_ Hans-Werner Sinn, Dr. Sc., president, ifo Institute for Economic Research (1999-2016), member, advisory council, Federal Ministry for Economic Affairs and Energy (Germany); professor emeritus, Ludwig-Maximilian-University. Translation into English by Yuri Kofner. Munich, 9 September 2020.*
Europe’s pandemic-induced economic crisis is just the continuation of the euro crisis that has been smoldering since 2008.
The heads of state and government of the EU have agreed on a large Recovery fund worth 750 billion euros to help the EU member states hardest hit by the corona epidemic.
But during the protracted negotiations on the package, it became increasingly clear that Europe’s pandemic-induced economic crisis was an extension of the euro crisis that had been simmering since the Lehman bankruptcy in 2008.
At its core, this crisis is a competitive crisis due to incorrect relative prices, triggered by the inflationary overpricing in the countries of southern Europe, which in turn is due to the glut of capital that the euro brought to these countries. The overpricing was the result of a bubble that burst with the Lehman crisis.
Invest in the north
After the euro bubble burst, phases of intensive capital flight from the Mediterranean to Germany occurred several times, causing the so-called Target balances in the eurozone’s international clearing system to skyrocket. Another phase that dwarfs all previous ones has now been triggered by the virus.
The Target balances measure net transfers in the euro area. Foreign lenders from all over the world demanded repayment of outstanding loans in the Mediterranean instead of rolling them further, and they invested the money in the north of the eurozone, especially in Germany. But southern European investors also switched their investments from the Mediterranean countries to Germany and transferred the corresponding amounts of money. Both of these forces forced the Bundesbank to build up outstanding credit positions in the Eurosystem for the EUR 1 trillion in fulfilling the transfer orders. The increase in German Target claims, at 114 billion euros in March 2020 alone, was by far the largest monthly increase since the introduction of the euro.
At two other highs of the euro crisis, in September 2011 and March 2012, the German Target balance had also risen sharply due to capital flight, but at that time it was “only” 59 billion euros and 69 billion euros respectively. In April and May of this year the capital market calmed down somewhat, but in June the German Target demand shot up again by 84 billion. From February to June 2020 it rose by 174 billion euros and most recently reached the highest level in the history of the euro, at 995 billion euros.
Conversely, the Italian Target debt had increased by 152 billion and the Spanish by 84 billion euros in the same period, which implied values of 537 and 462 billion euros at the end of June. That was a total of 999 billion euros. This number and the German number are so closely below the limit of one trillion euros that one can only wonder which secret forces in the background pulled the emergency brake. Investors fled Spain and Italy because they no longer believed these countries were safe, and they were able to flee because the central banks of these two countries gave the banks replacement liquidity from the national printing presses.
This included, on the one hand, the liquidity from various securities purchase programs of the ECB, such as the purchases as part of the Pandemic Emergency Purchasing Program (PEPP) and the longstanding Asset Purchasing Program (APP) as well as the decided temporary increase in this program due to the crisis. These actually provided for symmetrical purchases by all central banks of the Eurosystem and the ECB, but in fact, Italian securities were purchased at a disproportionately high rate.
On the other hand, the replacement liquidity comes from a special program worth over 500 billion euros as part of the Targeted Longer-Term Refinancing Operations (TLTROs), which was made available to the banks in the eurozone in mid-June. With an interest rate of minus one percent, the terms on which the TLTROs were granted were extremely favorable. They were so cheap that many banks lent the money and immediately invested it with their own central bank at a deposit rate of minus 0.5 percent. This gave them an immediate arbitrage gain equivalent to open subsidization by the Eurosystem.
However, a significant portion of the loan money was required to offset the outflows due to capital flight. Or perhaps it was just used to repay private foreign loans that were less affordable. In this case, the loans from the national printing press should not only be categorized as an aid to escape but rather as a means of making private capital flee by undercutting the conditions.
System out of balance
Be that as it may, events clearly show that the Eurosystem is far from achieving internal equilibrium. The hardcore of the imbalance can be seen by looking at production in the manufacturing sector, which suffered particularly from overpricing because, unlike the domestic sectors, it has to face international competition. In Italy, production was 19 percent below the pre-Lehman level before the corona crisis, and in Spain by 21 percent. In the corona crisis, the journey continued downhill, to minus 35 and minus 34 percent.
The Recovery fund is supposed to fight the fiasco, but money cannot solve the problem of incorrect relative prices of goods in the Eurosystem. That can only be done through open or real devaluations. But nobody wants to talk about that. Hope and pray is the dominant political strategy in Europe.
*Translated and republished without prior written consent. For educational purposes only.