Jens Weidmann Drops A Clanger
Central bank balance sheets as a percentage of GDP: the ECB is now in the lead. Heli-Ben must soon do something if he wants to reclaim the title of biggest money printer of the post WW2 era. (chart via Scott Barber of Reuters) – click chart for better resolution.
We have already commented extensively on the once again growing rift between the 'hawks', led by Jens Weidmann and the 'doves' at the ECB's governing council, the latter unsurprisingly mostly led by representatives of the 'Latin Bloc'.
Late last week German news magazine 'Der Speigel' chimed in with its assessment of the matter. Below are a few relevant snips:
„Last week, the ECB pumped more than half a trillion euros into the markets to maintain the money flow in the monetary zone. Europe has experienced a painful lack of liquidity ever since a large number of northern European banks reacted to the euro crisis by severing nearly all lines of credit to financial institutions in the south. Now, with the help of Draghi's second cash injection within just a few weeks, ailing southern European banks were once again able to grant loans and purchase sovereign bonds from their home countries.
Although this has eased the ongoing debt crisis on the Continent, and made Draghi into "Europe's rescuer" in the eyes of many politicians and financial managers, one of his leading partners views this approach with growing concern. Only two days before Draghi made his G-20 presentation, Jens Weidmann, president of Germany's central bank, the Bundesbank, spoke at the Mexico summit, and he had an entirely different message for his listeners. "The crisis cannot be resolved solely by throwing money at it," he said.
There is a rift among top-ranking officials at the ECB, and it also extends between the majority of the ECB's Governing Council and the Bundesbank. First, two leading German ECB officials — chief economist Jürgen Stark and Bundesbank President Axel Weber — resigned because the monetary authority was buying up sovereign bonds from Greece and Portugal. Then Weber's successor Weidmann objected to the ECB's purchase of government bonds from heavily indebted Italy.
Now, Weidmann is rebelling against the manner in which Draghi is giving European banks one new cash injection after another. Although Weidmann admits that the measures are basically correct, their conditions are "very generous," he complains — and expresses his total opposition to this policy in the jargon of the central bankers: "This can particularly become a problem if banks are discouraged from taking action to restructure their balance sheets and strengthen their capital base."
As we have also pointed out when we first discussed the latest wrangling over the ECB's policies, Weidmann has begun to complain about the Bundesbank's large TARGET-2 claims and has been muttering about wanting to 'securitize' them. As 'Der Spiegel' notes, this represents a noteworthy escalation of the dispute, as the only reason why the BuBa would even think of complaining about TARGET-2 claims would be the idea that a break-up of the the euro area is on the menu.
This notion has hitherto been a taboo for central bankers in euro-land. Readers may recall that ever since it has come to light that intra-euro area capital flight and current account deficits are surreptitiously financed via the TARGET-2 system, we have again and again stressed that these imbalances represent no problem unless the euro area were to break apart. The Spiegel article continues:
„[…] the conflict between Europe's two most important monetary policymakers has become increasingly apparent, and it's compounded almost on a weekly basis by contentious new issues. One day Weidmann votes against special conditions for the ECB with regard to the Greek debt haircut, the next day he objects to the long maturities on Draghi's loans to banks.
Last week, the conflict escalated to a new level. Weidmann complained in a letter to ECB President Draghi that the central bank was accepting increasingly lower-grade collateral in exchange for its cash injections. This poses a danger, he warned, as the central banks in the north of the euro zone are owed ever growing amounts of money by their counterparts in the south. If the euro zone broke apart, the Bundesbank would be left holding a good deal of its bad debt from so-called TARGET2 loans, which currently amount to some €500 billion ($660 billion), he warned.
This may sound somewhat technical to most laypeople, but among leading ECB officials the letter was seen as violating a taboo. TARGET2 refers to the central banks' internal payment system, which has accumulated massive imbalances during the course of the euro crisis. These inequalities aren't problematic as long as the monetary union remains intact. So far, the Bundesbank has always played down this risk. But Weidmann's about-face is a "disastrous signal," say ECB executives because, for the first time ever, the Bundesbank "is no longer ruling out a break-up of the euro zone."
BuBa president Jens Weidmann: not as happy as he looks here.
TARGET-2 Claims Revisited
The Buba's TARGET-2 claims have shot to a new record high as of February, up by nearly €49 billion in just one month (!). Chart via the German site 'Querschüsse' – click chart for better resolution.
Let us briefly return to the TARGET-2 imbalances and what they mean. In 'normal' times, the current account deficits of euro-land member nations would be financed via commercial banks and the private sector. If the inter-bank funding market were operating normally, banks in the deficit countries would simply borrow the funds they require from banks in the surplus countries. As the Bundesbank itself wrote in a recent report on the matter:
„The sharp rise in the Bundesbank’s TARGET2 balance since 2007 is essentially due to the tension on the money market and problems in the banking sector within the euro area. In the years prior to the financial crisis, Germany‘s cross-border payments were virtually balanced. Credit institutions’ (short-term) net external position in particular acted as a kind of “offsetting item” in the balance of payments. As the current account surplus and frequent net capital imports in portfolio transactions meant that incoming payments regularly outweighed outgoing payments, most years saw outflows of funds (net capital exports) in banks’ short-term credit business. Hence temporary TARGET2 positions werequickly reduced by private capital flows.
This all changed with the financial crisis. While funds tended to continue to flow into German banks from abroad due to non-bank payments and their own operations, after the onset of the crisis they were less willing, and in some cases unable, to lend these funds to foreign institutions on the interbank market. Instead, they gradually curtailed their refinancing operations with the Bundesbank – at least in the aggregate. Thus whereas the refinancing volume attributable to German institutions amounted to €250 billion at the start of 2007 it had fallen to €103 billion, by the end of 2010.
Conversely, since then banks domiciled in a number of other euro-area countries have been receiving larger amounts of central bank money through the Eurosystem.“
Well, here it is from the horse's mouth. We have of course explained all of this before. Essentially, the funding for commercial banks has been altered by the crisis: banks in the 'core' get all the deposit money fleeing from the periphery, so they need less funding from the central bank as their deposits increase. Conversely, since deposits at the commercial banks in the 'PIIGS' and a few other nations are shrinking, they must rely on more central bank funding.
So the euro-system keeps the commercial banks in the 'PIIGS' afloat. This means of course that the need to adjust current account balances to a sustainable level is not as pressing as it would otherwise be.
On the contrary, as you can see above, the BuBa's TARGET-2 claims keep rocketing higher.
So what about the risks this entails? As the Bundesbank points out, the risk tends to be shared among all central banks in the euro system, according to their share of the ECB's capital – if everything were to break apart, then the assets pledged as collateral for the ECB's refinancing operations would be pooled and distributed according to this 'capital key'. However, we think that the BuBa actually tends to considerably play down the risk in its report:
“There is no immediate change in the level of risk to the Bundesbank due to the rise in its TARGET2 settlement accounts. This risk is not directly related to the TARGET2 positions and arises from the risks associated with the Eurosystem’s liquidity supply. Although the Eurosystem as a whole has indeed incurred additional financial risks by expanding its refinancing operations and adjusting the collateral framework during the financial crisis, this was the result of a deliberate decision of the ECB Governing Council aimed at maintaining the financial system’s functional viability in a stress situation.
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.
In other words, the Bundesbank‘s risk position would be just the same if the positive settlement balance from TARGET2 were accrued not by the Bundesbank but instead by another Eurosystem national bank.
Now, why do we think this plays down the actual risk to the Bundesbank? For one thing, as we have frequently pointed out, the ECB has become Europe's biggest 'bad bank'. The 'risk control measures' it applies have deteriorated quite a bit in the course of the crisis and one must not forget that absent the allegedly 'temporary' monetization of a big pile of essentially illiquid bank assets, the commercial banks that are the biggest borrowers from the ECB would all be teetering on the verge of collapse. If they were in fact to collapse, then the value of many of the assets the ECB now holds would have to be realized. Many of these assets could turn out to be a toxic brew indeed if some of the biggest and most dubious commercial banks in the euro area were to become insolvent along with their sovereigns (let us not forget here that there is still a sovereign debt crisis on as well).
The required reserves of euro area banks have been slashed to 1% – and as one might imagine, the banks holding the by far smallest reserves against their deposit liabilities are of course precisely the banks that are the by far weakest of the bunch. The banks that have been redepositing funds with the ECB after the LTROs and now hold excess reserves are the strong banks.
Moreover, since the risk that Jens Weidmann actually thinks about is connected with a possible break-up of the euro area, one needs to also consider the exchange rate risk that would become manifest if the euro were to break up. Suddenly many assets that used to be denominated in euros would be re-denominated in lira, pesetas, drachma and so forth. If the euro were to cease to exist, it would be simply impossible to leave euro denominated assets denominated in euro terms. You can't denominate assets in terms of a non-existing currency after all.
In that event the BuBa's share of the pool of assets the euro-system holds against the growing pile of TARGET-2 claims at the central banks of the surplus nations would surely suffer a sizable haircut, especially as a putative new Deutsche Mark would presumably soar against all other European currencies.
Finally, we would like to clarify one more point: as various etatistes keep reminding us, a central bank in a fiat money system can not ever really suffer a 'loss' in the traditional sense. After all, the currency it issues is completely irredeemable anyway. Who cares what its 'assets' consist of? It can print as much money as it likes, against any assets of its choice. As we have once jokingly remarked, if Ben Bernanke were to replace the Fed's holdings of t-bonds with a crayon drawing by one of his children and pretend it was valued at $1.6 trillion, nothing would really change. Dollars would simply remain just as irredeemable as they have always been since 1971.
Of course there remains the not unimportant point that there is no free lunch. If losses occur, someone has to bear them. In the case of a central bank realizing losses, the losses will be fully socialized among the holders of the currency it issues, as it won't be possibly any longer to fully withdraw the liquidity that has been previously provided via asset sales. A technical work-around to this problem is certainly conceivable, but it wouldn't come 'for free'. The only viable solution would be to contract the money supply – but that would amount to a confiscatory deflation, as a great many deposit claims would consequently become worthless, or rather, would simply disappear.
So you see, there is no easy way out of the euro roach motel. No matter how the issue is in the end resolved, no painless way out exists. Again, let us keep in mind that all the losses that central banks around the world are so eager to keep from being realized can simply not be wished away. They have been incurred during the boom, which was actually the time when capital was squandered and consumed. We can not go back in time and 'unmake' the associated mistakes. The only question as always is: 'who shall bear the losses?'.
The answer of the eurocracy to this question so far is: not those who actually made the losses. Instead, the tax cows and all users of the euro are going to pay, whether they like it or not.
We hasten to add that this is no different from the fate US tax payers and users of the dollar have suffered as a result of the 2008 GFC and its aftermath, and the same holds for the UK and Japan. These days savers are being robbed everywhere by 'ZIRP' and massive money supply inflation in order to support irresponsible debtors and de facto insolvent banks.
What is so astonishing about all this is that there are actually still people who think this will somehow 'work'. We wonder why? It sure hasn't 'worked' the last time it has been tried, has it?
A nifty chart from the 'Spiegel' magazine of the growth of the ECB's balance sheet. Below are the balance sheets of the ECB, the Fed and the BoJ as a percentage of the GDP of their respective currency areas – click chart for better resolution.
And here is a more recent update of the ECB's balance sheet by Bloomberg (data as of yesterday) – the €3 trillion mark was indeed exceeded – click chart for better resolution.
ECB Hawks Are About to Gain a New Member
In the context of the ECB's governing board and the rift between 'hawks' and 'doves', it appears the hawks are about to win a small skirmish. France has now thrown its support behind the hawkish Yves Mersh from Luxembourg to replace the outgoing Spaniard Jose Manuel Gonzalez-Paramo. This could tilt the balance of power significantly toward the hawkish BuBa line. Frankly, we're a bit surprised that France of all countries would support a reportedly 'hawkish' representative to the ECB's board, but there it is. Apparently it is the result of horse trading over various plum bureaucrat jobs in the EU and has nothing to do with France's views about monetary policy.
“France is prepared to switch allegiance from Spain to Luxembourg in the battle for a seat on the Executive Board of the European Central Bank, according to diplomatic sources, an appointment that would tilt the balance towards anti-inflation traditionalists.
Spain, Luxembourg and Slovenia are in a three-horse race to replace Jose Manuel Gonzalez-Paramo when the Spaniard leaves the ECB at the end of May.
Since the ECB flooded banks with cheap money for a second time last week, some of its policymakers led by Bundesbank chief Jens Weidmann have expressed alarm that the dramatic loosening of lending policy will fuel imbalances in the euro zone and stoke inflationary pressures. The ECB hawks' bargaining position could be further bolstered if Luxembourg's central bank chief, Yves Mersch, wins the race.
French President Nicolas Sarkozy backed Spain to keep its seat on the ECB board before Madrid put forward the ECB's top lawyer Antonio Sainz de Vicuna as its candidate. Since then the veteran Mersch, who has one of the strictest anti-inflation stances among ECB policymakers, has entered the race for the post which manages the ECB's day-to-day business.
Sources said France was now backing him rather than Sainz de Vicuna as part of a grand deal on top jobs at European institutions, which could see France bag the European Bank for Reconstruction and Development.
ECB board members are chosen by euro zone governments rather than the central bank itself. A decision may be made as soon as Monday at a meeting of euro zone finance ministers before being rubber stamped by heads of government at a later date. The third man in the race is Slovenia's former central bank head Mitja Gaspari. While he is seen as a potential compromise candidate he remains an outsider in the contest.”
Prediction: if Francois Hollande wins the French presidency, he won't like that appointment one bit.
Meanwhile, if Mersh gets the job, then the markets better be prepared for the most recent LTRO representing the last such operation for quite a while. A tiny victory for holders and users of the euro we guess.
Luxembourg's Yves Mersh: a hawk comes in for a landing at the ECB's board.
(Photo via investmenteurope.net)
Addendum: Spain's Government Strikes Agreement with the Regions
As Reuters reports, Spain's overindebted regional governments have now struck an agreement with the central government over the new deficit target. Alas, it sounds as though conflicts area already preordained:
“Spain's centre-right government said on Tuesday it had agreement from most of the country's 17 autonomous regions to comply with harsh cost-cutting measures this year, but three regions including heavyweight Catalonia said the burden was unfair.
However, given that the new objectives were approved by the cabinet last week, all regions will have to stick to the new targets whether they voted against the moves or not.
Treasury Minister Cristobal Montoro met with the financial heads of all of the regions to drive home a message of austerity needed to quell doubts about Spain's fiscal discipline as the euro zone debt crisis drags on. At the meeting he won backing from all the regions controlled by the ruling People's Party for 10 billion euros ($13.1 billion) of spending cuts that the regions must make and that will likely bite into health and education services.
But the highly populated southern region of Andalucia, controlled by the Socialist party before local elections at the end of the month, voted against the targets, Montoro said at a news conference after the meeting. Catalonia, which makes up nearly a fifth of Spain's gross domestic product, abstained from the vote as did the Canary Islands.
Catalonia pledged to comply with the target but said it believes it is disproportionate and that the central government should take on more of the deficit-cutting responsibility. Montoro said the regions' commitment to deficit targets was key for Spain to move towards recovery. "We have to aspire to make this the last year of crisis," he said.
"The message we want to give is that all the public administrations are committed to cutting their deficit."
Prime Minister Mariano Rajoy defied the EU on Friday to soften Spain's deficit objective, but even his more realistic target will be beyond reach if regional leaders pose a similar challenge to his authority. The regions account for close to half of all public spending – the biggest parts of their budgets go on health and education – and almost all of them greatly overshot their spending targets last year.
Spain's country risk, as measured by the spread between its borrowing cost and that of Germany, overtook Italy's this week as concerns have grown over whether the regions, with a combined deficit of 30 billion euros, can tighten belts. Anti-austerity protests mounted last week as students anticipate deep cuts in education and healthcare.”
It remains to be seen whether this accord actually sticks in the face of mounting political and economic pressures in Spain. Color us doubtful.
Spain's IBEX stock index over the past two years. Since the stock market serves as a barometer for the social mood, we conclude that the social mood in Spain is grim indeed – click chart for better resolution.
Charts by: Bloomberg, Der Spiegel, StockCharts, Querschüsse, Reuters
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