In my article "How to Reduce Germany's Surplus" I alluded to the empirical fact that Germany's Target claims are half of the country's net foreign asset position which itself results from the accumulated current account surpluses of the past. Antonio Foglia takes up this side-remark to repeat the juicy narrative about the origins of these balances that he and other authors including Yanis Varoufakis have emphasized in the last few years, namely that Germany welcomed, or should have welcomed, the Target credit to rescue its own banks and carry out vendor financing.       

Yes, we can agree that the first wave of Target balances that accumulated until August 2012 resulted from the bail-outs of the Eurosystem, preventing a default of the southern  banking systems and governments, and that these  bail-outs also helped the foreign creditors, among them the German banking system.

But not only German banks were bailed out. While German banks were lending to the whole world and thus may have indirectly helped finance the credits to the South and to Ireland, they were not the most exposed lenders themselves. At the time of the Lehman collapse in 2008, the exposure of the French banking system to southern Europe and Ireland was a bit bigger that of the German banks even though France has a significantly smaller economy. Among those being bailed out, the British banks took third place and the Dutch fourth. British and French banks were no net lenders to the rest of the world. They acted as hubs, distributing the savings flows, which largely came from Germany, to the rest of the world, including southern Europe. Nevertheless, most of the triangular bail-outs resulted in the Bundesbank's Target claims, as French and British banks repaid their credits from Germany when they stopped lending to southern Europe and Ireland.

Who wanted the bail-outs? Was it the Bundesbank trying to rescue German banks along with French and British banks? I doubt that this is the case as the Bundesbank was largely opposed to the ECB's bail-out activities, arguing that the banks themselves rather than European tax payers should bear the write-off losses. In many crucial decisions of the ECB council the Bundesbank was simply overruled by majority voting. In fact, the President of the German Bundesbank Axel Weber, and the German ECB chief economist Jürgen Stark both resigned in 2011 from their positions in open protest to the bail-out activities, a protest they had launched as early as 2010. The current president Jens Weidman keeps protesting publicly without quitting though. These facts do not fit to the claim of Antonio Foglia.

And who carried out the bail-outs? Was it the ECB or the Bundesbank? Not quite. The truth is that the bail-outs took place by the decisions of southern central banks and the Irish central bank to exploit the existing scope for local money printing and the additional scope generated by the policy decisions of the ECB council. In the first wave of Target balances, the most important active decision of the ECB council was reducing collateral requirements for refinancing credit to trash value. The ECB also accepted securities as collateral that were not traded and tolerated assets created by ring-trading between banks which meant that no effective collateral was provided. The existing scope for local money printing came from ELA and the secret ANFA agreement. ELA credit was generated in the hundreds of billions of euros by local central banks, as the ECB could only have stopped it with 2/3 majority in the ECB council. The ANFA agreement gives national central banks the right to local money printing for a limited set of purposes. The Banca d'Italia, for example, used ANFA to purchase for more than 100 billion euros governments bonds from the Italian banking sector. All these measures implied that the national central banks of Southern Europe and Ireland provided the local commercial banks with the public credit that enabled them to repay the private credit international lenders were no longer willing to provide or roll over. To put it simply: When the crisis broke out, the inflicted countries legally "printed" the money they could not borrow any more to fulfil their international payment obligations.

Printing is only a figurative term, though, as the extra liquidity was used for electronic international payment orders to other countries which are reported as Target liablities and claims in the national central bank's balance sheets. The payment orders forced the central banks of the recipient countries to credit the payments. Thereby, these central banks, above all the Bundesbank, became the ultimate providers of the extra refinancing credit issued by their counterparts in southern Europe and Ireland.  

In the process, all of the money issued by the Bundesbank turned out to be payment-order money or outside money to use a technical term once introduced by Gurley and Shaw. The inside money resulting from the Bundesbank's lending freshly made money to German banks was gradually being crowed out by the abundance of outside money during this process.    

Note also that the Target balances by no means just reflected the bail-outs of existing foreign credit built up through previous current account balances. They also reflected to a considerable extent new current account deficits that were built up during the first few years of the crisis until 2011. The details are reported in Chapter 7 of my OUP book "The Euro Trap. On Bursting Bubbels, Budgets and Beliefs". Moreover, the money from the printing press as well as from the fiscal international rescue operations served to finance outright capital flight by national investors to other countries.

In a  detailed study of Greece, I showed that from the beginning of the crisis until March 2015, the overall public credit provided by fiscal institutions and the Eurosystem  to the Greek economy was 325 billion euros which was 182% of GDP. Of this sum, about one third was for bail-outs, i.e. a retroactive financing of pre-crisis current account deficits, one third was used for financing new current account deficits; and one third was used to finance Greek citizens' capital flight, i.e. investments by Greek citizen in the rest of the world. Even in 2016, the sum of Greek private and public consumption was more than 10% above Greek net national income. These facts are miles apart from the juicy narrative quoted above.

What about Antonio Foglio's vendor financing narrative? Was Target financing initiated by Germany for the purpose of selling its products to the South? Again, it is useful to look at the facts. When the euro was firmly announced on the Madrid Summit of 1995 and it was made clear that the exchange rates would be irrevocably fixed, the shrinking exchange risk implied a rapid elimination of the previously huge interest spreads in the south within two years. This triggered additional private and public credit that led to the inflationary bubble that burst in 2008, leaving behind overpriced torsos of once competitive economies. Yes, indeed, the German current account balances to some extent resulted from the southern and Irish imports that, in this order, French, German and British banks had financed. However, it would be overdrawn to accuse the French and British banks serving Germany's secret vendor financing plan.

Instead of endorsing the vendor credit narrative, I tend to believe that it was the euro as such that caused the excessive credit in the first place. The French, German and British creditors surely would not have been as negligent as they were had they not anticipated that the euro would make bankruptcies of borrowing countries very unlikely. After all, these countries all had the printing presses in their basements that in the case of emergency would enable them to service their debt with a currency that other countries would accept as legal tender. As explained above, history proved that these expectations were very correct. My conclusion is that the implicit debt mutualization  provided by the very existence of the euro as currency provided by local central banks rather than the ECB had eliminated the interest spreads and caused the bubbles in the South which themselves had resulted in the trade imbalances with Germany.

What about Antonio Foglia's suggestion that Germany had benefitted from the bail-outs as measured by the Target balances. It is true that the 857 billion Target claim of the Bundesbank is mutually guaranteed by all central banks of the Eurozone. Here he is formally right. If Target deficit countries default, the write off-losses will be shared by all central banks that stay in the Eurosystem. It is less clear what happens if the Euro breaks up. In that case, the Bundesbank has a claim against a system that no longer exists. No sharing rules have been agreed for this case. In all likelihood it will lose its claims, a fact which makes Germany vulnerable to black-mailing in the upcoming negotiations about a European fiscal union.  

However, the outright write-off losses are not the main issue. They would just mean that economic losses that take place anyway have to be booked. The point is that the Bundesbank has a claim that it can never call due and that carries a miniscule rate of interest equal to the ECB's main refinancing rate, which the majority of countries with substantial external debt positions in the ECB council has meanwhile set equal to zero and will likely keep in the neighborhood of zero for a long period of time, to prevent a number of Eurozone states from defaulting. But what is the present value of a claim on an interest flow that will likely stay very close to zero for a very long time? And what is the value of a mutual guarantee by all central banks that they will service a zero rate of interest for a debt that will never expire?             

In my opinion the Bundesbank's Target claims imply a creeping, silent and unspectacular, though elegant, expropriation of German tax payers that allows the Bundesbank and the German government to save their faces, but will nevertheless impose a burden on the German state whose present value comes close to the face value of the Target claims. It follows from this interpretation that Germany has actually given away about half of its net foreign wealth which by definition is its accumulated current account surplus net of other write-off losses.

My concerns are becoming even bigger in view of the new surge of Target balances that have occurred since the summer of 2014. As the ECB rightly argues this surge has little to do with the first waive culminating in 2012 which resulted from bail-outs with the local printing presses and capital flight. Instead, it is a more or less technical reaction to the QE program. This does not make the situation better though, to the contrary. The Target balances now result from a planned asset swap replacing nasty private creditors from abroad with the Bundesbank and a few other benevolent central banks.    

As the QE program is symmetrical and based on the juste-retour rule to the extent it applies to government bonds, it is not straightforward to understand why the Target balances which measures asymmetries between the euro countries could arise in the first place. After all, each central bank repurchases its own government's bonds in strict proportion to country size. Nevertheless, the asymmetries result from the fact that the bonds issued by southern European countries are largely dispersed outside these countries given that they were sold to foreign investors to finance the pre-crisis current account deficits. Thus, the process of sucking them back to the country of origin by the respective local central banks involves international payment orders that augment the Target balances.

To be more specific, suppose a German insurance company sells a Spanish government bond to the Banco de Espagna. In this case, the latter gives a payment order directly to the Bundesbank asking it to make new money and give it to the seller, thus crediting the payment order. This transaction is an asset swap that converts an interest bearing securitized Spanish debt held by a private creditor into a permanent book debt of the Spanish central bank with the Eurosystem which carries a zero rate of interest and can never be called due. True, the Spanish central bank now has the government bond, and the Spanish state formally retains its debt. However, according to the juste-retour rule agreed, the returns on the government bond (beyond the main refinancing rate, which however is zero) belong exclusively to the Spanish state. In Germany, on the other hand, the seller now has money which is a claim on the Bundesbank and the Bundesbank has a zero-interest Target claim on the Eurosystem which it can never call due.

The Bundesbank is also involved in triangular asset swaps clearing the Spanish debt with other countries. If, for example, the Spanish central bank buys a Spanish government bond back from an investor in Shanghai and this investor invests in Germany, say by buying a German company, the end result is again that the Bundesbank has a Target claim, the Spanish central bank has a Target liability and the German seller of the company holds money which is a claim against the Bundesbank. However, the German company now belongs to the Shanghai investor while the Spanish government debt has basically been wiped out in economic terms and replaced with a book debt vis-a-vis the Eurosytem.

Of course this is only an example. However, foreign investors have indeed tended to bring their money to Germany which is one of the reasons for the un-precedented overheating of this economy that we now observe, as measured by the Ifo indicator or the stock of unfilled orders of architects. Currently the outside money issued by the Bundesbank by fulfilling payment orders from other countries inside and outside the Eurosystem stands at about 30% of the entire Eurozone monetary base. This is more than the 26% the Bundesbank would normally have issued as inside money in a fully proportional and symmetrical equilibrium.

Are these good deals for Germany? Is it vendor financing that allows the German exporters to keep producing goods for the rest of the world?  I find the correlation between these semantics and what actually happens in the Eurosystem approaching zero, at best. The German economy is definitely not gaining. One should not confuse the German economy with the German export sector. The country has become an inn keeper where customers can buy unlimited drinks and the inn keeper can chalk up his claims, but does not have the right to call them due or charge an interest. If his clients are eventually unable or unwilling to pay, he has not earned money, but lost time and resources. The clients are the beneficiaries of such a policy, not the inn keeper.

This story is serious and cannot be settled with superficial and false narratives. The German Constitutional Court on 16 August 2017 for a second time expressed his opinion that the ECB is overstepping its mandate violating the prohibition of monetizing the state debt according to article 123 TFEU, and it again called the European Court of Justice concerning the purchases of government bonds by the Eurosystem. The European Court may once again side with the ECB, as it did in its OMT ruling, but it cannot probably afford seeking the full confrontation with the German Court which, eventually, is the only legal institution that has the right to rule whether or not a European action is compatible with the German constitution. And the constitution is very clear in terms of giving budgetary authority to EU institutions. The right of the purse is an unalienable right of the Bundestag whose full or partial transfer to a European institution would require a referendum in Germany.  

So, what should we do? In my opinion, the QE program has to stop now and we should give debt relief to those countries which cannot service their debt, allowing them to temporarily exit the euro to recover by way of devaluations. This would help these countries come back on their feet by boosting their competitiveness. The debt relief will have to be negotiated in a European debt conference and  to refer to all kinds of debt including bank debt, state debt and the Target debt. It would hurt the creditors, among them Germany, but it would lead Europe back to a sustainable equilibrium, as most debt relief plans have done.

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