Euro crisis, balance-of-payment, and TARGET223 May, 2012, 15:07. Posted by Zarathustra
Tags: Euro Crisis
The euro crisis is probably viewed primarily as a debt crisis.
While it is a debt crisis in a certain extent, it is clearly more than simply a debt crisis.
The euro crisis is also a banking crisis in some sense as peripheral countries’ banks are exposed to troubled sovereign, compromising their own capital position. In the event that the sovereign defaults or even leave the euro, you can be assured that banks will be in huge trouble as well, and people will probably start queuing outside banks. In other words bank run.
But the euro crisis is more than even that.
The design of euro, as mentioned many times before, is flawed. It is flawed because, as many have already pointed out, there is no political and fiscal union behind the monetary union. Also, it is impossible to expect that member states can all run a balanced budgets, or even a surplus. This is simply impossible under the rules of national accounting, unless the eurozone runs a big trade surplus with the rest of the world, which isn’t what is happening.
One may not naturally think about the euro crisis as a oldie balance-of-payment crisis, but in some way it is. Let’s say Germany is consistently running trade surplus with Greece (i.e. Greece is having a current account deficit), the current account deficit of Greece needs to be financed (remember, all balance-of-payment components must sum to zero). This could be in the form of lending from German banks to Greek, or portfolio investments, for example.
In the eurosystem TARGET2 payment system (Trans-European Automated Real-time Gross settlement system), a current account deficit of, for example, €100 for Greece (i.e. a current account surplus of €100 for Germany, for example) arise when a Greek household purchase a German product, for example. In this transaction, €100 of deposit in a Greek bank will be transferred to a German bank, first through the Bank of Greece, via TARGET2, then to the Bundesbank. What happens is that the Greek banks will be losing €100 of reserve being placed at the Bank of Greece, while the German bank, after receiving the €100 deposit, will have €100 extra reserve placed at the Bundesbank. This transaction will appear as a liability of Bank of Greece, and a claim on Bank of Greece by the Bundesbank.
This is fine if the Germans are “recycling” the trade surplus back into Greece via portfolio investment, or bank lending or anything like that. TARGET2 imbalances can also arise from people moving deposits from one country to another. This is not probably what’s happening since the financial crisis to Greece, with the mix of trade deficit, deposits being moved away from the country, and capital flow away from the country contributed to the increasing liabilities of Bank of Greece against the rest of the eurosystem, notably the Germans. According to a paper from the Austrian National Bank (i.e. the national central bank of Austria):
Since 2001, Greece has imported more goods and services each year than it has exported (current account balance –). Until 2007, most of these additional imports were covered by securities purchases by nonresidents (portfolio investment balance +). The plus or minus sign following “Deposits of nonresidents in Greece” (+) and “Deposits of residents abroad” (–) means that Greeks built up deposits at foreign banks while nonresidents increased their deposits at Greek banks. Offsetting flows such as these would appear to be a byproduct of monetary union. Closer analysis of the more recent developments shows considerable fluctuations in the period from 2009 to 2010. While nonresidents continued to purchase considerable volumes of Greek securities in 2009, the portfolio investment balance moved into negative territory in 2010, i. e. Greeks had to redeem more securities than they could sell new ones abroad. At the same time, Greeks began to transfer more deposits abroad (deposits of residents abroad –) while nonresidents failed to increase their deposits at Greek banks further in 2009 and went as far as to withdraw almost EUR 50 billion in 2010 (deposits of nonresidents in Greece switched from + to – ). These significant outflows were financed via the build-up of BoG liabilities toward the Eurosystem in the period from 2008 to 2010 (BoG deposits +). Specifically, the BoG built up TARGET2 liabilities as well as liabilities arising from the adjustment of banknotes in circulation in this period. In 2010 the cross-border liabilities of Greece increased further when it received the first tranche of the EU/IMF bailout package (other investment +).
There are certainly some worries that if Greece does leave the eurozone, the TARGET2 claims on Greece will become loss for the rest of the Eurozone central banks, and the Bundesbank is clearly worried. Here, the paper said:
If a country were to exit EMU, its commercial banks may no longer be able to meet their euro liabilities: while they may be able to obtain funding in the new national currency from their central bank, they may not be able to obtain euro liquidity from their central bank and they may have difficulties to fund themselves in euro on the private capital markets. Thus they may not be able to repay the maturing monetary policy operations in euro. Since these operations were transacted under the common rules of the Eurosystem, the losses would be allocated on a pro rata basis. Claims arising from monetary policy operations and claims toward the central bank of the withdrawing country in TARGET2 would fall accordingly.
Jobst, C. , Handig, M. & Holzfeidn, R. (2012). Understanding tarGet2: the eurosystem’s euro Payment System from an economic and Balance Sheet Perspective. Monetary Policy and the Economy.