Since the beginning of the European Central Bank’s asset purchase programme in March 2015, internal claims and liabilities in the euro area among national central banks (Target-2 balances) have been rising steadily. The Bundesbank’s claims have now reached a balance of €708bn, and Italy has passed Spain as the largest debtor with a balance of €355bn.
ECB representatives have played down the phenomenon, arguing that, unlike in the earlier period of stress around 2012, NCBs themselves are responsible for the change in the Target-2 balances, which is mainly a technical side effect of quantitative easing. Whenever a NCB in the euro area purchases a bond outside its own jurisdiction, there will be an international transaction settled in central bank money.
Furthermore, the ECB points out that NCBs also buy bonds outside the euro area. In fact, this is the majority of bond purchases, as large asset holding companies have their headquarters mostly in London, New York or other major financial centres. When NCBs purchase bonds from these institutions, the Bundesbank may credit the money to their Frankfurt reserve account.
The allocation of accounts has a long history. Even before the euro was introduced, most of the large global financial institutions had their central accounts in Frankfurt. Regardless of which countries’ bonds are bought, the Bundesbank gets to pay if the reserve account of the counterparty is in Frankfurt.
The ECB arguments are not totally convincing, because they focus on the primary impact, ignoring second-round effects. If the accounts of the counterparties were in Rome or Athens, instead of Frankfurt, it is very unlikely that Italy and Greece would become big Target-2 creditors as a result of QE. The counterparties’ account location explains only the initial allocation of liquidity in the euro area. After the purchases are made, the deposits can be moved freely across borders. Making the allocation of counterparties’ accounts responsible for Target-2 balances is wishful thinking.
A further cause for concern for ECB policy-makers is that purchases outside the euro area not only create internal capital flight in Europe, but can also have other side effects. Balance of payments statistics show a significant increase in non-euro area foreign direct investment into Europe. Big international holding companies are not necessarily the owners of the bonds – they mainly act as an intermediary for asset holders worldwide. A further side effect can be seen in changes in the euro area’s international investment position vis-à-vis non-euro countries. Investors in these countries sell their bonds to the ECB and in return buy equity and real estate, raising equity and house prices in many euro area countries. Most recently offshore financial centres have become the largest net asset holder vis-à-vis the euro area in the ECB’s statistics. Their current balance is €500bn. Before the 2008 financial crisis, this balance was close to zero.
These patterns suggest that the markets are taking advantage of QE to hedge their risks against a partial or complete euro break-up. Liquidity within Europe is moved to Germany, or stays there. Worldwide owners of euro area government bonds become the owners of European real estate and equities. If the euro should break up, they are well positioned to protect their wealth, while the Bundesbank will need to explain to German taxpayers why it viewed more than €500bn worth of Target-2 claims as a safe investment.
The ECB governing council meets on 8 December in Frankfurt to decide on whether and how to extend its asset purchase programme beyond the present cut-off date of March 2017. In making their decision, policy-makers should be aware of the risks that QE is contributing significantly to Target-2 disequilibrium. If the programme is indeed extended, the risks can only get bigger.
Frank Westermann is Professor of Economics at Osnabrück University.