Another week, another academic hyperventilating about the crucial importance of Target2. This week’s entry is from Michael Burda of Humboldt University. It summarises the situation with Target2 balances as follows:
Bundesbank surpluses with the ECB have swelled to well over €700 billion, or about 30% of German GDP. Germany has now become a hostage to the monetary union, since a unilateral exit would imply a new central bank with negative equity.
However, there’s no follow-up explanation for what this means. Apparently “a new central bank with negative equity” is something so unthinkable that it means that Germany has no choice but to be a “hostage” to monetary union.
My assessment, as argued in this article is that the Bundesbank losing its Target2 credit would be no more than a minor inconvenience to Germany. We now live in a world of fiat currencies. The man that accepted that euro for your cup of coffee this morning didn’t do so because he believes the central bank has “positive equity”. He did so because it’s the legal tender of the land.
The post-EMU Bundesbank (it wouldn’t be a new central bank) won’t have to worry about its equity position because it won’t have the same kind of solvency concerns that you and I have because it has the power to print money. (See this recent Bill Mitchell blog post “The ECB cannot go broke – get over it”).
Another disappointing aspect of Burda’s article is that while there is a single mention of “capital flight”, the use of language in the article predominantly links Target2 balances with the traditional trade balances associated with David Hume specie-flow theory. I’m sure Burda knows this but it is worth reminding people again that the ever-growing Bundesbank Target2 balance relates far more to capital flight from the periphery than current account balances. Here’s a graph of current account deficits as a percent of GDP, including the EU Commission’s forecasts for 2012.
And here’s a nice graph from an FT blog post by Gavyn Davies from a few weeks ago. Note that current account imbalances are getting smaller while the Target2 balances are getting bigger. Capital flight, not trade imbalances, is what’s driving the Target2 balances.