Wednesday, 3 June 2015

Oh dear, Professor Sinn......

Hans Werner Sinn has a post on Project Syndicate which purports to explain why the plans of Greek finance minister Yanis Varoufakis are much cleverer than anyone has realised. I don’t disagree that Mr. Varoufakis’s plans are clever: indeed I have written several posts on Forbes explaining just how clever they are. But Professor Sinn’s explanation, sadly, is very wide of the mark.

Here is Professor Sinn’s description of Mr. Varofakis’s strategy:
Plan B comprises two key elements. First, there is simple provocation, aimed at riling up Greek citizens and thus escalating tensions between the country and its creditors. Greece’s citizens must believe that they are escaping grave injustice if they are to continue to trust their government during the difficult period that would follow an exit from the eurozone.
Second, the Greek government is driving up the costs of Plan B for the other side, by allowing capital flight by its citizens. If it so chose, the government could contain this trend with a more conciliatory approach, or stop it outright with the introduction of capital controls. But doing so would weaken its negotiating position, and that is not an option.
So Mr. Varoufakis’s strategy, apparently, is Grexit, for which he is preparing by stoking antagonism between Greece and its creditors while asset-stripping the rest of the EU. This is despite Mr. Varoufakis’s repeated statements of support for the EU and indeed for the Euro, which long pre-date his appointment as finance minister. What kind of turncoat does Professor Sinn think he is?

But let us assume for a minute that Professor Sinn is correct about Mr. Varoufakis’s intentions. Yes, Mr. Varoufakis’s statements have been inflammatory, and the effect has been to increase tension between Greece and its creditors. But what of Professor Sinn’s second statement – that Greece is deliberately encouraging capital flight in order to increase the costs of Grexit for the rest of Europe.  How does this work?

Professor Sinn explains it thus:
Capital flight does not mean that capital is moving abroad in net terms, but rather that private capital is being turned into public capital. Basically, Greek citizens take out loans from local banks, funded largely by the Greek central bank, which acquires funds through the European Central Bank’s emergency liquidity assistance (ELA) scheme. They then transfer the money to other countries to purchase foreign assets (or redeem their debts), draining liquidity from their country’s banks.
Other eurozone central banks are thus forced to create new money to fulfill the payment orders for the Greek citizens, effectively giving the Greek central bank an overdraft credit, as measured by the so-called TARGET liabilities. In January and February, Greece’s TARGET debts increased by almost €1 billion ($1.1 billion) per day, owing to capital flight by Greek citizens and foreign investors. At the end of April, those debts amounted to €99 billion.
A Greek exit would not damage the accounts that its citizens have set up in other eurozone countries – let alone cause Greeks to lose the assets they have purchased with those accounts. But it would leave those countries’ central banks stuck with Greek citizens’ euro-denominated TARGET claims vis-à-vis Greece’s central bank, which would have assets denominated only in a restored drachma. Given the new currency’s inevitable devaluation, together with the fact that the Greek government does not have to backstop its central bank’s debt, a default depriving the other central banks of their claims would be all but certain.
A similar situation arises when Greek citizens withdraw cash from their accounts and hoard it in suitcases or take it abroad. If Greece abandoned the euro, a substantial share of these funds – which totaled €43 billion at the end of April – would flow into the rest of the eurozone, both to purchase goods and assets and to pay off debts, resulting in a net loss for the monetary union’s remaining members.
This is an extraordinarily confused piece of writing.

Firstly, Professor Sinn asserts that Greeks are borrowing from Greek banks in order to transfer Euros out of Greece. On exit and redenomination the loans would be converted to drachma, which would promptly devalue leaving the Greek borrowers in possession of stashes of Euros for which they would now pay much less. It’s a plausible strategy, I suppose. There is only one problem with it. It isn’t happening.

Private sector borrowing in Greece has actually been falling since 2010:

There was a tiny uptick in borrowing towards the end of 2014, no doubt because the prospects for the Greek economy looked brighter then. But the economy is now back in recession and lending has tailed off. The Bank of Greece’s figures show that private sector loans decreased by 1.2bn EUR in April. If there is capital flight going on, it isn’t funded by borrowing.

Professor Sinn also outlines an alternative: Greeks removing funds from banks and stashing them as physical cash. This is actually true. Demand for Euro notes & coins in Greece has soared and Greek mattresses have never been so stuffed. But why are Greeks doing this? After all, if they really want to move money out of Greece, by far the easiest way to do so is to open an account in, say, an Italian or Slovenian bank and electronically transfer the money there. Why are they removing funds from banks completely?

The answer has nothing to do with ELA, Target2 or the Greeks’ understandable desire to stiff the Germans. It is far simpler. Greece is very close to Cyprus, and the Greeks have not forgotten what happened there two years ago. They fear losing their deposits in order to bail out banks that are bankrupted by sudden removal of ELA. It is the ECB’s stranglehold on Greek bank liquidity that is driving their excessive demand for notes & coins.

In addition to conversion of deposits to physical cash, there has been a continual flow of deposits out of Greece since the beginning of the year. These are electronic transfers and they are almost certainly due to redenomination fears. For some reason Professor Sinn ignores these. Could it be that he does not understand - or chooses to deny – the purpose of the single currency? Or does he simply not understand modern electronic payments systems?

I suspect it is both. Let’s look at each in turn.

Firstly, the single currency. Free movement of capital within the EU is enshrined in treaty directives. Yes, capital controls were imposed in Cyprus to prevent capital flight after the banking system collapsed. But that was to ensure that the freeze on deposits in Cyprus’s broken banks held. Greek banks are wobbly, but they are still standing. Professor Sinn wishes Greece to impose capital controls not because its banks are broken, but simply because of the way the single currency works. Capital flight is supposed to happen in a monetary union: ordinary people and legitimate businesses should be able to move funds wherever they like and whenever they like within the union. Routinely interfering with this destroys the single currency.

Secondly, the payments mechanism. This is quite technical and I will have to do some accounting to explain how it all works. Basically, though, Sinn has confused the funding of banks with the movement of private sector deposits.

When a private sector agent makes a payment from a deposit account – whether that be to purchase goods or assets, withdraw physical cash or transfer funds elsewhere – the bank’s reserves reduce. To show this, let’s imagine that the customer is withdrawing physical cash. The accounting entries for the customer and his bank are as follows.

Customer:       CR deposit account (asset)
                        DR back pocket (asset)

Bank:               DR customer deposit account (liability)           
                        CR reserves (asset)

For non-accountants, please note that a CR to an asset reduces it: DR increases it. I have preserved this convention even for customer cash movements where it is perhaps counter-intuitive, as in the example above. It will be very important to remember this as we go through the Target2 accounting later on. 

The customer has simply exchanged one asset for another. But the bank actually has less money. This shows up as a reduction in reserves. Reserves are a form of “money” used only by banks among themselves. Their sole purpose is to facilitate movements in and out of customer deposit accounts. They are, in a word, “liquidity”.

If a lot of customers withdraw physical cash, or transfer funds to other banks, the bank can run out of reserves. Banks can borrow reserves from other banks by pledging assets as collateral, typically government debt. But if the bank can’t borrow reserves from other banks – and not many commercial banks will lend to Greek banks now, because who is going to accept Greek government debt as collateral? - it turns to its central bank.

Explaining ELA

Central banks will lend reserves to banks against a range of collateral, subject to haircuts and conditions. In the Eurosystem, provision of “emergency liquidity assistance” (ELA) is the responsibility of national central banks, though it requires ECB approval.

ELA is provided to Greek banks by the Hellenic Central Bank, which bears all the risks associated with it. Professor Sinn’s assertion that the risks of lending rebound to other central banks in the Eurosystem is flatly contradicted by the ECB:
ELA means the provision by a Eurosystem national central bank (NCB) of:

(a) central bank money and/or

 (b) any other assistance that may lead to an increase in central bank money to a solvent financial institution, or group of solvent financial institutions, that is facing temporary liquidity problems, without such operation being part of the single monetary policy. Responsibility for the provision of ELA lies with the NCB(s) concerned. This means that any costs of, and the risks arising from, the provision of ELA are incurred by the relevant NCB.
In the event of Greek default, the Hellenic National Bank would become technically insolvent because of all the Greek sovereign debt that has been pledged to it by Greek banks. But it would be the responsibility of the Greek sovereign to recapitalise it, not other central banks.

If Greece defaulted and left the Euro, the Hellenic National Bank would acquire the right to create the new national currency – a right it does not currently possess. Greek government debt, we assume, would be redenominated in the new currency (lex monetae). Grexit, therefore, would resolve the Hellenic National Bank’s “insolvency”. However, that would create a problem. What would it do with the Euro-denominated reserves on its balance sheet?

The simple answer is that it would also convert those to drachma. Greek banks would then be unable to meet demands for Euro deposit account withdrawals. Greece would have no choice but to impose capital controls and a bank holiday to avoid bankrupting the banks.

But the conversion of both Euro-denominated reserves and their collateral (Greek sovereign debt) to drachma would have no effect whatsoever on other central banks. There would be no losses anywhere else in the Eurozone. Sinn is simply wrong about ELA.

But what about Target2?

The question of Target2 balances is somewhat more complex. Target2 is the Eurosystem’s real-time gross settlement (RTGS) system. All Western central banks have RTGS systems: they are the core of the electronic payments systems upon which Westerners have come to depend. Target2 is a little more complex than the RTGS of a single country such as the UK.

But only a little more complex. It is in reality far more straightforward than a lot of the rubbish that is written about it suggests.

Example 1: How asymmetric trade flows cause Target2 imbalances

The Bank of England’s RTGS system can settle payments between people in London and people in Manchester. If people in Manchester make lots of purchases from companies based in London, funds flow from Manchester to London. But we use double entry accounting to record all movements of funds. So a net flow of say £1m private sector funds from Manchester to London through the Bank of England’s RTGS system looks like this:

Manchester private sector       CR cash at bank                 £1,000,000 (asset)                                                                                             DR e.g. fixed assets            £1,000,000  (asset)       

Manchester banks                   DR customer deposits        £1,000,000  (liability)                                                                                          CR reserves                        £1,000,000  (asset)

London banks                         CR customer deposits        £1,000,000 (liability)                                                                                            DR reserves                       £1,000,000  (asset)

London private sector             DR cash at bank                 £1,000,000  (asset)                                                                                            CR inventory                      £1,000,000  (asset)

This is what is known as “quadruple accounting”, where double entries are recorded for all four participants. You can see that there has been a movement of goods (fixed assets) from London to Manchester. You can also see that there has been a movement of cash from banks in Manchester to banks in London, which is recorded both as a change in “cash at bank” on the customer side and as a change in “customer deposits” at the banks. This is NOT two lots of money: it is the same money, recorded as an asset & liability pair (customer asset, bank liability). You can also see that there has been a movement of reserves from banks in Manchester to banks in London (remember CR to a bank’s reserve account reduces the balance).

Now let’s add in the central bank’s reserve accounts. Remember that reserves are assets for commercial banks. The corresponding liabilities are held at the central bank. We can think of reserve accounts at the central bank as similar to a bank customer’s transaction account: it contains a small amount of moving funds. So when there is a net flow of funds from Manchester to London, the reserve movements look like this:

Bank reserve accounts (assets):   
              Manchester banks    CR £1,000,000
              London banks          DR £1,000,000

Central bank reserve accounts (liabilities):
             Manchester                DR £1,000,000
             London                      CR £1,000,000

So at the central bank there is a reserve imbalance between Manchester and London. Manchester is in “deficit” and London is in “surplus”. Or, putting it another way, Manchester has a net liability to the central bank and London has a net claim on it. As the entries balance, we could ignore the central bank completely and say that London has a net claim on Manchester.

But this is silly. London’s private sector has already received cash. All the reserve entries show is that there has been a net flow of funds from Manchester to London. In this case it is balanced by a net flow of goods in the other direction. What this is showing, therefore, is that London has a trade surplus and Manchester a trade deficit. In no sense does Manchester “owe” London anything. It has already paid.

Now, using the above example, replace Manchester with Greece, London with Germany, and the Bank of England with the ECB. All Target2 does is facilitate and record these movements of funds. It is a gross misunderstanding of RTGS settlement accounting to describe the imbalances arising from these movements as “debts”, as Professor Sinn does.

So we can see clearly how Target2 records the trade imbalance between Germany and Greece. But there was a large trade imbalance between Germany and Greece before the financial crisis. Why did this not show up as a Target2 imbalance?

The reason is that prior to the financial crisis, Greece’s trade deficit with Germany was funded by borrowing from German banks. Let me show you how this works.

Example 2: How foreign financing of trade deficits eliminates Target2 imbalances

Greek customer takes out a loan of 1,000,000m EUR from a German bank (in practice this was often mercantile credit, i.e. importer borrowed from exporter who in turn borrowed from his own local bank, but let’s not complicate things). The loan accounting entries are as follows:

Greek customer                      CR German bank loan                         1,000,000 (liability)                                                 DR cash at German bank                    1,000,000 (asset)

German bank                          DR Greek customer loan account       1,000,000 (asset)                                                 CR Greek customer deposit account  1,000,000 (liability)

The Greek customer pays the money to the German exporter.  The accounting entries are as follows:

Greek customer                      DR goods & services received            1,000,000 (asset)                                                 CR cash at German bank                    1,000,000 (asset)

German exporter                    CR inventory                                       1,000,000 (asset)                                                 DR cash at bank                                  1,000,000 (asset)

German banks (aggregate)    DR Greek customer deposit account  1,000,000 (liability)
                                                CR German exporter deposit acct      1,000,000 (liability)

RTGS reserve accounts (liability):
            DR Germany   1,000,000
            CR Germany   1,000,000          

In other words, although the customer is Greek, the financial transaction in effect takes place entirely within Germany. This is why there were no Target2 imbalances even though Greece had a large trade deficit with Germany.

When the Greek crisis hit, German banks stopped financing German exports to Greece. Greek customers were forced to borrow from Greek banks instead (you can see this clearly as a spike in Greek bank lending in early 2010 in the chart above). The result was a large Target2 imbalance.

But as the Greek economy faltered, imports to Greece fell massively. Trade stopped being the main cause of the Target2 imbalance. What replaced it was capital flight. And it is capital flight, not trade, that is currently causing the Target2 imbalance to grow.

Example 3: How capital flight exacerbates Target2 imbalances

Suppose we have a Greek who has £1mEUR of cash deposits at Greek banks. Fearing capital controls, redenomination and seizure of his deposits, he decides to move his money to safety in Germany. So he opens a deposit account at a German bank and transfers his money electronically from his Greek bank deposits to the German bank. The accounting entries look like this.

Greek customer          CR Greek bank deposits          1,000,000 (asset)
                                    DR German bank deposit        1,000,000 (asset)

Greek bank                  DR customer deposits             1,000,000 (liability)                                     
                                    CR reserves                             1,000,000 (asset)

German bank              CR customer deposits              1,000,000 (liability)                                    
                                    DR reserves                             1,000,000 (liability)

RTGS reserve accounts (liability):
              Greece            DR 1,000,000
              Germany         CR 1,000,000

The Greek customer’s decision to move his money to safety widens the Target2 imbalance.

Because Professor Sinn believes that Target2 “deficits” are actual debts, and Greece is already very highly indebted, he thinks that Greece should take steps to stop the Target2 imbalances increasing. Greece should therefore impose capital controls so that our Greek customer can’t move his money to safety outside Greece. Presumably Professor Sinn also thinks that Greece should eliminate its trade deficit, though he doesn’t say this.

Central banks do not allow banks to run persistent reserve account deficits. Greek banks experiencing capital flight therefore have to borrow reserves to top up their reserve accounts. At present, because no-one else will lend to them, they borrow reserves from the Hellenic Central Bank, as I explained above. The Hellenic Central Bank’s balance sheet is therefore expanding by an amount corresponding to the growth of Greece’s Target2 deficit. But that does not mean they are the same thing. Professor Sinn unfortunately confuses them.

How would Grexit affect Target2?

Much time and energy has been spent discussing what the effect on Target2 – and, by extension, the ECB – would be if Greece left the Euro. Unfortunately most of the explanations are wrong.

Currently, Greece is running a Target2 deficit which is entirely covered, as far as Greek banks are concerned, by ELA from the Hellenic Central Bank. Suppose that Greece defaults, creates a new currency and redenominates all sovereign debt and all bank reserves into drachma, including reserves created through ELA. What does this do to Target2?

Nothing. Nothing at all. Zilch. Nada. Nix.

The Target2 “deficit” would remain as a notional liability of the newly-independent Greek state. It would still be denominated in Euros, since Greece would have no power to redenominate it. It would be frozen, since Greek capital controls and suspension of external trade in Euros would mean no further Target2 transactions. It would not need to be settled, paid, reallocated or otherwise disposed of. It could simply be ignored.

“But”, I hear you say, “surely there’s a catch?”

There is no catch. The existing Target2 deficit for Greece is entirely balanced by payments already made from Greek banks to banks elsewhere in the Eurozone. No-one is going to lose any money if Greece stops using Target2 because it ditches the Euro.

I admit, it has taken me quite a while to "get" this, despite the promptings of my good friend Beate Reszat who has always insisted that Target2 is simply a "black box" computer system and has nothing whatsoever to do with national accounting. But having now worked through the accounting, I am sure of my ground. The whole Target2 imbalances issue is a complete red herring.

If someone felt like being tidy, they could simply eliminate Greece’s notional Target2 deficit by proportionately reducing the Target2 surpluses of its Eurozone trade partners. In fact as the balancing reserves in Greek banks would already have been redenominated into drachma, this would technically be the correct thing to do. The Hellenic Central Bank leaving the Eurosystem and redenominating Greek bank reserves into drachma would reduce the aggregate quantity of Euro-denominated reserves in the Eurosystem. Bringing Target2 into line with this would preserve the consistency of Target2 balances with Eurosystem reserves. But it isn’t strictly necessary.

Nor is Greek redenomination potentially inflationary for the rest of the Eurozone, as some have suggested. Rather the reverse, actually. Capital flight can be inflationary for “safe haven” countries. If Greece left the Eurozone, capital flight would stop due to capital controls. This would be deflationary for the rest of the Eurozone, not inflationary.

Once the dust had settled, of course, Greece would want to lift capital controls and start trading with the Eurozone again. Most trade would probably be in Euros and settled via Target2.  But that is true for any non-Eurozone country trading in Euros with the Eurozone. The Euro would be a foreign currency for Greece. It would have to earn euros through trade. And because of this, it would need to run a substantial trade surplus, helped by inevitable devaluation of the drachma. So if it were not “tidied up”, Greece’s Target2 deficit would shrink over time.

To sum up, Professor Sinn’s piece is wrong from beginning to end. Sadly, because there is so little general understanding of what is a pretty technical subject, and he is one of the few people paying attention to Target2, he is widely believed. Even Wolfgang Munchau, who should know better, was convinced. I despair, I really do.


  1. Suppose that Greece defaults, creates a new currency and redenominates all foreign debt to the drachma...

  2. Ratio of government expenditure to gross domestic product (GDP) was 51% in 2013. How well would she earn euros through trade?

    She might have other trading partners too.

  3. The TARGET2 is right. The only thing I think perhaps you're missing is that once TARGET2 transfers cease, all deposits and loans within the Greek banking system *automatically* become a new currency. There is no need for a bank holiday or anything. The mismatch is just patched up at the Greek central bank level with a simple recapitalisation journal and everything continues on regardless.

    Very simply the Greek Euro becomes as different from the German Euro and the Egyptian Pound is from the British Pound.

    In other words you have to go to an institution with legs in both camps to do an *exchange* between German Euros and Greek Euros (or whatever you want to call them at that point). Or you have to do good old correspondence banking.

    And if the Greek demand for cash has been dealt with by the Greek Central bank, and therefore the notes have the magic 'Y' in the serial number then other Eurozone members have a simple way of determining which Euros remain 'real' and which are Greek and therefore not *convertible* outside of Greece.

    Greeks going to cash rather than transferring their deposits to a bank in Germany et al actually makes the Greek government's job of going to a new currency much easier. The bank notes are already marked!

  4. The other point is that once the convertibility is stopped and TARGET2 transfers cease there can be no capital flight, only an alteration in the relative exchange values of German and Greek Euros.

    If you have Greek Euros you've got to find somebody to take them from you in exchange or you're stuck with them.

  5. Frances, I'm sure you are right about the banking identities, but just to elaborate on a point I was trying to make in 140 characters...

    Imagine you have a stock of 1000bn Euros in the rest of the Eurozone and 50bn in Greece. And Greece redenominates into drachma. Then the total amount of European Euros is 1000bn.

    If Greeks transfer 25bn into German Euros then that reduces the Greek stock of Euros and increases the European stock. Therefore, on redenomination there will now be 1025bn European Euros.

    The Germans hate this kind of thing. The Greeks have effectively printed more Euros before leaving.

    The Greeks who, in Sinn's imagination, borrowed in Greek Euros and bought German Euros can now change them back; earning themselves a tidy profit. This profit is taken at the expense of the Europeans through a lower exchange rate for the European Euro.

    1. At present, the ECB is agreeing to exchange an unlimited number of Greek Euros for German Euros at parity. This is the wrong price.

      If the Greek Euro becomes devalued then the ECB will be nursing a loss proportional to the size of the Target 2 balance.

      This is basic common sense. It has bought Greek Euros at the wrong price therefore it must lose from this. You are proposing to effectively write off the loss by not crystalising it and pretending that the Greek Euros still have their old value.

      I think that the problem with the balance sheet assessment comes at the end where you freeze the Target 2 balances - with both sides having the same value as before. In fact the Greek side is worth less than the German side. Your balance sheet is simply not writing down the loss to the ECB.

      You are right that no-one noticeably loses from this, but only because the sums are so small relative to the size of the EZ economy.

    2. Reduction of loss is not a profit is it?

      Bad, hedgers. Bad, deposit risk arbitragers.

    3. Ari,

      You are making the same fundamental mistake as Professor Sinn. There are no "Greek euros" or "German euros". There are only European euros. So the ECB is not exchanging Greek and German euros at par. Both countries are using the same currency, which is produced by the Eurosystem. The NCBs are not autonomous entities, they are part of the Eurosystem. They do not create their own currencies : collectively, they create the single currency.

      It us therefore totally wrong to talk about "devaluation of the Greek Euro". While Greece remains part of the Eurozone, there is no such thing. What both you and Professor Sinn want to do is treat Greece as if it has already left the Eurozone.

    4. @FC - What both you and Professor Sinn want to do is treat Greece as if it has already left the euro-zone.

      From their perspective that's the 'only' legal way to exit from the EURO.

    5. You seem to be saying that the only way of enabling a country to leave the Euro is to pretend the Euro doesn't exist.

    6. Yes. Because from a political perspective that's what Mrs. Merkel did. She said; Breaking up the Euro does mean breaking up 'Europe.'' Mr. Sinn's article's reflect politics and not economics in a first place.

  6. Great post with a valuable descritptiion of the TARGET 2 and ELA systems.

  7. Dear Frances
    The ELA is also present in the ECB balance sheet. If it disappears or is redenominated in GRD what is going to happen on the liability side of the ECB?

  8. Hello Frances, thanks for the great post. Note that you are not alone rebutting Sinn, Willem Buiter has also corrected him on the TARGET2 issue quite a few times over the years.
    Patrick VB

  9. Hi Frances,
    Amazed you managed a(n excellent) Target 2 article with mentioning Karl Whelan!
    Just wanted to pick up on something, related to what Ari talks about above.
    If Target 2 assets at NCBs are reduced proportionally as the Greek liability is set to zero, I believe this would not balance the redenomination of reserves as a significant portion of the Target 2 balances were created by reserves leaving the Greek banks. Because of this, the NCBs would see their capital fall, possibly to the extent they would need recapitalising. This is not economically meaningful (certainly doesnt count as a loss), but think it should be stated for completeness.

  10. "And because of this, it would need to run a substantial trade surplus, helped by inevitable devaluation of the drachma. So if it were not “tidied up”, Greece’s Target2 deficit would shrink over time" - that is a courageous assumption for an economy which, in its nearly 200 years of existence, has never even come close to having a trade surplus even when the currency was Drachma.

    Let me simplify the technical issues: per April 15, the Bank of Greece showed Euro-liabilities to other EZ Central Banks of 99 BEUR. If Greece were to fall into the Aegean, someone would be out of 99 BEUR. If Greece were to stay on ground but go to the Drachma, someone would still be owed 99 BEUR. If the latter prefer to wait until Greece has accumulated 99 BEUR in external surpluses, they have that option. If not, they will sooner or later have to realize losses. Or am I wrong?

    PS: yes, FinMin Varoufakis has always been a fervent supporter of the Euro and of Greece's remaining in the Eurozone (no surprise because, otherwise, Greece would get a lot less funding). For the first time on February 18, 2012 and many, many times thereafter, Varoufakis has argued that Greece should default but stay in the Eurozone. Don't see why his opinion would have changed in the last 4 months.

    1. I agree kleingut

      The balance is a liabilaty of the Bank of Greece and an asset of the ECB.

  11. > Frances

    You are wrong to say that Target 2 is inconsequential.

    Bank liabilaties created by Greek banks lending that end up residing at German banks are funded by Greek NCB interest payments to the ECB. If that stopped then the funding for those liabilaties would stop.

  12. We are dealing with a particular Austrian /Euro view of the "free" exchange of goods which is / will eventually lead to total social collapse.
    We can see this in the classic exchange between Peter Joseph ( of the albeit flawed but close to the truth Zeitgeist Movement) and a classic and very capable Mises mafia propagandist Stefan Molyneux.
    Begins proper at 19.00
    In it Molyneux won the technical debate as he rightly observed that Joseph only "has a Output" and seems to not want to engage a detailed critic of the functionality of the system perhaps because he is not fully aware of social credit principles and therefore fleshes out his argument with flowery language.
    At 44.00 minutes Molyneux gives the classic Mises simplistic $ and pencil exchange argument......never understanding that there is cohersion in the exchange given that money is not part of the commons.
    What we see in the euro area is the final destruction of Christian principles which first began in the north many 100rs of years ago - when total this always ALWAYS leads to collapse of empire as everybody approaches the event horizon of mental breakdown as a result of hothouse like scarcity conditions.


  14. If anyone cares to, I would appreciate being enlightened on the following points:

    1) I take it that, if things were normal, there would be no target2 imbalances because the private banks would fund the current account deficits and capital flight. If private banks did that and if there were a Grexit, private banks would lose a lot of money. Why does the same not apply to target2?
    2) Yes, ELA is the risk of the national Central Banks. But if the Bank of Greece is lending to Greek banks, it needs to get the funding from somewhere. If the Bank of Greece were to become insolvent, its funders would lose money. Or not? BTW: it should be noted that, notwithstanding the fact that the ECB cannot become insolvent, NCB's certainly can.
    3) I am not sure that HW Sinn calls target2 loans or debt. I would call them claims. The Bundesbank has a lot of claims against the ECB under the title of target2. That's an asset of the Bundesbank. If that asset becomes worthless, the Bundesbank loses a lot of equity (which it doesn't have).
    4) I understand that the US Fed requires regional Fed's to settle claims similar to target2 once a year. The ECB system does not seem to have such a mechanism. Corrrect?
    5) Is the principal issue really target2 or ELA or whatever? Or is it not the question of cross-border liabilities of Greece? Gross foreign debt of the ENTIRE economy. Those are the savings of other countries which have been transferred to Greece. Regardless who lends them or who borrows them, they are within Greece's borders. If Greece goes down the tube, those savings of other countries will do the same. Or not?

    One more point. One of the predecessors of target2 was the payment/clearing system which the Nazis implemented with occupied countries. They used that system to milk countries like France (or Greece!) under various titles (like reimbursements for occupation expenses, etc.). Like everything else, they did that to the tilt. At the end of the war, there were huge imbalances (contrary to target2 of today, in those days Germany was the one who owed). If I am not mistaken, the famous 'forced loan' to Germany which Greece still claims had its origin in those imbalances. In fact, somewhere I read that there never was a loan agreement but only those imbalances. I believe those imbalances were a major issue at the 1954 debt conference.

    1. Hi Kleingut
      1) No , target 2 inbalances occur whenever there is an inbalance of cross border transactions. When a deposit moves from a Greek bank to a German bank the bank of Greece incurs a debt to the ECB who in turn incurs a debt to the bundesbank who then credits the reserve account of the German bank.
      2) NCB create the reserves for ELA on there own balance sheet process in return for commercial bank debt.
      3)Agreed. The Budesbank would loose an asset and loose equity.
      4) That is the case for the intra eurosystem claims.
      5)What would happen would depend on the policy of the ECB and the remaining member governments. On the face of it if nothing was done, then you would have NCBs with less assets than reserves, which could devalue the worth of the currency and could be inflationary.

      I'm reading most of this from here

    2. Guys,

      All respect to Karl Whelan, but this is all intercompany transfers such as you would find an a commercial conglomerate. We don't start arguing about which bit of, say, Lloyds Banking Group owns what, do we? It is all funny money and it disappears in the consolidation.

      If the Hellenic Central Bank were to leave the Eurosystem (or rather the Euro bit of it), it would be the same as if Lloyds floated one of its constituent parts. Actually it has just done this, so we know how it is done. There needs to be a clean separation of balance sheets. The parent has to provide capital (in Greece's case this would be return of the reserves it contributed to the Eurosystem when it joined the Euro). And the balance sheets on both sides are left intact. I will write a follow up post explaining how this would work. Believe me, it is NOT sensible for the Eurozone to insist on settlement of Target2 deficit and repayment of ELA. That would cause real losses for the ECB.

      It is just as ridiculous to talk about the Hellenic Central Bank "owing" anything to the Bundesbank as it would be to claim that the newly formed TSB owes anything to the Bank of Scotland.

    3. Debits = Credits , for each transaction and the total of the transactions.

      In you text, it looks like the Greek people and Germans people are better at accounting than the people of the nation of shopkeepers, the English.

      I think this is what you meant:

      Manchester private sector
      CR cash at bank £1,000,000 (asset) DR e.g. fixed assets £1,000,000 (asset)

      Manchester banks
      DR customer deposits £1,000,000 (liability) CR reserves £1,000,000 (asset)

      London banks
      CR customer deposits £1,000,000 (liability) DR reserves £1,000,000 (asset)

      London private sector
      DR cash at bank £1,000,000 (asset) CR inventory £1,000,000 (asset)

    4. Well spotted. I had to do this in HTML and the formatting is really difficult to read. Seems my eyes started playing me tricks. Apologies. I have corrected.

      Pity you had to spoil what was a good spot with a rude comment, though.

    5. I apologize. I was hoping it wouldn't be taken that way.

    6. This is again a great and thorough post.

      I hardly ever disagree with Frances. But here I do for the reasons given the other commenters. Surely it is like a "intercompany transfers" when the company or euro is non-reversible but the whole point of discussion is that it might not be. When the cost is assessed the target2 needs to be accounted. And consequently I think Sinn is right that deposit out-flow is strengthening Greece stance.

      If the balance sheets are left intact, I agree, there is no equity loss on either side. But in case of default + Grexit I'm not sure whether the Targer2 claims will be honored.

      For the record: I think we need to fix euro, meaning change of treaties and more fiscal integration.

    7. I agree the target T claims are real debts. They link loans , in one country to the deposits in another country . Its a clearing system that results in inter NCB liabilaties.

      In principle of the mechanism the the prof is correct . In a hypothetical case that all the Greek people transferred all their deposits to German banks then the initial liability for the Greek peoples money would reside in Germany. Same for the National Deposit insurance scheme, the money of the Greek people would be in the German scheme.

    8. Jussi and Dinero,

      You are both hoodwinked by the existence of things called "NCBs" in the Target2 structure. These are not "national central banks" in any meaningful sense. They are simply an illusory and wholly unnecessary complication of a perfectly straightforward single-currency RTGS structure such as exists in other currency unions such as the UK. That is why I used the UK as an example.

      We in the UK actually considered all these issues in detail because of the possibility of Scotland's secession - which would have been our equivalent of Grexit. No-one ever suggested that Scotland, which has a large trade deficit with respect to the rest of the UK, would "owe" the rest of the UK anything. The question just did not arise, even though creation of a new Scottish currency was the preferred alternative of most people who looked at this in detail. But that is because we never did anything so silly as to create "central banks" fir the countries in our union.

      It is a measure of how little comprehension of the nature of a single currency there is in European policymakng circles that Target2 was created with an "NCB" structure at all. Target2 has been over-complicated to preserve the illusion of national monetary autonomy. We have to work with that over-complication, but we should not give it power and legitimacy it does not deserve.

    9. Frances,

      I think I can see it both ways. If Euro were a real single currency area, I would have no reservations. Yet the Euro is a mixed bag, those NCB are very real and important part of the institutional setup. E.g. ELA risks are not shared. So are the T2 records. It has been always about illusion of sovereignty or illusion of single-currency area, now it is time to choose. I hope we all agree with you!

    10. This comment has been removed by the author.

    11. > Frances

      No that is not the case. The clearing processes that go across NCBs balance sheets, as opposed to the clearing processes that are confined to one balance sheet , are not settled between NCBs with assets other than the outstanding balances themselves and so it is not like a perfectly straightforward single-currency RTGS structure such as exists in other currency unions.
      In the UK if Scottish Banks left the UK the issue would not arrise beacause the clearing has allready been settled in full with BoE reserves. The compaison would be simmilar but still not quite the same if the assets of the BoE were all commercial bank bonds, including Scottish bank bonds, then in that scenario if the Scottish banks left you would have the same issue as the one being discussed here.

    12. Yes, the asset side is a considerable problem. But that is exactly why you don't want Greece to settle its Target2 balances! Double entry accounting, remember. The backing for them would be sovereign debt - and what would happen to that in a Grexit?

    13. Jussi, I wholeheartedly agree. This whole issue has only arisen because the Euro institutional structures do not treat it as a single currency. We could say it has been set up to fail.

      The really surprising part of all this is that if the Euro genuinely were a single currency, countries could leave and countries could join without in any way disturbing the integrity of the single currency. It is because it is not really a single currency that a country leaving threatens its entire existence.

    14. >Frances

      These issues associated with Bank's having their asset risk exposure concentrated directly or indirectly in individual countries or geographical areas are much less likely to occur where the banks have there own branches evenly spread out over the currency area.

  15. This comment has been removed by the author.

  16. Formated better:

    Manchester private sector
    CR cash at bank £1,000,000 (asset)
    DR e.g. fixed assets £1,000,000 (asset)

    Manchester banks
    DR customer deposits £1,000,000 (liability)
    CR reserves £1,000,000 (asset)

    London banks
    CR customer deposits £1,000,000 (liability)
    DR reserves £1,000,000 (asset)

    London private sector
    DR cash at bank £1,000,000 (asset)
    CR inventory £1,000,000 (asset)

  17. Frances, you are right that it, in a commercial conglomerate, it's all funny money and it disappears in the consolidation. Except --- when the conglomerate becomes insolvent one tends to discover that the assets on one legal entity do not automatically wash with the liabilities of another. I simply can't fathom how the Bank of Greece can show a Euro-liability to a foreign entity subject to foreign law which does not remain a Euro-liability after Grexit.

    I agree that insisting on settlement of Target2 deficit and repayment of ELA would cause real losses for the ECB but that is exactly the point which Sinn is making (if one forgives him some of the shots from the hip in his article). Of course, the ECB-system could just leave their claims against the BoG sitting on its books even after Grexit but they wouldn't be worth much. BTW, the reserves which the ECB would have to return to the BoG after Grexit are peanuts in the grand scheme of things.

    Look forward to your follow-up article.

    1. My argument is exactly that the Eurosystem should leave the claims where they are. They aren't worth fighting over.

      This whole matter is in my view a major distraction from the real disaster that Grexit would cause, which is interruption of critical supply chains and massive disruption of trade flows. No-one is talking about this, but the economic consequences not just for Greece but for the Mediterranean and Eastern Europe could be very severe. This is why Target2 matters. The balances are a sideshow.

      There is also the geopolitical risk: we forget that Greece is a Balkan country, and the Balkans are anything but stable. This is why the US is concerned.

    2. This comment has been removed by the author.

    3. "My argument is exactly that the Eurosystem should leave the claims where they are. They aren't worth fighting over."

      I think that's the crux of your disagreement with Sinn. You're thinking macroeconomics/politics. He's thinking accounting. From a strict accounting viewpoint, in case of Grexit, Yanis not gonna send any euros to the ECB any time soon, so the Greek liabilities on the ECB balance sheet must be either written off, or reserved against as bad debts, as a commercial bank would when the borrower has vanished. Not doing so is accounting fraud.

      Let's remember that in the orthodox German view of central banking, a negative equity situation is insolvency, which causes the world to go woof and thus cannot be envisaged. Grexit not gonna take the ECB there, but to retain a constant equity cushion to be safe from woof risk non greek eurozone taxpayers would have to recapitalize the ECB by redeeming some of their euros (paper or digital) to "fund" the write off/reserving of Greek liabilities while maintaining constant ECB equity.

      Yes this view is retarded -- there's no woof when a central bank goes into negative equity, it's fine to do so within inflation constraints -- but the logic is internally consistent, and you have to temporarily adopt the woof view if you want to understand Sinn on details. You see the connendrum Super Mario is in: no doubt he knows there's no woof risk, but he can only take actions that look accountingly accurate enough to the woof cargo cult.

    4. Cig,

      Sinn and I are both thinking accounting, but he is taking a deconsolidated view of the Eurosystem whereas I take a consolidated view. If you take a consolidated view, the Target2 balances are a complete non-issue: a country leaving the Euro causes the Eurosystem balance sheet to shrink in total but there is no solvency issue. This is consistent with my general theme, which is that in a single currency area the concept of a "national central bank" as a discrete autonomous entity is meaningless. I didn't spend enough time on this in the post, but it is the heart of the matter. Sinn does not understand the single currency. To be fair, neither did the designers of Target2. The NCB-ECB layer is wholly unnecessary.

      The other mistake that everyone is making is confusing Grexit with sovereign default and talking about "default" or "insolvency" of the Bank of Greece. That's another red herring. A country leaving the Euro should be modelled as floatation of a subsidiary, not default of a borrower.

    5. I would add that if a negotiated exit included Greece agreeing to continue to pay interest on the Target2 liability in return for continued access to the system for Euro payments as a non-Euro user, then in no sense could Greece be considered to have defaulted on its Target2 liability. This is actually the best solution for everyone, and it is what both I and Karl Whelan suggest. I just didn't mention the interest in the post as I wanted to focus on the consolidated balance sheet accounting.

  18. I agree that target2 is a sideshow. In fact, I would argue that the whole debt issue is a sideshow because it could be resolved on the spot if a few dozen people in a conference room agreed. The main show requires more than a few dozen people in a conference room and a lot of time; possibly a generation.

    Having just finished another book on the history of modern Greece, the real issue of the Greek economy has been unchanged since 1832, namely: how that economy, notably its private sector, can generate enough economic value on its own, i. e. without perpetual funding from abroad. Interestingly, it wasn't continuous bad news. Instead, there have been 3 or 4 periods of enormous growth and stability, always preceded by total financial chaos. The greatest such chaos was the massive default of 1893, followed by 20 years of economic miracle. Interestingly, that was due to an International Financial Commission which overruled Greece's sovereignty (and which commission was absolished only in 1978!).

    I am a fan of Keynes chapter on "Germany's capacity to pay' in his book "The economic consequences of peace". He did not talk about fiscal or monetary policy. Instead, he analyzed Germany's economic potential industry by industry and explained that Germany could only pay if one allowed its economy to generate the wealth to make such payments. In early 2011, the CEO of Allianz was quoted as saying "If we ever want to get our money back from the South, we will have to redirect our foreign investments from other areas to the South". That comment went unnoticed and I don't see this logic being discussed at any of the endless negotiations about Greece.

    1. One of the videos linked to your blog, Klaus, is of a conference in LSE and has a question asked by a member of the audience to that former IMF Greek woman called xafa. The question is along those lines, of which sectors of the Greek economy might most benefit from investment and development.

      Her answer? (I paraphrase), "I do not believe in a command economy; the markets will decide."

      The Troika is so incompetent and remains trapped by neoliberal dogma, such that they cannot even imagine how private sector investment can be encouraged or discouraged by government policy. This single remark indicates why the eurozone crisis is set to continue: a failure by its economic and political leadership in understanding how capitalism used to work.

  19. Francis
    If I understand you correctly, your post has helped me see that NCBs in the ESCB effectively pool those parts of their balance sheets on which their native commercial banks conduct clearing, and that they use the ECB RTGS to organise this rather than clear on a proprietary ECB balance sheet. If this is right, then how does ECB QE work. Does the ECB operate like just another NCB in the system or does it credit the NCB whose govt securities it has bought, and if so, how?

  20. just to add some color. The target2 balances are remunerated at the MRO level. Why? If it is fictitious why pay interest on it????

  21. What a great post! I agree: Grexit would be inconsequential for TARGET2. It is a simple account problem between Greek central bank and ECB as notional liability.

  22. The Greeks will most likely not "recapitalise" the NCB, whatever that means. You don't need to recapitalise a CB, see for example the Czech CB, it operated with negative equity for a few years, it's equity turned positive by 2014, it could have operated that way indefinitely; see:

    Sinn's analysis is correct. Greece willingly or not, is increasing the exposure of the ECB to making a loss in the event the bonds and ELA is not repaid, which will mean less profit divided across NCB's and treasuries in the future and increasing the stocks of sovereign debts in all the countries across the eurozone.

    You have to realise that the euro has purchasing power across the eurozone, while the drachma will not have this property. It will not trade at par with the euro and german cars or whatever will cost more, while in euros they will cost the same.

    So both the Greece and the Greek public are doing the rational thing by increasing ELA as much as possible and withdrawing, or rather "converting" deposits into currency.

    1. Extraordinary logic. According to you:

      1) An independent Greek central bank post-Grexit could operate indefinitely as a technically insolvent entity, so the Greek sovereign would not need to recapitalise it

      2) the Eurozone's system of central banks cannot take any losses because that would make it insolvent, which would force sovereigns to recapitalise it, thereby increasing sovereign debt.

      Make your mind up, please. Either a central bank can operate as an insolvent entity or it can't. Which is it, please?

      Any holder of Euros, of any nationality, could profit from post exit devaluation of Greece's new currency. Speculating on a falling currency is open to Germans as much as Greeks. But capital flight is principally to avoid losses arising from such a redenomination and devaluation, not to gain from them. Professor Sinn has created a straw man. Unfortunately you believe it is real.

  23. Frances,

    The ECB faces a contingent loss or at least a marginal cost on its Target 2 asset claim on the Greek central bank

    - IF -

    at some point in the future, the Greek central bank is unable/unwilling to pay the (full) Euro (positive) interest due on that amount.

    That is the marginal risk to the ECB and the rest of the Eurosystem - interest revenue.

    That risk depends in part on prospects for interest rate normalization, and that tends to obscure the potential implications in current circumstances.

    It's about interest rates, as always. The meaning of and implications arising from Target 2 imbalances depends on that.

    1. Hi JKH,

      I didn't discuss the question of interest in this post as I wanted to focus on the consolidated balance sheet accounting, but yes, I agree. We would normally expect interest to continue to be paid on a frozen balance, though I guess you could settle it by calculating the NPV of future cash flows and paying it as a lump sum.

      The point is that the balance does not have to be "repaid" and it is in no-one's interests that it should be.

    2. Frances,

      I've reread your post. I think its an excellent operational description. I did my own post several years ago at Monetary Realism, covering the same scope. I think we agree on operations. As you say, there aren't many people around who wade into this stuff and emerge with coherence in tact.

      I do have a different interpretation when it comes to various contingencies associated with Greece.

      In short, Greece's Target 2 net liability position will become it's debt to the Eurosystem at such time it declares it will no longer be willing to pay future interest that may become due on that position.

      In other words, what is normally not debt becomes debt as soon as Greece breaks the rules that allow a non-debt interpretation.

      It is contingent debt in that sense.

      It becomes debt because in refusing to pay interest, Greece would effectively convert a Target 2 liability to the equivalent of currency, with all attendant seigniorage benefits.

      Germany and the others will not willingly accommodate this transfer of Eurosystem seigniorage benefits to a rogue participant/ defector/ exiter.

      You mentioned an NPV interest calculation. There is no economic reason for Germany not to equate that to the book value of the T2 liability.

      I have a far more favorable impression of Sinn's analysis than yourself. I've read enough of his stuff going back a few years to conclude that he has been misunderstood by a number of critics. I've seen nothing of big importance that I disagree with.

      For example, I interpret his point about borrowing from banks to send Euros out of Greece as simply a generic arbitrage example. The core issue is net private sector capital outflows - however they come about. And I haven't noticed him referring to T2 liabilities as debt other than in those contingent circumstances that would make it debt as I have described above.

      So that's my skunk at the garden party contribution, Frances. I'll just close by repeating that it's a great operational description, and that our differences in interpretation are pretty much restricted to an area of some considerable contingent weirdness.

  24. In the European Monetary Union, when a bank makes a transfer to another country of the Union it loses monetary base.
    For the sake of simplicity, let us imagine the country is Greece.
    In normal times the same Greek Bank replenishes its monetary base ex ante by finding funds in the foreign interbank market.
    If this does not happen, the reduced Greek Monetary base is registered by a Target2 liabilities of the Greek Central Bank towards the ECB, which, in turn, will recognize a Target2 claim in favour of Buba, for instance.
    Two things are to be made clear :
    1)the target 2 liabilities is obviously an item on the liabilities side of the balance sheet of the Greek Central Bank and it rectifies the value of the monetary base after the daily bank transactions.
    We do not get away from the question if we say that target2 acts as a sort of "counters" of monetary base.
    2)The passive and active interest rate of targets 2 : what is the reason?
    The seignorage income of ECB, mainly though not exclusively especially after the QE, is due to money printing for loans to member banks.
    Greek cross-border transfers, without compensatory amounts from abroad, will cause a decrease in its monetary base and a corresponding increase in the monetary base of the other member countries.
    And now the key point .
    What will the commercial banks of these countries do? They will repay the loans they got from their central banks and this will make the seignourage income decrease.
    I remember reading, time ago, that German banks had no longer outstanding loans with BUBA.
    Finally, the interests (debited and credited) on target2 serve to neutralize the impact of transfer between Member States on seigniorage income of each National Central Bank .
    This tecnical preliminary is necessary to understand the heart of the debate between Frances Coppola and Prof. Sinn.
    Undoubtedly , Sinn made a mistake when he talked about the Greeks who went into debts with their NCB and transferred corresponding capitals abroad.
    We can only say that, tank to the ECB, the Greeks have managed to turn bad euros (theirs) because subject to possible redenomination, into good euros (deposited in the banks of core countries or in their mattresses)
    This has been made possible thanks to ELA (money printing)together with lack of control of capital movements.
    Frances Coppola quite rightly said there is no currency union unless the capital movements are free.
    But Prof. Sinn is right too when he says that time is on Greek side because they are amassing "good" euro abroad.
    Unfortunately for core countries, the printed money did not remain in Greece but it ended up abroad, as shown by the strong growth of target2 liabilities.
    And now the toughest problem : what will happen to the target2 liabilities of Greece if it exits the Eurozone?
    I admit I have knowledge gaps : I do not know if NCBs are legal entities other than the ECB or if they are its component parts.
    If they are its component parts, Frances is right : they neutralize each other ; but if they are different legal entities, they are actual liabilities.

    Hobi 50

  25. "When the Greek crisis hit, German banks stopped financing German exports to Greece. Greek customers were forced to borrow from Greek banks instead (you can see this clearly as a spike in Greek bank lending in early 2010 in the chart above). The result was a large Target2 imbalance. "

    In the chart there seems to be a one-off spike and then plateau of loans to private sector before gradual decline. This struck me as strange and definitely not indicative of change of behaviour of German lenders in response to the crisis (this wouldn't have been 20bn in one month a year into the crisis and then nothing more, but more gradual response throughout the first year or more of the crisis).
    So I checked Bank of Greece's website and found here: at the bottom a more detailed spreadsheet with the aggregate loans. It seems that there is indeed a one-off spike of 20bn of "Loans to private sector" in June 2010, almost exactly offset by a decrease of 20bn in "Corporate bonds issued by NFCs and held by MFIs". Could this be a result of some debt restructuring instead of the change of behaviour that you are suggesting?

  26. "When the Greek crisis hit, German banks stopped financing German exports to Greece. Greek customers were forced to borrow from Greek banks instead "

    This is completly wrong !
    There is no connection between DOMESTIC bank financing and Target2 liabilities.
    For the sake of simplicity if Greek imports had to be ALL financed by the Greek banking system ,you could notice anyway a corrispondent increase of target2 liabilities.
    I thought I had made it clear in my previous post (but evidently I had not ) the target2 liabilities shows a decrease of the monetary base of the country(and Target2 claim increase ).

    Hobi 50

  27. "As it is a real-time gross settlement (RTGS) system, payments are handled individually. Unconditional payment orders are automatically processed one at a time on a continuous basis. Thus, TARGET2 provides immediate and final settlement of all payments, provided that there are sufficient funds or overdraft facilities available on the payer’s account with its central bank."
    "Information guide for TARGET2 users" version 4.0, 2010
    p.7 section title What is TARGET2?

    And what is gross settlement?

    "DEFINITION of 'Real Time Gross Settlement - RTGS'

    The continuous settlement of payments on an individual order basis without netting debits with credits across the books of a central bank."

  28. I meant to leave out the last link for simplicity as the second was sufficient and clearer.

  29. One thing I wanted to mention:

    On this type of transfer being called "capital flight", that the asset still has the same owner. In other words if a Greek person moves their deposit abroad they still own it and the foreign deposit is still pretty liquid for that person. I am looking at this from the point of view of the person's asset accounts and their capital account. The asset (personal account) may have moved but they still own it (have a claim to it). Their capital account is still with them and if they are still in the country the capital still belongs to a resident.

  30. As a layman, I wonder: how does interest payment occur in TARGET2? Is it inter-bank interbank operations, just like how reserves are loaned out and paid back with interests? Or is it direct payment on TARGET2 balance?

  31. Probably my previous post was too long and people didn't read it.
    I wrote.

    "1)the target 2 liabilities is obviously an item on the liabilities side of the balance sheet of the Greek Central Bank and it rectifies the value of the monetary base after the daily bank transactions.
    We do not get away from the question if we say that target2 acts as a sort of "counters" of monetary base.
    2)The passive and active interest rate of targets 2 : what is the reason?
    The seignorage income of ECB, mainly though not exclusively especially after the QE, is due to money printing for loans to member banks.
    Greek cross-border transfers, without compensatory amounts from abroad, will cause a decrease in its monetary base and a corresponding increase in the monetary base of the other member countries.
    And now the key point .
    What will the commercial banks of these countries do? They will repay the loans they got from their central banks and this will make the seignourage income decrease.
    I remember reading, time ago, that German banks had no longer outstanding loans with BUBA.
    Finally, the interests (debited and credited) on target2 serve to neutralize the impact of transfer between Member States on seigniorage income of each National Central Bank ."

    So the Target2 liabilities( or claim ) are only adjustment items of the Monetary Base originated by trans border flow of funds in the Currency Union.

    Hobi 50

    1. > Hobi 50

      The mechanism of taret 2 adjusts the monetary base of the NCBs in accordance with cross border transactions but the issue under scrutiny is the other side of the NCBs balance sheets, the inter NCB assets and liabilaties of T2 balances. As one NCB T2 asset increases its monetary base increases also.

    2. That's what I said !
      Next poit is to understand why the target 2 balances are subjects to the MRO interest rate.
      Only to adjust the seignourage revenue of each CB.

      Hobi 50