all. It seems more like two sides of the same coin. If the peripheral countries' banks were not able to replace lost loans of capital flight with loans from national central banks, the peripheral countries' banks would collapse. This would precipitate and much larger macroeconomic adjustment, which would of course precipitate a much larger current account adjustment. This process would continue until the current account comes into balance. Hence the Citigroup Global Markets paper fails to refute Sinn, Martin Wolf, and Krugman on the critical matter.

As for why Target2 imbalances increased faster than current account imbalances since 2008, well imagine what would happen if you assigned a man to dig a 3 foot hole. He would dig a certain amount and be done. But if you are filling in the hole while he is digging, he may dig up ten times as much dirt and still not be done. This is what is happening-- the market is attempting to 'correct' the peripheral countries' imbalances through capital flight, but the imbalances are persisting due to Target2 financing. Hence the total capital flight, over time, builds up to a higher amount than the imbalances, as market corrective forces are not allowed to have their effect.

I guess what I am getting at in the final analysis is why a country like Greece has seen such little current account adjustment for an already relatively large (10% of GDP) macroeconomic adjustment. Looking at Target2 helps fill in the picture, but does not tell the whole story. What we really need is a sectoral analysis of the Greek economy. This is because for a healthy adjustment to happen, the current account imbalance must be more sensitive than GDP to shocks. For a 5% fall in GDP, we would want to see a 20% or 30% or more fall in the current account imbalance. For example, Latvia traded a 22.5% fall in GDP for a 100% wipeout of its current account imbalance. In 2009, US GDP fell by about 4-5%, and the goods deficit in trade fell by about 50%. On the other hand, Greece GDP fell by 10%, but the current account imbalance is only down 10%. At this rate, Greece would have to have GDP fall by 100% (obv impossible) to eliminate its imbalances.

For the current account to be more sensitive than GDP to shocks, the sectors of the economy that are externally oriented must be more sensitive than the purely domestic sector of the economy. For example, large durable goods orders are usually more volatile than other portions of GDP. If a country's trade deficits consists of imports of automobiles, then you would expect its balance of payments to fall more quickly percentagewise than GDP in response to a shock. But if a country's trade deficit consists of imports of electricity on a fixed contract, then it would be relatively insensitive.

But this is a digression.

[Politico]

I mean for God sakes Krugman had the tenacity to come out with an article today saying that "Europe's Problem Is Too Little Spending". I mean what planet is he living on? I mean if that doesn't show you that he is completely irrelevant to any discussion of economics today(that and his consistent mistaken comments claiming x country or y country or z country is completely fine in debt servicing and him eating sand each time) I don't know what can.

I mean the degree of which he has been unbelievably wrong over and over and over again and continues to produce crap like this article this morning just shows you the guy should have been thrown out of the economics and economic columnist professions years ago.


Its becoming beyond absurd! These Keynesians seem intent on thrusting themselves into becoming the laughing stock of the world.

Yeah, Krugman is quite the laughingstock these days. He is basically living off the reputation he gained from his enormous contributions to international trade, his specialty and ultimately what he should stick to. But he's just made an ass out of himself since 2008. A lot of it is his politics getting in the way of his judgment (And his politics has been shaped by being in an Ivory Tower his entire life rather than being in the real world). He is in denial about not being right about everything. The man thinks Keynes is the Newton of economics, and therefore he believes himself to be the Einstein of economics (Or the Hawking, if you prefer). Nobody gave him the memo that Smith and Friedman hold those honors.

[Politico]

Its becoming beyond absurd! These Keynesians seem intent on thrusting themselves into becoming the laughing stock of the world.

Not at all Wonk.  Your neo-liberal model collapsed in 2008, just as it always does (and did most famously in 1929), under the crushing weight of deflation and concentration.  It is neoliberal capitalism that should be the laughing stock of the world - it has failed over and over again.

Keynesianism by contrast works very well.

Yep, it's working great in Europe! And I am so glad that opebo has solved all of the world's problems with a simple, elegant solution: print money!

[minionofmidas]

Well, obviously it's not gross debt as such that is at issue. Rather, it's availability of credit.

[Wonkish1]

Well, obviously it's not gross debt as such that is at issue. Rather, it's availability of credit.

No its budget solvency that is the issue(of which debt to GDP is an issue, growth is an issue, cost of capital is an issue, forward liabilities is an issue, and the size of deficits is an issue). Creditors rightfully will not put their institutions and their investors at risk by lending into these countries just the same way we shouldn't expect lenders to forever continue to lend into a subprime mortgage mess. For the same reason why lower interest rates wouldn't have solved the subprime mess(and instead only make it worse) we shouldn't act like lower interest rates would solve a spending problem in the Eurozone.

To expect creditors to shoulder that risk is to expect that they put their investors money, their institutions, and the financial system as a whole at risk by lending into a bad situation(just like in past credit bubbles).

[Wonkish1]

I don't want to be held to this, but I think there is a pretty good chance we're looking at a D-Day in Europe practically right around Christmas. Looking at the 19th, 20th, 21st, 22nd, 23rd or right after the markets wake up to reality in the few days after Christmas and extending out maybe a couple days after new years.

I was originally expecting something from the beginning of January to the end of March. But now I'm looking at one very $hitty Christmas holiday for many people in Europe.


I've never engaged in this level of timing before(I usually time to a 6 month or even 1 year period never this specific), and there a lot of variables at play here. But there is some catalysts coming up that this the first time I'm going to venture a guess this specific.

[opebo]

Not at all Wonk.  Your neo-liberal model collapsed in 2008, just as it always does (and did most famously in 1929), under the crushing weight of deflation and concentration.  It is neoliberal capitalism that should be the laughing stock of the world - it has failed over and over again.

Keynesianism by contrast works very well.

Yep, it's working great in Europe!

Neoliberal austerity is what is being tried in Europe, politico, not Keynesianism.

[Beet]

I don't want to be held to this, but I think there is a pretty good chance we're looking at a D-Day in Europe practically right around Christmas. Looking at the 19th, 20th, 21st, 22nd, 23rd or right after the markets wake up to reality in the few days after Christmas and extending out maybe a couple days after new years.

I was originally expecting something from the beginning of January to the end of March. But now I'm looking at one very $hitty Christmas holiday for many people in Europe.


I've never engaged in this level of timing before(I usually time to a 6 month or even 1 year period never this specific), and there a lot of variables at play here. But there is some catalysts coming up that this the first time I'm going to venture a guess this specific.

What specific catalysts are you looking at?

[Wonkish1]

I don't want to be held to this, but I think there is a pretty good chance we're looking at a D-Day in Europe practically right around Christmas. Looking at the 19th, 20th, 21st, 22nd, 23rd or right after the markets wake up to reality in the few days after Christmas and extending out maybe a couple days after new years.

I was originally expecting something from the beginning of January to the end of March. But now I'm looking at one very $hitty Christmas holiday for many people in Europe.


I've never engaged in this level of timing before(I usually time to a 6 month or even 1 year period never this specific), and there a lot of variables at play here. But there is some catalysts coming up that this the first time I'm going to venture a guess this specific.

What specific catalysts are you looking at?

Lets just say it involves Greece's default deal.

[Wonkish1]

I don't want to be held to this, but I think there is a pretty good chance we're looking at a D-Day in Europe practically right around Christmas. Looking at the 19th, 20th, 21st, 22nd, 23rd or right after the markets wake up to reality in the few days after Christmas and extending out maybe a couple days after new years.

I was originally expecting something from the beginning of January to the end of March. But now I'm looking at one very $hitty Christmas holiday for many people in Europe.


I've never engaged in this level of timing before(I usually time to a 6 month or even 1 year period never this specific), and there a lot of variables at play here. But there is some catalysts coming up that this the first time I'm going to venture a guess this specific.

What specific catalysts are you looking at?

Lets just say it involves Greece's default deal.

Well apparently it looks like the IMF is stepping in to cover the shortfall so lets take this catalyst off the table.

The primary risk going forward in the very near term is in a large Euro bank going under and causing a cascade of events in the banking sector.