pat mcardle_from the original sinn to the ten commandments1

7/30/2019 Pat McArdle_From the Original Sinn to the Ten Commandments1

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The Institute of International and European Affairs

Tel: (353) 1-874 6756.Fax: (353) 1- 878 6880.E-mail: [email protected].

Web: www.iiea.com8 North Great Georges Street,Dublin 1,Ireland

The Euro Crisis: From the original Sinn to the ten commandments an analysis of Hans Werner Sinnslatest proposals. Institute of International and European Affairs 2012.

Written by Pat McArdle.

Cover design and type by Brian Martin.

This briefing forms part of the IIEAs E View project, which is part-funded by DG Communication of the European Parliament.

The Institute of International and European Affairs does not express any opinions of its own. The wordsand opinions expressed in this document are the sole responsibility of the author.


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From the original Sinn to the ten commandments an analysis of Hans Werner Sinns latest proposals

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Introduction

When the history of the crisis is written, there will be a chapter, or perhaps a footnote, on thecurious case of Hans-Werner Sinn and The ECBs Stealth Bailout. Sinn is President of theIFO Institute, best known for its monthly survey of the German economy, and this was thetitle of a piece he wrote in June 20111. It was very controversial and rejected or highly qualifiedby most commentators2 but Sinn has doggedly persisted, going so far as to call a pressconference in Frankfurt in the face of opposition from both the Bundesbank and the ECB

which rejected his findings.

The most recent contribution from Sinn was published before Christmas, in the form of anNBER Working Paper3. While most of his more controversial claims are omitted orobfuscated, he has not given up on them and the clearest expression of his views is to be found

in his presentation to the DG ECFIN ARC Conference last November4.

The introduction to his June 2011 paper read:

The Eurozone crisis lingers on. This column argues that the Eurozone paymentssystem has been operating as a hidden bailout whereby the Bundesbank has beenlending money to the crisis-stricken Eurozone members via the Target system on theorder of 300 billion. Urgent corrective action is needed, the author argues, as thescope for this sort of transfer is limited. If markets sense the end of the line, theEurozone may face a crisis like the one Britain faced in 1992.

The introduction to the more recent NBER paper states:

This paper investigates the Target balances, an accounting system hidden in remotecorners of the balance sheets of the Eurozones National Central Banks (NCBs), toanalyze the Eurozones internal imbalance. It shows that the Target surpluses anddeficits basically have to be understood as classical balance-of-payments surpluses anddeficits as known from fixed-exchange-rate systems. To finance the balance-of-payments deficits, the European Central Bank (ECB) tolerated and actively supported

voluminous money creation and lending by the NCBs of the periphery at the expenseof money creation and lending in the core. This has shifted the Eurozones stock of netrefinancing credit from the core to the periphery and has converted the NCBs of thecore into institutions that mainly borrow and destroy euro currency rather than print

and lend it. The reallocation of refinancing credit was a public capital flow through theECB system that helped the crisis countries in the same sense as the official capital

1Availableat:http://www.voxeu.org/index.php?q=node/6599

2ThelistincludestheECB( here),theBundesbank(here),ProfessorKarlWhelan( here),JeanPisani-Ferryof

Bruegel(here)andabouthalfadozenfinancehousesincludingGoldmanSachsandCitibank.MartinWolf,in

theFinancialTimes,andPaulKrugman,intheNewYorkTimes,gaveitamuchmorefavourablereception.3Targetloans,currentaccountbalancesandcapitalflows:TheECBsrescuefacilityWorkingPaper17626,

NBERNovember2011.Availableat:http://www.nber.org/papers/w17626.pdf4Availableat:http://ec.europa.eu/economy_finance/events/2011/2011-11-21-annual-research-

conference_en/pdf/session04_sinn_en.pdf


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flows through the formal euro rescue facilities (EFSF, EFSM and the like) did, but itactually came much earlier, bypassing the European parliaments. It was a rescue

program that predated the rescue programs.

Data Update

It may be useful to begin by updating Sinns data which are not as hidden as he makes out infact, the key series is published in the Bundesbanks monthly report as Other Assets. Therapid growth in this item was very obvious5 and its counterpart is to be found in the balancesheets of the other central banks, usually under Other Liabilities. However, some centralbanks, e.g. Bank of Greece, Bank of Italy and Bank of Portugal, openly reveal them in their

monthly reports and nearly all of them show their TARGET2 debit balances, to give them theircorrect name, in their annual reports.

For example, note 28 to the 2010 accounts of the Central Bank of Ireland read This itemrepresents the Banks net liability to the ECB as a result of euro cross-border paymentstransacted over the TARGET2 system by all NCBs (National Central Banks) participating init.6 The amounts were 145.2 billion and 53.5 billion at end 2010 and 2009, respectively. Onedoes not, therefore, need to be a Sherlock Holmes to track them down, particularly as theNCBs have a standardised set of accounts.

The latest TARGET2 balances data relate to October with a few (more up-to-date) exceptionswhereas Sinns NBER paper only has data to August. He will not be happy with developmentsin the meantime. Basically, the Eurosystem has done the opposite to what he recommendedand the Target imbalances grew rapidly in the latter part of 2011.

The German credit balance outstanding increased to 495 billion and the counterpart to this isto be found in what Sinn calls the PIIGS (Portugal, Ireland, Italy, Greece and Spain). We shalldefer, for the moment, the reason why this is happening in order to focus on recentdevelopments. In the most recent six-month period for which data are available, credit

TARGET balances, which represent cross-border capital inflows to Germany, amounted to172 billion and they came from Spain (71 billion), France (76 billion) and, above all, Italy(161 billion)7. Of the Programme countries, Ireland and Portugal recorded moderate inflows

while Greece had more significant outflows. One valuable service that Sinn has performed is to

5InmuchthesamewaythattherapidgrowthintheCentralBankofIrelandsOtherAssetsitemwasalso

obvioustoanyonewhocaredtolookthoughinthiscaseitrepresentedemergencyliquidityassistance

(ELA)toIrishbanks.6Availableat:http://www.centralbank.ie/publications/Documents/2010%20Annual%20Report%20-

%20FINAL.pdf

7ThecomparisonisdistortedbecausetheGermanfigurerelatestoNovemberwhereastheItalianoneisfor

Decemberandthereweresubstantialoutflows(41billion)inDecember.Itislikelythattheend-December

Germanpositionwillbeintheorderof550billion.


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introduce a geographical focus on the very large capital flows that are part of the crisis. Hisemphasis on the balance of payments to the exclusion of all else is, however, questionable.

The second half of 2011 was really a Spain, France and Italy story and a comparison of the twoseries in the chart confirms that practically all of their outflows occurred during this period8.Italy now has the biggest debit balance outstanding, followed by Ireland and then Greece but

with Spain and France catching up rapidly. It is also noteworthy that Germany is thedestination of the vast bulk of the flows, though the Netherlands began to feature morerecently.

In the early stages, e.g. Ireland in 2009, this reflected the withdrawal of capital by Germanbanks and other investors9; more recently, e.g. Italy in 2011, it is a mixture with domesticresidents also shifting assets overseas. Surprisingly, few people are putting their money inFinland and, in the past six months, Ireland attracted marginally more inflows thanLuxembourg, though some of these would have been from official sources.

8FranceisabitofasurprisevirtuallyallofitsoutflowsoccurredinSeptember.

9SinnportraysthisdifferentlyinhisJune2011article:theyreflectIrelandspastcurrentaccountdeficits

withotherEurozonenationsthathavenotbeenfinancedbyinflowsofprivateorpubliccapital,butratherby

theIrishCentralBanksmoneycreation(typicallybywayofextendingcredittoitscommercialbanks)."


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This picture is confirmed by the time-series data which highlight the particularly rapiddeterioration in the Italian and French positions and the general levelling-off that other

countries experienced. Italian outflows were particularly strong in three of the last four monthsof 2011 and Germany was the net beneficiary. It is little wonder that yields on short-termGerman government debt turned negative.

The broad picture is as follows. German banks funded the party in the periphery. When thesub-prime crisis broke, they rushed to withdraw funds in 2008 and 200910, mainly from Irelandand France. A ratings downgrade and a series of unattributed ECB briefings against Irelandsparked a further 50 billion outflow in the run up to the Irish Troika Programme inNovember 2010; again, these flows went exclusively to Germany11. This was followed by aperiod of relative stability until mid-2011 when the crisis spread to core countries like Italy andFrance, prompting another 200 billion to move into Germany12. This was accompanied,

however, by a loss of confidence on the part of US investors who withdrew funds from manyEU countries, Germany included.

10Inthe12monthstoSep2009,Irelandlost64billionwhileGermanygained109billion.

11Almosttwo-thirdsofallcapitalflowsintoGermanybetween2008and2010originatedinIreland.This

reflectedcapitalmovementsasthebalanceofpaymentsdeficitonthecurrentaccountwasrelativelysmall

(10%ofthetotalflow).SomeofthiswouldhavereflectedIrishresidentsmovingassetsabroadbutavery

substantialamount,ifnotthevastbulkofit,reflectedtherepatriationofGermaninvestmentinIreland.This,

inturn,explainswhytheECBandothersweresoinsistentthatbondholdersinIrishbanksberepaidinfull.12In2011,outflowsfromSpainandItalyaccountedforalmost90%oftheinflowtoGermany.


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The Stealth Bailout That Wasnt

So much for the data the big question is what do these flows tell us and do they represent ahidden 500 billion bailout as Sinn contends? Many have tried to explain this over the past year

with, it must be said, limited success.

Most people will not have heard of TARGET (Trans-European Automated Real-time GrossSettlement Express Transfer System), an interbank payment system for the real-time processingof cross-border transfers throughout the EU, and will be even less familiar with the notion of

TARGET debit and credit balances.

TARGET2 is the plumbing of the Eurosystem. It is like a water pipe. If the German HighWater Authority (the Bundesbank) decides to send a gallon of water (liquidity) to (the Central

Bank of) Ireland, this is recorded in the High Water (Euro System of Central Banks or ESCB)accounts as a credit to Ireland of one gallon of water. The water flows through the pipe(TARGET2).

Since TARGET is simply a conduit, it reflects all cross-border payments. This includes tradepayments associated with imports and exports, current transfers, direct investment flows andcapital movements. In normal circumstances, these various flows net out leaving TARGET2balances close to zero. This even happens when there is a deficit on the balance-of-paymentscurrent account as there is usually a roughly equal contra flow.

In the pre-Euro days, when national currencies existed, a countrys stock of foreign exchangereserves placed a limit on the extent to which adverse balance-of-payments flows could betolerated, as, for example, the UK found when Sterling was ejected from the EMS in 1992. Inthis context, Sinns views represent a return to a mercantilist view of things. However, itremains the case that looking at a water pipe and measuring the throughput tells one nothingabout the factors that determine the supply and demand for water. Its only merit is that itreveals the origins and destination of the water in a cross-border balance-of-payments context,

which, as we have seen above, does give us some useful insights.

In reality, however, the TARGET2 debit balances are the mirror images of other transactionsto which Sinn pays little attention13, viz., the monetary policy activities of the ECB and theEuropean System of Central Banks (ESCB) which are anything but stealthy. The bailout, ifthere is one, is to be found in the ECBs monetary policy, not in the more elusive TARGET2

data.

13Hisearlypapersdonotmentionthematallanditisunclearwhetherhemissedtheconnectionor

deliberatelyignoredit.HiscontentionthattheIrishCentralBankwasborrowingfromtheBundesbankpoints

towardstheformer.


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The Role of the ESCB

The ECB is the lender of last resort to the euro banking system and it has provided copiousamounts of funds to the banks in recent years, notably in the second half of 2011. Indeed, itsbalance sheet is now greater than that of either the FED or the Bank of England but this is not

well known, possibly because the ECB does not trumpet it. At the same time, the ECB iscriticised for not acting as a lender of last resort to governments by buying vastly greaterquantities of sovereign bonds14.

The liquidity in question is provided as part of the ECBs standard monetary policy operationsand the borrowings are collateralised. As the Bank of Spain puts it:

Under the Eurosystem rules for monetary policy management, all operations providing

liquidity to the banking system must be backed by adequate underlying assetsacceptable to the system as eligible for use as collateral. If, after daily valuation, themarket value of the assets used as loan collateral has fallen below the lower triggerpoint set for each security, the borrower must provide additional assets or cash.15

There is also provision for Emergency Liquidity Assistance (ELA) which can be used whenbanks run out of standard collateral. In this circumstance, lower quality assets are accepted butthe interest rate charged is higher (3% versus 1%) and ECB approval is required. Moreover,unlike the standard liquidity measures, which are the responsibility of the Eurosystem as a

whole, ELA represents a charge on the lending national central bank (NCB) and, ultimately, itsGovernment. For example, note 20 to the 2010 accounts of the Central Bank of Ireland stated

that Other Assets of

50.3 billion included

49.5 billion in relation to ELA advanced outsideof the Eurosystems monetary policy operations to domestic credit institutions covered byguarantee (of the Irish Government). It added that all facilities are fully collateralised andinclude sovereign collateral as well as a broad range of security pledged by the counterpartiesinvolved and stated that where appropriate, haircuts (ranging from 5.5 per cent to 80 per cent)have been applied to the collateral.

14SeepreviousIIEApostshere:http://www.iiea.com/blogosphere/the-legal-constraints-that-bind-the-ecb-

15Availableat:

http://www.bde.es/webbde/SES/Secciones/Publicaciones/PublicacionesAnuales/InformesAnuales/10/Fich/b

alancee.pdf


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It is obvious from the charts that there is a close correlation between emergency liquiditysupplied by the ESCB and the debit TARGET balances of the four countries Ireland,

Greece, Spain and Italy. In extremis, the two tend to move hand in hand. This is not surprisingas one is a counterpart of the other. In compiling these data, I have boosted the ECB standardliquidity figures by adding estimated ELA for Ireland and Greece, hence the label ESCB ratherthan ECB. I have also inverted the TARGET2 balances in order to better depict therelationship between the two series. The balance-of-payments flows that Sinn describes areonly possible because of the ESCB financing.

The central banks, for their part, regularly comment on the relationship between ESCB lendingand TARGET2 balances. For example, the 2009 Annual Report of the Bank of Greece notedthat the 13.7 billion increase in its TARGET2 debit balances (from 35.3 billion to 49.0billion) was largely due to the increased liquidity that the Bank provided to credit institutions

during 2009 in the context of the single monetary policy; the largest part of this liquidity wastransferred abroad by credit institutions through the TARGET2 system.16

The Banco de Portugal went one better and produced a chart to show the relationship betweenmonetary policy and TARGET2 debit balances. This chart is reproduced below (updated byme to show the latest 2011 figures where possible).

16Availableat:http://www.bankofgreece.gr/BogEkdoseis/Summary_Annrep2010.pdf


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The BdeP pointed out that the growth of claims related to monetary policy operations causesa very sharp rise in the Banks intra-Eurosystem liabilities (TARGET2). This rise is also due to

the change in liabilities to credit institutions, the increase in foreign reserves and euro assetsportfolio and the continuous decline in the amount of banknotes put into circulation by Bancode Portugal.17

It is clear from the chart that the monetary policy operations dominate and that the TARGET2debit balances are the counterpart on the liabilities side of the balance sheet. The same is trueof the other NCBs. Obviously, any net injection of liquidity by a central bank has the potentialto fund balance of payments outflows. To the extent that it does, the NCBs claims on bankson the assets side of the balance sheet are matched by a liability in the form of debit

TARGET2 balances on the other side.

The other items are minor but it is worth drawing attention to the bonds purchased one. Atend 2010, the ECB had bought over 60.9 billion worth of peripheral countries governmentbonds via its Securities Market Programme (SMP) 18 of which the Banco de Portugal held 2.8billion. If this programme were to escalate, it represents another source of liquidity which has

17Availableat:http://www.bportugal.pt/en-

US/EstudosEconomicos/Publicacoes/RelatorioAnual/Publications/cap10_10_e.pdf

18Thetotalisnowinexcessof200billion.


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the potential to generate further increases in the TARGET2 debit balances (provided it is notsterilised by the NCB in question).

Barring this, the driving factor will be the ECBs liquidity providing operations. In other words,the extent of the outflows and, thus, TARGET2 debit balances, is bounded by the ECBoperations which, in turn, are constrained by the amount of available collateral. This is anotherpoint that Sinn missed he argued that the limit came from the scope of the German banks topay down their borrowings from the Bundesbank and ignored the fact that banks could depositexcess balances with it, virtually without limit, albeit at low rates of interest.

Contrary to some assertions, there is a scarcity of collateral and the ECB is currently in theprocess of relaxing the collateral conditions. There is, thus, a limit to the extent to which debit

TARGET2 balances in the peripheral countries can grow in the absence of further easing inthe conditions governing the acceptability of collateral19.

The straightforward conclusion from all of this is that there is a massive bailout of theperiphery in the form of ESCB lending to credit institutions which has been facilitated andaugmented by relaxation of the criteria governing the acceptability of collateral. Without this,the TARGET imbalances could not exist. There is, however, one bailout, and it is not really astealth one as the ESCB figures are highlighted each month.

Sinns Evolving Position

Sinn is hard to analyse because he keeps changing his position. He appears to be unable toaccept that he has made any error so he keeps shifting his ground amid torturous prose.

A useful starting point is provided by Olaf Storbeck, a German journalist who has locked hornswith Sinn, and who provided a useful summary of the state of play following the publication ofa commentary on the issue in the ECBs October monthly bulletin.20

In his earlier versions, Sinn proposed that tight national caps on TARGET balances beimposed. The implication was that once a country hit the cap no more net outflows would bepermitted to finance imports or capital outflows or whatever. The ECBs response was that

TARGET2 balances represent the uneven distribution of central bank liquidity within the

Eurosystem and that there can be no upper limit on payment flows within a single currencyarea. It could have added that the imposition of such a cap would be akin to imposingdraconian exchange controls to restrict all outflows. This suggestion does not appear in SinnsNBER paper.

19AtpresentELAappearstoberestrictedtoIreland(45billion)andGreece(55billion).Ifothercountries

weretoresorttoELAonalargescale,thishasthepotentialtofacilitatefurthergrowthinTARGETbalances,

subjecttoECBapprovalwhichIbelieveisrequired,againcontrarytoSinnsassertion.20Availablehere:http://economicsintelligence.com/2011/10/14/target2-debate-the-ecb-finally-gets-

involved/


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Another allegation was that the mechanics of the Eurosystem implied that the Bundesbankgave credit to other euro countries at the expense of German banks to the tune of the

TARGET2 balance, now500 billion. The ECB said that there was no negative impact onlending in Germany or elsewhere as a positive TARGET2 balance does not imply constraintsin the supply of credit ... but is a sign of the availability of ample liquidity. This is the oppositeof what Sinn said and, indeed, Economics 101 would teach you that capital flight is more likelyto be associated with tighter conditions in the periphery and looser monetary policy at thecentre and, of course, the ECB is supplying unlimited (collateralised) liquidity. The Germanbanks used the proceeds of the inflows to repay borrowings from the ECB, presumablybecause the demand for credit in Germany had already been satisfied. This suggestion, too, hasbeen dropped and substituted by a lot of waffle about the destruction of money in the NBERpaper.

A key Sinn proposal was that the ESCB should emulate the US practice of settling theirequivalent of the TARGET2 balances once a year with gold backed securities or treasury bills.The ECB pointed out that there are no limits on payment flows within the US and that thedebits and credits that arise between the different FED districts are no more constraining thanthe Eurosystem TARGET2 balances. Moreover, the mechanism used to settle them has noinfluence on cross border payment flows but does affect the key used to share profits andlosses between them.

The NBER Sinn paper contains another long-winded discussion culminating in the memorablestatement that if the other NCBs had to pay the Bundesbank with assets they do not have,this could prove an unbearable hardship for some of them, driving them into bankruptcyovernight and destroying the Eurosystem. He then goes on to speculate about the NCBssecuring their TARGET2 liabilities by handing over the collateral pledged by the commercialbanks but seems to reject this due to the low quality of this collateral. Finally, he muses abouttightening the collateral criteria but concludes that this would not command a majority on theECB board. He was right on that one as the ECB subsequently announced a relaxation of thecollateral criteria in December 2011.

As we have seen, Sinns original claim was that the Bundesbank has a huge exposure to the

other NCBs, which owe it 500 billion. The Bundesbank, itself, had earlier pointed out21 that

there is no immediate change in the level of risk to it due to the rise in its TARGET2

settlement accounts. It added that the risk is not directly related to the TARGET2 positions

and arises from the risks associated with the Eurosystems liquidity supply and is shared amongthe NCBs in accordance with their shares in the ECBs capital. In other words, the

Bundesbanks exposure would be the same if the credit TARGET balance was with the Irish

Central Bank!

21http://www.bundesbank.de/download/volkswirtschaft/monatsberichte/2011/201103mb_en.pdf


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Sinns Elusive Conclusion

There is little doubt, however, that the allegation of a massive secret bailout has resonated withmany of Sinns followers, particularly those who read the Bild. The more refined version of itnow in circulation, which is espoused by many in the German establishment, envisages a Eurozone breakup, bankruptcy of the peripheral countries and a collapse in the value of thecollateral posted22 to zero. In this case, the bankrupt countries might refuse to repay the debt,in which case Germany (and a few others) would truly be on the hook.

Sinns NBER paper looks like a sanitised version of what he really wanted to say. It concludesthat the:

Target imbalances show that a system with idiosyncratic country risks and international

interest spreads for public and private bonds is incompatible with a monetary systemthat allows countries to finance their balance-of-payments deficits with the printingpress, without having to pay for the extra money-printing with marketable assets.

The EU has two choices. Either it socializes national debts in order to eliminate theinternational differences in interest rates (by creating a uniform default risk for allcountries), limiting excessive borrowing through the imposition of politically mandatedconstraints. Or it ensures that the Target balances are paid annually with marketableassets, keeping the debt burdens within the national responsibility and allowing forcountry defaults and interest differentials.

Frankly, this is hard to unscramble but he seems to say that things cant go on the way they areand the options are to curb borrowing from the ECB or to settle the TARGET balancesannually, which is the same thing. My response is that the TARGET imbalances willautomatically unwind when the ECB is repaid.

The ECB is, of course, quite keen to get its money back. To this end, it bounced Ireland into abailout even though the Irish Government was fully funded for another nine months. Duringthe bailout negotiations it initially proposed that the Irish banks deleverage over a three-monthperiod. This was completely unrealistic and the period was extended to three years, which isstill too short. However, the deleveraging process is underway and Irish banks borrowingsfrom the ECB have fallen by about 40 billion. It is likely that a more broad scale resumptionof capital inflows (and there have been some already) will be necessary for the ECB loans and

the TARGET2 debit balances to unwind fully, a process that will take several years.

22EventhoughthisisnotnecessarilyallfromthecountryoftheNCBinquestion.


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The Unrepentant Sinn

A clearer and less expurgated account of Sinns true views may be found in his paper to the2011 Annual Research Conference at DG ECFIN in November 201123. There, he proposed 10commandments, which can be summarised as follows:

1. Further purchases of government bonds by the euro rescue fund EFSF and the ECBare prohibited.

2. The credit that the GIPS national central banks have drawn from the Bundesbank (andthe Dutch Central Bank) via the ECB system (TARGET) is not to increase further.(Note that he excludes Italy). The Target balances are to be settled once yearly withmarketable assets bearing market interest rates.

3. Voting rights in the ECB Council should be weighted by ECB capital shares.4. The ECB Council is to require unanimity and the approval of the creditor countries

governments for any inter-country credit transfers that it tolerates or induces.5. The EFSF is to concentrate on liquidity assistance for crisis countries and limit such

assistance to two years.6. If a euro country cannot service its debts after the two years, an impending insolvency

instead of a mere illiquidity is to be presumed. In such a case, and under exclusion ofthe cross-default rules, an automatic haircut of up to 50% is to be applied to thematuring bonds, and only to them. The depreciated old debt is to be replaced by newsovereign bonds guaranteed up to 80 percent by the EFSF, limiting such guarantees to30 percent of GDP.

7. A country whose guarantees are drawn or that exceeds the guarantee limit must declareinsolvency. The country in question will be granted a haircut on its entire sovereigndebt, and it must leave the Eurozone.

8. After the Basel III system for bank regulation, a Basel IV system is needed in which therisk weights for sovereign debt are to be raised from zero to the level for mid-sizedcompanies.

9. Common equity (Tier-1 ratio and inverse leverage ratio) is to be increased by 50percent with respect to Basel III.

10.Weak banks unable to raise enough capital in the market to fulfil these requirements areto be forced to recapitalise and will be partly nationalised. The government is to sell itsshares in them once the crisis has been overcome.

23Availableat:http://ec.europa.eu/economy_finance/events/2011/2011-11-21-annual-research-

conference_en/pdf/session04_sinn_en.pdf


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Conclusion

Sinn has done us some service. By introducing a geographic (balance-of-payments) dimensionto the debate, he has focussed attention on the sources and destination of capital flows;however, this is mainly of statistical interest and the TARGET imbalances reflect the ECBsliquidity operations which are funding capital flight principally to Germany and should not beseen as distinct from them or additional to them which was the impression created by Sinn.

Talk of a stealth bailout is merely inflaming an already delicate situation.

The rest of the NBER paper is an inconclusive mishmash, however Sinns real views are mostlikely those he outlined to the recent DG ECFIN conference. These are completely unrealisticand, if adopted, would signal the end of the EU as we know it. This may well be his realobjective.

In the extreme scenario of a euro break up leading to several countries going bankrupt,Germany could end up with huge liabilities. Germany thus has the greatest vested interest inmaintaining the euro intact. There is something vaguely appropriate about this given the extentto which German banks financed the party in the periphery. The real merit of Sinns work isthat he was the first to highlight this reality.