TARGET losses in case of a euro breakup

by Hans-Werner Sinn

Vox
October 22, 2012

Evaluation of the financial costs of a Eurozone breakup depends critically on the interpretation of the balances central banks hold in the EZ payment system. This column, which replies to the interpretation by De Grauwe and Ji, argues that TARGET balances represent real wealth that would be lost in a breakup.

When exchange rate adjustments are impossible, imbalances of cross-border payment flows must be accommodated officially. This baseline fact about monetary union has sparked extensive discussion on what the resulting asset positions mean (Sinn 2011a,b, Tornell and Westermann 2012, Whelan 2012).

On one side, Sinn and Wollmershäuser (2012) argue that Finland, the Netherlands, Luxembourg, and Germany face the risk of losing the TARGET claims of their national central banks should the euro break up. On the other, De Grauwe and Ji (2012) deny that such a risk exists1. They base this on the grounds that:

• The risk stems only from these countries' self-chosen net foreign asset position;
• Fiat money has a value independent of the corresponding national central bank's assets; and
• Foreign speculators could be excluded from a currency conversion if necessary;

Given that the Eurozone's gross TARGET claims or liabilities today amount to about €1 trillion and constitute the largest single item in the balance sheets of most central banks of Eurozone members, this would be good news for the four countries mentioned. If De Grauwe and Ji are right, however, one wonders why Moody's recently announced that it is considering a downgrade of the credit ratings of Germany, the Netherlands, and Luxembourg in view of the riskiness, among other factors, of their huge TARGET claims2. Can it be that the analysts of Moody's have overlooked something?

I will show that they didn't and that, in fact, all three points of De Grauwe and Ji are erroneous or do not apply to the assessment of TARGET losses in the case of Eurozone breakup. To this end, let me consider the issue in more detail. I will start by reviewing the nature of the TARGET imbalances according to Sinn and Wollmershäuser (2012) and then proceed, in turn, to each of the De Grauwe and Ji (2012) counterarguments. Some of my comments also apply to a new paper by Buiter and Rahbari (2012b) that came out after this note was written. I briefly refer to what I perceive as their error in the section on fiat money.

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