Don Alexander, MBA
Associate, RSD Solutions Inc.
The ECB, through its payment mechanism - European System of Central Banks (ESCB), acts as a de facto lender of last resort for troubled banks and member-country central banks across Europe. The troubled banks, largely from deficit countries, obtain funding through the ESCB and indirectly finance the deficits, by central banks lending money against discounted public debt.
The funds flow through the ESCB’s settlement system (real-time) called “target”. Since 2007, when private capital flows dried up, large asset and liability positions emerged on the balance sheet of central banks. The Bundesbank is the dominant creditor and dominant debtor central banks are those of Greece, Ireland, Portugal and Spain (GIPS). The imbalances correspond to the cumulative current account deficits of those countries.
A problem will emerge if these countries become insolvent and it impacts the solvency of the debtor country central banks. This imposes large losses on the creditor central banks that are under pressure to aid domestic banks. Taxpayers of the creditor country would have to bailout the central bank and recapitalize the banking system. This mechanism serves as an indirect fiscal transfer.
This backdoor financing scheme shifts credit away from the surplus countries stifling growth. This process can only be stopped, barring a major crisis, by a government takeover and adding central bank debt to government debt, already at alarmingly high levels. This makes debt restructuring inevitable, increases the chances for a banking crisis and redenominating debt in a new, weaker currency. The Eurozone has two choices, according to Sinn: a default/restructuring or open-ended support.
For more on the ECB’s stealth bailout click on the link to VoxEU, a policy portal set up by the Centre for Economic Policy Research: http://www.voxeu.org/index.php?q=node/6599
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