The Euro Trap
The German critique: Target2 balances, bailouts and current-account imbalances.
Summary
Hans-Werner Sinn ran the Ifo Institute in Munich and became the most prominent German critic of euro area crisis policy. This book sets out his analysis and his proposals.
His diagnosis concerns competitiveness. The euro's introduction lowered interest rates in the periphery, which produced credit booms, which raised wages and prices faster than in Germany, which left those countries with cost levels that could not compete inside a fixed exchange rate. He calculates the real depreciation each country would need and argues that internal devaluation of that magnitude is politically impossible.
His technical contribution is the analysis of Target2 balances, the claims that arise between national central banks within the euro system. Sinn argued that the growing Bundesbank Target2 claim represented a real credit exposure that had substituted for private capital flows into the periphery, and that it constituted a bailout conducted through the payment system without parliamentary approval. This provoked a substantial controversy, with opponents arguing that Target2 balances are an accounting consequence of a single currency area and carry no independent risk. Sinn's proposals include a mechanism for temporary exit and re-entry, debt restructuring, and stricter limits on central bank credit. The book is polemical and its analysis is contested at every point. It is the clearest statement of the German critical position and the Target2 material is a genuine analytical contribution regardless of the interpretation.
Key takeaways 7
- Euro entry lowered peripheral interest rates and produced credit booms that raised costs above competitive levels.
- Internal devaluation of the magnitude required in several countries is politically impossible, which leaves the imbalance unresolved.
- Sinn argues that Bundesbank Target2 claims represent real credit exposure that substituted for withdrawn private capital flows.
- Central bank liquidity provision to periphery banks constituted a fiscal transfer conducted without parliamentary approval.
- Sinn proposes a mechanism permitting temporary exit and re-entry rather than treating membership as irreversible.
- Debt restructuring is preferable to indefinite official financing because it allocates losses to the lenders who took the risk.
- The Target2 interpretation is contested, with opponents holding that the balances are an accounting consequence of monetary union carrying no independent risk.
Who should read it
Investors in European assets who want the German critical analysis of euro area crisis policy and the Target2 argument in its original form.
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