The Money View

First the ECB, then the IMF, Part One

The fact of the matter is that European bank funding markets are collapsing onto the ECB balance sheet.  Forget about the €200 billion of outright peripheral bond purchases--small potatoes.   National central bank exposures, through the TARGET clearing system, now exceed €400 billion, and private bank exposures, through discount lending and deposit facilities, are the same order of magnitude.  

Apparently everybody, borrowers and lenders, public and private, wants the ECB as their counterparty.  Reluctant though the ECB may be to step into that role, and vocal as the ECB has been about that reluctance, what we are seeing in practice is that it has no choice, literally.  

Clearing imbalances within the Eurozone that cannot be resolved in the interbank market show up mechanically as imbalances between national central banks on the books of the ECB (see here for details).  The ECB lends to the central bank of the deficit country and borrows from the central bank of the surplus country, so expanding its own balance sheet on both sides.   (Think Greece on the asset side, and Germany on the liability side.)

Something quite similar happens when private banks settle private clearing imbalances not by shifting reserves from deficit to surplus but rather by the deficit bank borrowing from the ECB and the surplus bank lending.  Again, the ECB balance sheet expands on both sides.

Why is this happening?  

The underlying problem is that deficit central banks and deficit private banks increasingly have nothing to sell (or to pledge) that surplus central banks and surplus private banks want to buy (or accept as collateral for a loan).   The ECB is also reluctant to buy--it is serving as pawnbroker of last resort, not dealer of last resort.  

The consequence is that the ECB  is more or less forced to lend, against more or less whatever collateral is offered; even bad collateral is better than no collateral.  (The famous Bagehot Principle offers an out, since it urges valuation of collateral at non-stress prices.)  

Now comes the latest deal over eurozone fiscal rules, presumably the deal that ECB President Draghi asked for last week.  It is a deal about sovereign budget discipline.  But if I read Draghi's speech right, we should not expect him to be buying sovereign debt.  (That will be the IMF's job, if anyone's, and with strict conditionality; details to be sorted later.)

Instead, he'll be buying bank debt, specifically the debt of the banks that hold the sovereign debt.  Banks currently borrowing from their own national central banks will therefore be able to repay, and consequently the national central banks will be able to repay the ECB.  This takes national central banks out of the picture on the asset side. 

What about the liability side?  Here, perhaps in a longer time frame, I think the logical move is again to take the national central bank out of the equation, by replacing liabilities to the Bundesbank with deposits to the credit of private banks.    Freed from the responsibility to fund ECB loans to other central banks, the Bundesbank will be able to return to its preferred asset holding, German sovereign bonds.

Bottom line, we're not going to be using the payment system to hide imbalances any more.  The ECB is going to serve as a proper lender of last resort to the banking system, affirmatively and up front rather than mechanically and through the back door.  But it will be doing so only to the banking system, not to sovereign debtors.   It is a first step, taken only because hiding imbalances in the payments system was beginning to cause problems in the payment system, but it is the right step and opens the door to more.



what surplus private banks are there in the EU?


This posting is confusing me because the ECB is presented as if it were separate from the NCBs when in fact the ECB is the consolidated balance sheet of the NCBs. Thus the intra-system claims and liabilities are accounting entries that net out in consolidation. They are not the same as credits extended by the ECB to a private bank. As long as a euro is a euro, the EZ is a currency union like the U.S. and the relations between the system as a whole and its constituents can’t be where the drama lies. (No one worries about the claims or liabilities of the Kansas City Fed.) The claims built up at the Bundesbank are mostly the reflection of deposits migrating away from the GIIPs banks and corresponding liabilities at their NCBs. My understanding here may be off—it comes almost entirely from a paper by Bindseil and Konig, “The economics of TARGET2 balances.” Am I missing something?

The part of the post about the ECB intermediating as the result of a collapse of interbank lending is much clearer to me. But this will require intra-system claims/liability entries in the deconsolidated NCB balance sheets, won’t it? If the interbank lending market hadn’t broken down, there would be no need for intra-system claims/liabilities in handling these imbalances. (See pp. 18-20 of the Bindseil/Konig paper.)


By payments imbalance you mean balance of payments, right?


To Tom mainly (but answers to the others implied along the way),

You are not the only one to point out to me that, the way the Eurosystem works, its interface with the rest of the economy (net system assets and net system liabilities) is all booked on the balance sheets of the individual national central banks.   Specifically, the money base (currency plus bank reserves) is all booked as the liability of one or another of the national central banks that together comprise the monetary union.   

My video showing a balance sheet of the ECB as something separate from the balance sheet of the national central banks is therefore, as you say, confusing.  Since the purpose of the videos is to clarify, not confuse, I need to do better.  Let me try.

The Bindseil-Konig article you mention is very much worth careful attention, and I would like to identify myself with everything they say.  But even they refer to the central bank as something more than the consolidated balance sheet of the national central banks.  (See in particular section 7.3.)   In normal times, imbalances within the system can be dealt with by intra-system borrowing and lending—some national central banks will be creditors of the system and others will be debtors, but the debt of the debtors is all fully (even overly) collateralized.  But in extraordinary times, available collateral may be insufficient and the interbank market freezes up, in which case the central bank steps in, lending to one side and borrowing from the other.

In normal times, intra-system borrowing and lending between national central banks just picks up whatever slack is left by intra-system borrowing and lending between private banks in different areas.  In extraordinary times, both forms of borrowing and lending break down.  My point, I suppose, is that we are living in extraordinary times. 

In my video I show intra-system borrowing and lending and direct borrowing and lending both as assets and liabilities of the ECB.  This is technically incorrect, because the TARGET 2 intra-system borrowing and lending is netted out by consolidation of national central bank balance sheets whereas the direct borrowing and lending is not.  But I would point out that, and this is the key point, the whole reason intra-system borrowing and lending is netted out is because we are thinking of the system as a union—talk about breakdown of the Eurosystem is exactly talk about whether accounting consolidation makes economic sense.

Finally, I would direct readers to the Bindseil-Konig discussion of the variety of possible sources of payments imbalance.  What they say is correct, but let me try to state it a bit more clearly than they do.   Payments imbalance, even in a monetary union, can be seen as the net consequence of cross-border flows of goods (current account) and funds (capital account).  In normal times, intra-system balances between national central banks simply absorb temporary payment imbalances that will soon be reversed. 

Bindseil-Konig emphasize further that current account deficits do not necessarily imply payment deficits, and they are completely correct about that, since in normal times there will be offsetting capital flows the other way, maybe even more than offsetting.  (That means, by the way, that the talk about austerity is largely beside the point for the immediate problem.) 

What is happening now in the Eurozone is two things.  First, there is a flow of funds out of certain banks and certain regions; mechanically this flow shows up as intra-system borrowing on TARGET2.   The worry here is that these balances are getting pretty large, and one wants to be able to imagine a future in which flows go the other way so that balances are repaid. 

Second, there is a flow of funds out of the Eurozone itself, which is exacerbating the intra-system imbalances.   The system as a whole is facing a payment deficit, but there is no global monetary union, so there is no mechanical system of meeting those deficits by international borrowing and lending.  The nearest we have is the system of liquidity swaps between central banks.  More on that in posts to come.

I hope this helps.  If not, push me again please.  I'm committed to understanding this, and I've been a teacher long enough to know that I won't understand it fully until I am able to explain it.


I only came across this blog yesterday, but was very pleased to find it. I very much enjoyed The New Lombard Street.

I was going to say what Tom said (though not as well). I see you have already made a reply.

I still do not fully follow it. Perhaps the situation would be clarified if you could explain what you think the ECB is going to do. What will its intention be, and what securities and cash will go where? I.e. leaving out any locations that do not really exist but are added for the sake of simplification (I do not mean to say this is an illegitimate thing to do, just that it may not help here).


To Anonymous,

Yes, balance of payments but internally within the Eurosystem.  To my mind, Martin Wolf gets it exactly right when he says:  

"This is, at its bottom, a balance of payments crisis. Resolving payments crises inside a large, closed economy requires huge adjustments, on both sides. That is truth. All else is commentary."


Thanks, Prof. Mehrling, for providing some clarity on yet another facet of this intriguing (and awful, messy) situation. Clearly this is all significant for any future global economic zone.

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