Euroland deposits and loans, part 2

The continually widening divergence between the loan/deposit ratios in the core and the periphery of Euroland is of course nothing more than the monetary manifestation of the balance of payments crisis that now exists within the Euro, with Germany amassing large surpluses (and hence gains claims on its partners) but the periphery (including France) suffering large deficits and a consequent increase in their levels of indebtedness to the core.

This is a situation that has been in existence for a decade or more but it seems that this notionally unsustainable situation has somehow not only been sustained but allowed to become even worse over recent years despite (or because of) the authorities’ pledges to solve the expanding crisis.

In the period prior to the onset of the crisis, the excess deposits of the German banks that were the product of Germany’s tendency towards an intra system balance of payments surplus would have been lent voluntarily by the banks through the conventional interbank markets but, since the advent of the crisis and the demise of conventional interbank flows across the Euro member states’ common borders, these flows have been obliged to occur, in a sense involuntarily, via the TARGET system. As German banks have in effect ‘lent’ their surplus funds to the Bundesbank, accepting this is a simplified version of what happens, the Bundesbank has then been obliged by the rules of the Euro mechanism to lend these same funds on to the weaker members of the single currency, such as Greece.

It is no coincidence that the explosion in the volume of funds within the TARGET system and the Bundesbank’s claims on the TARGET system have both occurred as the loan to deposit ratios in the periphery have either deteriorated further or remained ‘strained’. Had TARGET not existed, and the Bundesbank not been obliged by the system to take on the role of lender of last resort to Euroland, then it is most probable that the ‘Euro system’ would have failed months ago.

Some have suggested that in effect the rise in the TARGET volumes is the result of the Euroland interbank markets collapsing onto the ECB’s balance sheet just as US interbank flows ended up running through the Federal Reserve Board (FRB) in the crisis, but this is not strictly the case in Euroland as the ECB does not have a balance sheet, and instead interbank flows have collapsed onto the Bundesbank’s balance sheet which is a very different political state of affairs to the US/FRB situation.

The ECB/EU’s policy responses to the crises have brought no improvement in underlying bank solvency because provision of a few more or even a lot more TARGET-financed LTROs simply papers over the cracks. There is no solving of the root cause problems, and in fact such policies may make the underlying competitiveness problems within Euroland worse by preventing the full force of the necessary deflation from occurring in the periphery. There is also the well recognised problem that Euroland lacks a single sovereign state as guarantor and there is no single fiscal authority. But perhaps worst of all, behind all of the visible challenges, is the growing realisation that the authorities have failed, and seemingly continue to fail, to grasp the gravity of the situation.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla