Ifo Viewpoint No. 130: Buying Out the Store with the Printing Press

Hans-Werner Sinn
Munich, 10 November 2011

The European Central Bank (ECB) finally deigned to make a statement regarding the economics of the Target balances issue in its October Monthly Bulletin. It confirms the facts that the Ifo Institute presented in a working paper last June. Since the ECB does not have its own reporting system for such balances, it followed the Ifo approach and drew the data from the statistics of the International Monetary Fund (IMF); it arrived at the same figures as Ifo.

The broader public and some journalists have not yet realised that these balances embody a huge lending operation from Germany to the troubled euro countries. A journalist even argued that the ECB denies the claim that it has drawn credit from the Bundesbank. The ECB does not deny it; in fact, it couldn’t even if it wanted to, since the Target claims are shown on the Bundesbank’s balance sheet officially as a capital export (and thus as a credit!) through the ECB system.

The Target balances are credits in the ECB system that result from the cross-border shift of central bank money creation within a monetary union. Specifically, whereas the national central banks (NCBs) of the countries in distress, namely Greece, Ireland, Portugal and Spain (GIPS), as well as Italy of late, are printing money far above what is needed for circulation within their respective jurisdictions and lending it out to their citizens in order for them to acquire goods or assets from the rest of the Eurozone countries, the Bundesbank’s refinancing credit and the money it creates undergo a retrenchment. In other words, refinancing credit is being relocated from Germany to the GIIPS.

A similar process occurred under the Bretton Woods system, which fixed the exchange rates between European currencies and the US dollar. The USA paid for then-cheap European goods and equity stakes in European companies with freshly printed money lent by the Federal Reserve to the commercial banks. The dollars were converted into deutschmarks by the Bundesbank, and the resulting “dollar D-mark” crowded out one-to-one the stocks of deutschmarks created through refinancing credit by the Bundesbank. Refinancing credit was thus being shifted from the Bundesbank to the Federal Reserve, entailing a capital export through the central bank system from Germany to the USA. It was said then that Germany tolerated the process in order to help finance the Vietnam war.

Just as back then the “dollar D-mark” crowded out the “refi D-mark” in Germany, since autumn 2007 the “GIPS euros” are crowding out the “refi euro” in Germany one-to-one. By now, this refinancing-credit shift has turned the Bundesbank from a net creditor into a net debtor to the German banking system. This is a shocking development. In the South the money-printing presses are running hot, while in Germany the Bundesbank has turned on its money shredders.

Under the Bretton Woods system, the Bundesbank could exchange part of the inflowing dollars for US Treasuries. The French even sent a warship to the US to return the dollars converted into gold. This eventually broke the Bretton Woods system. Today, in exchange for its lending, the Bundesbank receives claims on the Eurosystem that yield little interest (1.25 per cent at the moment) and which nobody knows whether they can be called due if the Eurozone were to break up. The Bundesbank has already accumulated 450 billion euros in Target claims, of which 106 billion built up in August and September alone. This is the largest position in the Bundesbank’s balance sheet, a significant portion of Germany’s net foreign asset position and twice as much as the rescue funds that Germany is to provide under the European Financial Stability Facility (EFSF). If the Eurozone had an internal settlement system similar to the one used by the US Federal Reserve System, the Bundesbank could demand that marketable assets yielding good returns be turned over to it to settle the balances.

Big companies such as Hochtief and Kaufhof, small and medium-sized businesses, stocks and real estate whet the appetite of investors from the troubled countries, who get fresh money from their NCBs for the purpose. In the meantime, it is not only Spaniards, Irish and Greeks who are on a shopping spree in Germany. They have been joined by many Italian wealth owners who, with the money freshly printed by their NCB, are buying anything that is not nailed to the floor. The money the Germans get for this bargain sale ends up in the money shredders at the Bundesbank. The Banca d’Italia’s Target balance deteriorated by 110 billion euros in the past three months, going from 6 billion in claims in June to 104 billion in liabilities in September. In August and September alone the Banca d’Italia drew 86 billion in Target loans. These debts are the counterpart to the Bundesbank’s claims. When will politicians wake up to this fact and do something about it?

Hans-Werner Sinn
Professor of Economics and Public Finance
President, Ifo Institute

Published as “Ausverkauf mit der Druckerpresse“, Handelsblatt, No. 218, 10 November 2011, p. 8.