To repeat, the ECB is not conducting a stealth bailout

Perhaps you have seen Hans-Werner Sinn’s incendiary commentary from 1 Jun on the ECB’s stealth bailout. Well, Karl Whelan who has many years’ central bank experience finds that “Professor Sinn’s analysis is incorrect and that his policy prescriptions are extremely dangerous”. He wrote a recent post at Vox, which Credit Writedowns carried yesterday under the title The ECB is not conducting a stealth bailout.

Willem Buiter is now out with a commentary on the same issue corroborating Whelan’s view. Below are the bullet points he highlights in his analysis for Citigroup followed by the full article.

This is seriously technical stuff, but still very important. I have underlined the key bits because his argument ties in with something I have been banging on about for some time, namely that banks – in Germany or elsewhere – are not reserve constrained in a convertible floating exchange rate credit system.

Banks are never constrained by reserves or reserve ratios. Banks are capital constrained. In our fiat money system, the central bank uses reserves in the system to help the it hit a target interest rate. So, the central bank provides the system with enough reserves to meet any reserve ratio at its target rate. The reserves are about helping set interest rates, not about pyramiding money on a reserve base.

Banks are never reserve constrained

I don’t think the ECB has made a secret about the ways in which it is exposed to the periphery in providing liquidity. My sense is that the ECB wants the EFSF to take on more of the burden. But, for political reasons, Europe can neither provide credible terms on the EFSF facility or permit burden-sharing by bailing in creditors. In any case, here are Buiter’s points. Enjoy.

  • We review recent articles by Martin Wolf and Hans-Werner Sinn on the role and interpretation of intra-Eurosystem (Target2) credit imbalances. We dispute their conclusions on both conceptual and empirical grounds.
  • Target2 is the payment and settlement system in the euro area for euro transactions between national central banks (and some private participants) with central bank money.
  • Increases in Target2 net liabilities of, say, the Central Bank of Ireland (CBI) should not be automatically interpreted as financing of Irish current account deficits.
  • The ECB, like any other major central bank, targets an interest rate, not money or credit stocks – those are endogenously/demand-determined by commercial banks.
  • Increases in CBI Target2 net liabilities thus do not cause reductions in central bank credit for German, or indeed any other euro area country’s, banks.
  • The stock of net Target2 claims of the Bundesbank does not reflect its exposure to risk and financial losses of other euro area central banks – the right measure would be the total exposure of the Eurosystem multiplied by the adjusted ECB capital share of the Bundesbank.
  • The Interdistrict Settlement Account procedures of the Federal Reserve System do not prevent sustained interdistrict credit imbalances.
  • Intra-Eurosystem credit and Target2 imbalances primarily reflect the difficulty of obtaining private market funding for euro area periphery banks. While a serious issue, we argue this is conceptually distinct from the case made by Wolf and Sinn.

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Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.