Two identical countries A and B share a common (paper) currency C. The demand for currency is 5% of annual (Nominal) GDP.
Suppose B decides to quit the currency union and print its own currency. There are two different ways it could do this:
1. Convert and destroy. The people in B convert their C notes into their government's newly-printed B notes, and their government then destroys the C notes it has collected. The two countries carry on as before.
2. Print and spend. The people in B convert their C notes into B notes, and their government spends the C notes in country A. Or the government in B prints and spends the new B notes, and the people in B spend their unwanted C notes in country A. ("Spend" could include buying assets, including financial assets, and not just spending on newly-produced goods). Either country A now faces a doubling of the price level, which imposes a 5% of NGDP inflation tax on the people of country A, or else the government in country A increases taxes or sells assets worth 5% of GDP to prevent the supply of currency doubling.
By following the "print and spend" option, instead of the "convert and destroy" option, country B imposes a one-time tax of 5% of annual GDP on country A.
I haven't been following their disagreement very closely, but I think I'm agreeing with Hans-Werner Sinn and disagreeing with Karl Whelan. Institutional details like Target2 just encloud what is at root a very simple story.
It is extremely unlikely that the government of a country like Greece, in current circumstances, would follow anything like "convert and destroy".
But Greece is a small country, and 5% of a small country's NGDP is an even smaller percentage of a bigger country's NGDP. And it will be an even smaller percentage if Greeks continue to hold Euros as well as Drachmas. But magnitudes aside, it has the same effect as one more default.
If country A suspects that country B is planning to follow a "print and spend" exit from the common currency, it might want to jump ship first, so it is country B that makes the transfer to country A. There are incentives for a "currency run" at the supra-national level. Last one left holding the common currency is the sucker.
Of course, if there is initially a recession caused by an excess demand for the medium of exchange, there's a silver lining in all this "excess supply" of currency.
Worthwhile Canadian Initiative 
Jacques,
Thanks.
Actually, my question was an attempt to make a point of mootness about the definition.
To try and make it further, can you (or somebody) give me an example of a currency union consisting of two or more countries in which at least one of the countries doesn’t not have its own operational central bank acting as a clearer for its own commercial banking system?
(e.g. the Eurozone does not fit with this qualification. Neither does Canada nor the United States.)
meant:
“in which at least one of the countries does not have”
JKH: I don’t know enough about dollarized South American economies (Ecuador and Salvador).
An interesting aside : for a long time, the Caisses Populaires, the largest financial institution in Québec, could not clear their cheques though the BoC. They had to use a federally chartered bank do it. You could say that Québec didn’t have its own central bank for clearing while in monetary union with Canada.
Are there here economic monetary history Ph.D connoisseurs of the Latin Monetary Union who could bring up their lights?
JKH: sorry. Not Salvador but Panama.
Jacques,
I don’t know how it works now, but when the foreign banks came into Canada in the early 1980’s as “Schedule B” banks, they each had to set up clearing accounts (reserve accounts essentially) with a Canadian chartered bank of their choice. The Bank of Canada farmed out that function to the chartered banks and the chartered banks competed for that foreign bank business. The somewhat imperfect analogy there was that each of the chartered banks operated as a central bank for its own group of foreign banks in the context of that foreign bank reserve clearing function. The Bank of Canada then played the role of the super central bank relative to those foreign commercial banks. Each chartered bank would experience a net clearing effect attributable to the aggregate of its foreign bank client clearers, which would be vaguely analogous to the Target2 clearings of the Eurozone – although that clearing effect was merely a subset of the total clearings of all of the bank’s customers.
give me an example of a currency union consisting of two or more countries in which at least one of the countries doesn’t not have its own operational central bank acting as a clearer for its own commercial banking system?
Is there any reason in your mind why that shouldn’t work even if there is no historical example?
And do you know of currency unions between nations that have worked out? And if so, why?
Sorry, lots of questions. Just seems like we’ve chosen the worst of all possible systems here in Europe.
“The answer to the last point depends on the mechanics of balance sheet resolution. The assets of a legacy position would be available to pay off the liability position that includes Target2. A key point is that an ex-Greece Eurozone going forward would have no interest in retaining a legacy position that includes loans to Greek banks and funding from the rest of the Eurozone. It would want to see resolution and repayment of those loans so that it has no Greek lending on the balance sheet, and consequent repayment of the Target2 position. A similar point applies to Euro currency issued from the legacy balance sheet, although the resolution of that also depends on currency redemption coming in. Rather messy.”
Thanks JKH, well explained again. Yes, there are usually assets to cover the liabilities. But in case of Greece the cumulative negative balance of payments and depressed state of the economy means that there are not enough assets in aggregate level, thus ELA. But it is true that in resolution some of the liabilities can be covered by the assets.
I just feel that in a currency union a citizen should only be liable of his/her balance sheet not of his/her member states banks’ aggregate. It just strikes bizarre to me. IMO this is against some very elementary characteristic of a currency union. The nature of liability after a deposit payment should be always the same and shouldn’t depend whether they are cross-border or no, that is why we call it a union. And it shouldn’t depend on the balance of payments or member state banking operations/balance sheets.
But on the other hand the Euro members are sovereigns – from that point of view the citizens should be on the hook for their respective government debts. But target2 claims are just a big heap without earmarks. Then this all is messy and complicated because of the chartered banking and sovereign connection with its banking sector / NCB. And as you said Greece can anyway default them all in if decides so. Messy indeed.
JP had an old post which is relevant:
http://jpkoning.blogspot.fi/2011/12/ecb-ncbs-collateral-capital-key-target2.html
(The post has the following quote:)
“The March 2011 Bundesbank report describes this:
‘An actual loss will be incurred only if and when a Eurosystem counterparty defaults and the collateral it posted does not realise the full value of the collateralised refinancing operations despite the risk control measures applied by the Eurosystem. Any actual loss would always be borne by the Eurosystem as a whole, regardless of which national bank records it. The cost of such a loss would be shared among the national banks in line with the capital key.'”
If we take that on face value I think it is fair to say that Bundesbank, at the time, agreed that target2 shouldn’t be borne by respective NCB.
“An interesting wrinkle is that the ELA loans to the Greek banks are on the books of the Greek NCB but loans losses in this case are strictly for the account of Greece (a policy imposed by the ECB) – i.e. such losses will not be shared and are outside of the normal risk sharing formula for the Eurozone. That puts the Greek state on the hook for ensuring that an equivalent amount is available to repay those loans so that Target2 can be repaid to the rest of the Eurozone. That’s one way that the balance sheet would imply a future tax liability as well. Of course, Greece supposedly has the option of defaulting on everything under the sun, including that Target2 liability.”
That comes to an interesting point of collateralization. I think collateral is posted and held at the NCBs on the behalf of the Euro system. This relates to the resolution – in normal operations the banks are posting their asset to the respective NCB against the target2 claims they are incurring.
But above means that ELA is not that different in the grand scheme of things – because even in normal liquidity operations target2 claims are not collateralized. So in the case of the break-up there is no factual economic difference what Greece can default whether respective target2 claims are generated by the ELA or through normal liquidity operations. From moral point of view though this might make a difference.
“Just seems like we’ve chosen the worst of all possible systems here in Europe.”
There doens’t seem to be political support for a better/workable (federal) system. It is rather telling how the Euro system has been set up.
Oliver,
My statement there was a bit convoluted.
Turn it around, and the question becomes:
Is there any country in the world with a single central bank issuing its own fiat currency that is not composed of different “regions” with different economic resources and needs? In that sense and in the previous context, every standard fiat currency issuer can be considered to be a currency union, and the definition becomes somewhat moot.
So my point is about language I guess. I think the Eurozone is a currency union, but an ineffective one because of fiscal dysfunction of one type or another.
Jussi,
“If we take that on face value I think it is fair to say that Bundesbank, at the time, agreed that target2 shouldn’t be borne by respective NCB.”
I think that statement applies to the risk faced by an NCB in respect of Euro system counterparties to its asset holdings. And that’s fine so long as the NCB remains intact as a functioning part of the Euro system. Losses are absorbed according to risk sharing.
But that does not say that the Euro system will simply forget about the Target2 liability of an NCB that exits the Eurosystem.
At the time of exit, the NCB balance sheet will reflect the status of any cumulative losses as per the risk sharing formula to that point. But then the remaining balance sheet has to be resolved in some fashion.
I think the Target2 liability becomes a crystallized debt at that point – to be repaid or defaulted by the NCB or written off by the ECB.
Have a look at JP’s latest. I think he gets it right:
http://jpkoning.blogspot.ca/2015/06/euros-without-eurozone.html
“I think that statement applies to the risk faced by an NCB in respect of Euro system counterparties to its asset holdings. And that’s fine so long as the NCB remains intact as a functioning part of the Euro system. Losses are absorbed according to risk sharing.
But that does not say that the Euro system will simply forget about the Target2 liability of an NCB that exits the Eurosystem.”
Agreed (my interpretation wasn’t accurate, thanks).
“At the time of exit, the NCB balance sheet will reflect the status of any cumulative losses as per the risk sharing formula to that point. But then the remaining balance sheet has to be resolved in some fashion.”
I think I agree. The ELA is weird though, there are no assets against it, yet it is non-shared liability. So the NCB might end up with negative equity because of that?
“I think the Target2 liability becomes a crystallized debt at that point – to be repaid or defaulted by the NCB or written off by the ECB.
Have a look at JP’s latest. I think he gets it right:
http://jpkoning.blogspot.ca/2015/06/euros-without-eurozone.html”
Yes, I liked JP’s post. And totally agree with it – as well as I think I also get the idea of “the contingent Target2 liability” (after reading Sinn 2011). I agree, from the system point of view, everything Sinn/you are saying.
But after reading Coppola, I think there is also different point of view beyond accounting if you will. The crux is that the way the Eurosystem was setup and now interpreted doesn’t reflect the way it was sold and voted for at the inception of the Euro (and during). E.g. it didn’t alleviate balance of payments crises – which given Sinn’s view is quite obvious.
I think it comes clear if we ask why the issued currency (notes and coins) liability is recorded on balance sheets of the NCBs and yet the currency is clearly meant to be issued as a shared liability? There seems to be a stark contradiction: it was said it is the liability of the whole, yet it was booked as a liability of individual NCBs. In similar fashion I think we need to propagate the idea to target2 claims. If we put currency on the ECB balance sheet it would be really awkward/impossible to record target2 claims on NCBs balance sheets reflecting deposit payments. Would currency and deposits in all member countries even trade at par if they are treated differently as above.
If we acknowledge there is a discrepancy we have two different views, Sinn’s view and, lets say, voters’ view. So I repeat we need to acknowledge the political commitment – even if it contrast starkly the way the Eurosystem was set up. If we acknowledge this contrast it should have implications whether we can say without reservations that target2 claims need to be crystallized as debt if the balance sheets are to be resolved. That’s all I’m saying.
Three questions (anyone):
1. How the reconcile “immediate finality” (e.g. http://www.ecb.europa.eu/paym/t2/html/index.en.html) and the potential future tax liability Sinn’s view is implying?
2. Given Sinn’s view, what is the substantial difference from risk sharing point of view between the EMU and the Euro system?
3. And relating to that: in below quotations, what is the risk borne by the Eurosystem if not the one it faces at the time of exit? Or can a NCB get more equity (according the capital key) if it faces a loss on asset side?
“An actual loss will be incurred only if and when a Eurosystem counterparty defaults and the collateral it posted does not realise the full value of the collateralised refinancing operations despite the risk control measures applied by the Eurosystem. Any actual loss would always be borne by the Eurosystem as a whole, regardless of which national bank records it. The cost of such a loss would be shared among the national banks in line with the capital key.”
Jussi,
These are three interesting questions. They all relate to risk; who takes the hit if there is a default?
First, some background framework: Target2 is a clearing system. It obviously must have the total balances for every participating member. This is useful information. We can collect all the banks in any nation and then analyse how the collective balance sheets grow over several years.
More framework: Banks within any country are extensions of the NCB. Because we know the balance sheet of each bank, we can sum up the implied balance sheet of each NCB. This gives us a measure of the relative obligations of each NCB. The Target2 information shows that German banks are accumulating euro credits and Greek banks are incurring euro debits.
Can we find answers to your three questions within this framework?
We will use an example of a German car sold to a Greek buyer. Assume that neither the car builder nor the car buyer have their own money; each must depend upon a bank loan to proceed. This will break down into a number of events:
1. The German car builder will get a loan from a bank. He will build a car and pay his workers. Money will be dispersed into the economy and will increase the amount of deposits in the Target2 (German) account.
2. The Greek buyer will get a loan and take possession of the car, wearing it out over a few years. Will the Greek buyer get the loan from a Greek bank or a German bank? Hmmmm.
2A. The Greek buyer may not need a loan. Perhaps he is a VERY well paid Greek government employee who pays cash. Unfortunately, the Greek government depends upon loans to fund VERY good wages. Does the Greek government borrow from Greek banks or from German banks? Hmmmm.
3. After several years, the cars are worn out. Loans only retire when paid or are defaulted upon.
I would say that “NO, we cannot find answers from this example.” Instead, we see that the example provides many ways of shifting risk:
First, the real buyer of the initial car is the German Bank. Who is the risk taker here, the bank or the supporting government?
Second, the buyer may be take a loan OR his employer may take a loan. If the employer takes the loan, the risk of collateral loss (and normal depreciation) has shifted from the buyer to the employer (or the risk been effectively hidden).
The Target2 data seem to indicate that Greek employers are taking loans to buy German cars from German banks. Unfortunately, the cars are now worn out but the loans remain unpaid. Who will take the loss?
The German car builder will get a loan from a bank. He will build a car and pay his workers. Money will be dispersed into the economy and will increase the amount of deposits in the Target2 (German) account.
Target2 will be incurred only if money is moved across German’s border.
The Greek buyer will get a loan and take possession of the car, wearing it out over a few years. Will the Greek buyer get the loan from a Greek bank or a German bank? Hmmmm.
Yes, but I guess 99 % of the household loans are, still, within country. We can, IMO, assume this away. Yet in theory it blurs the picture. I think Sinn’s view will be day by day harder to justify as more and more people will use accounts outside their home country.
2A. The Greek buyer may not need a loan. Perhaps he is a VERY well paid Greek government employee who pays cash. Unfortunately, the Greek government depends upon loans to fund VERY good wages. Does the Greek government borrow from Greek banks or from German banks? Hmmmm.
If the government issues a bond, I reckon the money will be always (necessarily, JKH?) summoned to local bank or a local branch of foreign bank. This will, AFAIK, incur credit on the respective governments Target2 account if it is receiving cross-border bank deposits as proceeds. But if the government then uses proceeds for cross-border payments the Target2 will be debited respectively.
Adding to/editing 2A:
I think we need to keep in mind that moving deposit cross-border always has a Target2 reflection. So the governments might, and probably have, accounts in different member states (or even in other currency areas) but that doesn’t change the picture much. The target2 keeps track where deposits are now relative to where they were created.
Given that Germany runs a current account surplus, no Greek bank can ultimately lend to buy a german car. Only a german bank can. And since the official policy of Germany is to run a permanent trade surplus, even that bank can’t lend.
By having a trade surplus, Germany is refusing to be paid. Why should anyone repay debts for which the creditor refuses payment and threfore make it imoossible to pay?
I think the Eurozone is a currency union, but an ineffective one because of fiscal dysfunction of one type or another.
Agreed. What interests me, or what I find interesting about Coppola’s post, is the question whether, putting fiscal issues aside, there are different types of monetary unions. Or what does the term monetary union mean?
If one takes union to mean the abolition of borders, a monetary union must therefore be one in which all things related to the payments system are in effect supranational. The mere existence of target2 balances violates this principle, at least if it is strictly interpretated in the way Sinn does. Coppola proposes a liberal interpretation of the accounting facts to make it fit the above definition. But I fear, in the case of a Grexit, Sinn and you are right in that such a liberal interpretation would not stand a chance.
A valid question is also, whether such a setup would funtion better in normal times and whether the exit of a member would be render different results. We’ll never know for sure, I guess.
In the end, the Euro system seems a bit like a marriage with separate estates, whereas to me personally the term union implies community of property. But target2 tells me the founders of the Euro thought otherwise.
Poor old Target2 just can’t get any respect.
In current circumstances, there has been a deposit outflow from the commercial banks of Greece to banks in other countries that take Euro deposits – mostly banks in the other Eurozone countries. The money flow associated with that deposit loss is recycled in effect by Target2 back to Greece – as a Target2 claim of the non-Greece Eurozone banking system on the Greek central bank (NCB), a claim that constitutes a balance sheet liability for the Greek NCB. It is in effect a form of funding, plugging the hole in the balance sheet that is left when Greek system reserves (issued by the Greek NCB as a liability) are debited to pay for the flow of funds from the Greek banking system to other banking systems.
The Greek NCB in addition then lends money to the Greek commercial banks through ELA, replacing the hole left in their balance sheets through the deposit loss. While the accounting may be awkward to explain, at the end of the day, the Greek NCB balance sheet expands with ELA assets and Target2 funding. It is a pass through of funding in this sense, with the Target2 system as the intermediary.
SUPPOSE the Eurozone banking system were structured in a different way. Suppose every commercial bank in the zone regardless of country domicile had a reserve account directly with the ECB. In other words, suppose there were no national central banks (NCBs), just the ECB.
Then consider today’s scenario in that structure.
The Greek deposit outflow that is now aggregated at around 100 billion Euros through Target2 would then consist of a number of funding shortages across various Greek commercial banks, resulting from their inability to replace deposit outflows through normal funding channels. Those funding shortages would show up first as reserve account overdrafts directly on the books of the ECB. And then, similar to the current use of ELA funding provided by the Greek NCB to the Greek commercial banks, the ECB would have provided similar funding to the Greek commercial banks directly from its own books.
But there would be no difference in terms of the fiscal characteristics of this crisis.
The only difference would be in the display of the aggregation or disaggregation of the various funding profiles for the Greek banking system. Target2 would simply vanish as a middle man for the recycling of aggregate Greek deposit outflows back to Greece. The ECB would be the pure middleman, without the NCBs or Target2.
So don’t blame poor old Target2. It’s just a facilitating clearing AND FUNDING system to accommodate funding aggregation at the level of the existing NCBs. No direct implication for the fiscal characteristics of the existing Eurozone architecture.
Poor old Target2 just can’t get any respect.
🙂
I think I understand, thanks.
Btw, I wasn’t implying fiscal consequences, merely national ones in the sense that data that was conveniently aggregated along national borders (target2) might influence the course of the impending bankrupcy procedure and would provide welcome fodder for divorce lawyers and the media alike.
But I guess even if banks were being directly funded by the ECB, a) considering banks are registered somewhere, one could still easily divide along national lines and b) a looming secession with banks remaining in their respective national as opposed to currency areas was always bound to be framed in national terms anyway. That’s sort of the point of a nation exiting a currency area, I guess. It’s a question of where you cut, not which data you collect.
Anyway, time to stop boring everyone with my musings.
Nice explanations by JKH.
The view “TARGET2 intra-ESCB liabilities are not really debt” can be shown to be inconsistent by various though experiments.
Here’s the simplest.
Suppose the Greek NCB holds €10bn of German government bonds acquired because of various historic reasons. Now suppose the ECB buys these bonds worth €10bn from the Greek NCB. This happens via a reduction in the Greek NCB’s liabilities via TARGET2 entry.
Greek residents have now less foreign assets as well as less foreign liabilities.
All well and good.
But according to those who argue that intra-ESCB liabilities shouldn’t count as debt, Greek residents have lost an asset.
They cannot simultaneously claim that the intra-ESCB liability is not debt and that Greek net foreign assets are unchanged (in the above example).
Ramanan / JKH,
We (always) agree(d) on the accounting side.
Would you mind to comment whether you see the problem (my question #1 above) that the Euro doesn’t offer “immediate finality” as the ECB / politicians promised (e.g. here: http://www.ecb.europa.eu/paym/t2/html/index.en.html). I refer to the case where a Greek pays for a German car which incurs Target2 liability. If that liability is paid through taxes at the time of the break-up the Greek can be considered to pay his/her car twice. Or maybe the case is more glaring when the Greek’s government pays it cross-border bills as they will end up being funded by the Bank of Greece Target2 liability. So a government payment creates at the same time a liability for the very same government, payable at the time of the break-up. Thanks.
Jussi,
If Greece leaves the Eurozone, it is natural to expect that the Target2 liability should be repaid to the ECB/residual Eurozone.
The Target2 liability is a liability of the existing Greek NCB.
If the Greek NCB balance sheet held assets of sufficient Euro value to cover that liability, and if those assets could be realized for that Euro value, then the T2 liability could be repaid from the balance sheet resources of the Greek NCB. This could be very problematic in fact due to the questionable quality and lack of liquidity in such assets. Then it becomes a higher order fiscal liability for Greece, given that it is in effect extracting its NCB from the Euro system.
This is not paying for the car twice. It is paying for the car, plus paying for what is effectively the Greek banking system’s liability in respect of the capital inflow (a capital account surplus) that resulted from buying the car as an import (the corresponding current account deficit). Looking through the transaction to the end points, it is buying the car in exchange for monetary assets of questionable value. Pay for the car first, and then later reimburse for the bad assets used to pay for the car.
Thanks again JKH,
That was again agreed and a clear way to put it.
“Then it becomes a higher order fiscal liability for Greece, given that it is in effect extracting its NCB from the Euro system.”
If the Eurosystem/Troika were ousting Greece, should the Eurosystem bear the (net) liabilities of the Bank of Greece? But if that is true then there are two ways of seeing how the resolution should be made (for the record I don’t know who’s the one to blame for the current mess)?
“it is buying the car in exchange for monetary assets of questionable value”
For me this goes against the very essence of the currency union. The Euros should represent the monetary assets, if questionable in value (as they are if losses are not shared), it compromise the value of the Euros. But I appreciate that with strong fiscal independence there is a moral hazard present if the above idea is not binding.
@ Jussi & JKH
Just found this:
…Another issue which arises from the decentralised legal structure of TARGET 2 is the issue of TARGET balances which has been the subject of media comment over the last few years.
TARGET 2 balances are not foreseen to be settled. They are booking entries in CB balance sheets. Basically, for each euro issued in net terms, a Euro system national central bank (NCB) automatically generates a claim of the ECB on itself. However, no settlement at any horizon is attached to that claim, reflecting a principle of confidence within an integrated monetary area.
In the early years of TARGET 2, balances were not that significant but more recently, they have become material by any standard. Indeed, in mid-2012 they peaked at roughly 10 percent of euro area GDP. However, the statement sometimes made that they represent bilateral obligations between Eurosystem CBs is not correct except on an intraday basis.
The Governing Council of the ECB decided in 1999 that the bilateral balances should be netted on a daily basis by novation which was considered to be in line with the principle of an integrated monetary area. Consequently, with effect from 30 November 2000, the claims and liabilities related to TARGET ( TARGET 1 in those days ) have been netted by novation at the end of each TARGET day resulting in each Eurosystem CB having an obligation or claim towards the ECB with this concept being reflected in Article 6 of the TARGET 2 Guideline.
Whilst the Harmonised Conditions appended to the TARGET 2 Guideline address the issue of insolvency of a participant, understandably they do not envisage the failure of a Eurosystem central bank to honour its obligations. However, the theoretical case of an NCB leaving the Eurosystem and being unable to reimburse its TARGET liability has been described by Deutsche Bundesbank as follows “Should a country with TARGET liabilities opt to leave the euro area, any claims the ECB might have on the NCB of that country would initially persist in the same amount. If the exiting central bank proved unable to repay its liabilities despite loss-offsetting within the Eurosystem and the collateral available, it would be necessary to devise a solution for the outstanding amount. Only if and when a residual claim was deemed unrecoverable would the ECB actually recognise a loss by virtue of writing it off as a bad debt.” The ECB could then call on its shareholders – that is the central banks of the remaining euro area countries – to participate in the loss according to their shares in the ECB’s capital.
http://enews.ebf-fbe.eu/2014/01/who-said-payment-systems-are-simple-legal-issues-arising-from-the-structure-of-target-2/
And regarding finality of payments and the double payment that Jussi mentioned, there is this, which I’m not quite sure what to make of. Maybe JKH can take a stab? Sorry about all the copy paste, but it would a much greater waste of webspace if I were to attempt to put it into my own words.
…we need to verify whether the European monetary union adopted a single currency indeed.
Though surprising, the answer is negative, the reason being the lack of payment finality between euro area member countries. The Trans-European Automated Real-time Gross-settlement Express Transfer (TARGET) system is managed by the central banks of the member countries, and the payments between countries (between their residents) are made through their central banks. In the absence of final payments between the member countries, through the agency of the ECB, national currencies are not yet made homogeneous. This means that, de facto, the switching to the monetary union has been purely nominal. Member countries of the euro area did not replace their national currencies with a single currency, but simply changed their currency’s name. Hence, different euros are circulating within each country within the monetary union. Therefore, we note the existence of a nonsensical situation, as countries abandoned their monetary sovereignty without really losing it.
http://www.quantum-macroeconomics.info/international-economics/
or this:
Click to access Schmitt-B.-2014-The-formation-of-sovereign-debt.-Diagnosis-and-remedy-Social-Science-Research-Network-SSRN.pdf
And I’m not sure what Mr. Roger Jones, Chairman of the TARGET Working Group, whom I quoted @ 10:28 means when he says reflecting a principle of confidence. Seems to me keeping tabs indefinitely reflects the opposite of having confidence in each other. Or maybe it means that it reflects confidence that the system won’t be put to a test?
Jussi,
“For me this goes against the very essence of the currency union.”
I agree.
But in fact there is no longer a currency union to which this principle applies.
I.e. no longer a currency union to which Greece belongs in this case.
The original car transaction and value given in Euros at the micro level is fine.
But if Greece leaves the union, there must be a macroeconomic settlement of previously incurred international intra-union financial claims.
Specifically, international capital account claims must be settled on the basis of Greece now no longer belonging to the union.
Looking through to the international macro accounts, the car was purchased with a Target2 liability.
That liability was OK as an indefinite position under the terms of the union.
But when Greece leaves the union, it is no longer OK as such an indefinite position. It becomes due. The ex-Greece union wants their money back.
See also my next comment to Oliver.
Oliver,
“Should a country with TARGET liabilities opt to leave the euro area, any claims the ECB might have on the NCB of that country would initially persist in the same amount. If the exiting central bank proved unable to repay its liabilities despite loss-offsetting within the Eurosystem and the collateral available, it would be necessary to devise a solution for the outstanding amount. Only if and when a residual claim was deemed unrecoverable would the ECB actually recognise a loss by virtue of writing it off as a bad debt.”
I hadn’t seen that, but that is what I’ve been saying.
The nature of a Target2 liability changes as the result of a transition from status quo going concern Eurozone membership to exit from that membership. A liability that was once tolerated as indefinite now becomes due.
(This is where Coppola’s anti-Sinn post was basically incorrect and where Sinn is correct.)
Oliver,
I think I’ll leave quantum macroeconomics to the quantum macroeconomic theorists.
🙂
JKH,
“But in fact there is no longer a currency union to which this principle applies.”
Yes, I see the logic.
But enforcing the logic means that the Euros are not only backed by the central Bank assets but also with fiscal transfers in the case of the break-up. I’m not sure any country was agreeing to support the value of Euros by fiscal transfers. Yes, Greece broke fiscal packages / treaties but that doesn’t mean they automatically have the contingent liability of the Target2 claims. That might be problematic from fiscal / monetary policy division point of view.
Contingent Target2 claims would also mean that deposit par pricing is tricky because there is always a positive probability for the break-up in the future. Also incentives are bizarre, basically people should always borrow money from the bank domiciled in other member country to avoid possible future tax liability.
If claims are not on any NCB the currency area is more solid and efficient.
Oliver, interesting texts, nice research 🙂
“Should a country with TARGET liabilities opt to leave the euro area, any claims the ECB might have on the NCB of that country would initially persist in the same amount. If the exiting central bank proved unable to repay its liabilities despite loss-offsetting within the Eurosystem and the collateral available, it would be necessary to devise a solution for the outstanding amount. Only if and when a residual claim was deemed unrecoverable would the ECB actually recognise a loss by virtue of writing it off as a bad debt.”
I read this as the Bundesbank (as also in its other quote) agrees that the liabilities of given NCB is limited to assets it holds. And anything beyond the assets should be covered by the ECB (and its owners on capital key basis) not by the respective member country.
JKH
Yes, and I think everyone agrees with you. The question is, could it be different and would that make a difference?
Jussi
Thanks.
To rephrase your point, which I think I would agree with: for the Euro to be considered a single, homogenous currency, inter-country payments would have to be settled finally by the ECB through novation on their behalf, while excluding the possiblity of subrogating against any entities other than its own shareholders according to the predefined capital key. Does that make sense?
That obviously places a much higher burden on the ECB to homogenise the quality of what would then be a supranational banking system. But then, that is a minimum requirement for any functioning currency area, I would have thought.
More importantly, to the extent that the above is correct, it would also mean that the shortcomings of the Euro area are not solely its missing fiscal integration but also a monetary system which is still divided, if only contingently, along national borders.
As for quantums and quarks. I have no idea who came up with that daft name, but they are a formation of proto Post Keynesians around Bernard Schmitt (SSRN paper link) with proponents here in Switzerland, France and, I’m sorry to say, Canada (L. P. Rochon) :-). But, even after a couple of attemtps, I can’t get my head around their concept of doubling of international debt. I tohught maybe someone wiser than myself could translate. It does have something to do with final settlement, though, which is why I brought it up.