EUROPEAN DIARY:A continuation of current policy towards euro zone stragglers could sink the entire project, Hans-Werner Sinn argues, writes ARTHUR BEESLEY
THE EUROPEAN Central Bank’s vast support for Ireland and the other stricken euro zone countries is exercising the considerable mind of Hans-Werner Sinn, a well-known big beast on the German economic scene. The situation is increasingly unsustainable, he warns. Take note.
Prof Sinn is president of the Ifo Institute for Economic Research in Munich, which publishes a closely watched monthly index of German business sentiment and is prominent in public debate.
In the present malaise he sees ECB support for Ireland and other stragglers threatening a break-up of the euro zone – a no-no in European circles – or the creation of a fully-fledged European transfer union, which is politically toxic in Germany.
It must be said here that Sinn has a reputation in German media circles of being a bit of a headline-grabber, and ranks behind others in the policymaking world. But his assessment of the current state of play in the debt crisis makes for very uncomfortable reading indeed.
The same is true of his recommendation for urgent corrective action, which would apply aggressive shock treatment to Ireland’s creaking banks with highly risky, unpredictable consequences.
Whatever about that, his emphasis on the pivotal role of the Bundesbank in the ECB’s support for the euro zone stragglers leaves little doubt as to where the cash is coming from to keep Ireland’s financial system intact.
Using the “GIPS” acronym instead of “PIGS”, Sinn argues that the ECB should be doing much more to unwind its extraordinary interventions in Greece, Ireland, Portugal and Spain. His anxiety centres on the ECB’s “target” system, through which the Frankfurt-based bank provides an unlimited amount of emergency lending – via national central banks – to commercial banks in any country that might have the need.
“The longer the cheap money drug is indulged in, the more painful the withdrawal. Wait too long and no cure will be possible,” he wrote last week.
In the target scheme the ECB functions like an intermediary. The money it lends originates in the national central banks of economically strong countries, who receive interest on their claims.
The Bundesbank is by far the biggest contributor. Sinn notes that its involvement has been growing by almost €100 billion per year. By the end of 2010, its claims stood at €326 billion.
Ireland’s borrowings under the system were estimated last year at €146.1 billion, the biggest of any country and exceeding those of Greece by €59 billion.
Together, the liabilities of all four GIPS countries had grown to €344 billion in 2010 from minus €30 billion in 2007, when the credit crunch first struck.
“This was, in effect, a bailout long before the corresponding parliaments took any notice. This bailout made it possible for the GIPS to continue living beyond their means, and it saved them from a drastic reduction in credit flows,” Sinn wrote.
He argues that the Bundesbank’s participation – and that of other strong national central banks – comes at the expense of loans in their home economies. Such “surrogate lending” is lopsided, he said, and cannot be extended arbitrarily.
The GIPS account for 68 per cent of ECB loans, but their economies represent only 18 per cent of euro zone gross domestic product. By the end of 2010, the stock ECB loans to the other 13 euro countries had shrunk to €184 billion euro, just 32 per cent of the total.
“If the net money flow out of the GIPS countries continues at a rate of 100 billion annually, this policy can be continued for at most two further years,” Sinn wrote.
“The situation is as dangerous as the one in 1992. That was when the British pound collapsed because the Bank of England had fewer deutschmarks and francs to sell than Gorges Soros was buying.”
Sinn sees merit in measures like those deployed in the equivalent US system, in which individual Federal Reserve districts must settle their outstanding accounts with each other once a year. “Adopting the US system could mean, for example, that target liabilities have to be paid annually with gold, currency reserves, or other marketable assets that cannot be produced by the paying country itself.
“This rule would force the GIPS banks to seek financing in the private market where interest rates are high, and the GIPS economies would then react by borrowing less and reducing their current-account deficits.”
However, that rather extreme notion takes no account of the potential for financial and political chaos that would ensue.
While Sinn said allowing the European Stability Mechanism permanent euro zone bailout fund to issue eurobonds could salvage the ECB’s position, it would not solve the fundamental problem.
“It would perpetuate the GIPS countries’ trade deficits and prevent the necessary real depreciation that they have to undergo to become competitive again.”