Gavyn Davies drew some interesting parallels between the ECB and the IMF last week. This follows on his post the "ultimate taboo", in which he analyzed the idea of "convertibility risk", a term first used by ECB head Mario Draghi in a speech in late July.
Gavyn points out that in explicitly drawing attention to its job of controlling convertibility risk - ie. ensuring that all euros are the same - the modern ECB is becoming more like the IMF. Specifically, during Bretton Woods the IMF sometimes financed the balance of payments deficits of member nations in order to ensure the system of fixed exchange rates stayed, well, fixed. When it did so, the IMF was engaging in a mind game of sorts with the market, for the market knew that the IMF knew that the market knew that rates could be modified if attacked with enough force. In admitting to the world the existence of convertibility risk, the ECB is now displaying an IMF-degree of hyper self-awareness... for the first time.
In order to ensure that this financing was not permanent, the IMF would impose limits on the borrowing nation's finances. This is what the ECB is now doing, too, as Gavyn points out. For instance, in order to be able to participate in the ECB's new outright monetary transactions (OMT) program, nations will be expected to conform to basic ECB requirements or risk being dropped. This is the idea of "conditionality".
In the comments I brought up a comparison to the institution that the IMF could have been if Keynes had won his debate against Harry Dexter White: the International Clearing Union (ICU). I only point this out because having as many comparisons as possible might help shed clarity on the Target2 imbalance problem. It also just so happens that I am reading Barry Eichengreen's book Exorbitant Privilege which touches on this bit of monetary history.
The ICU was first put forward by Keynes in 1941. Much like the ECB clears all intra-European payments on its own books via Target2, the ICU was to have cleared all international payments on its own books. Where the ECB uses the euro, the ICU would have used the bancor. Keynes's purpose for establishing the clearing union was to ensure that each country would be "allowed a certain margin of resources and a certain interval of time within which to effect a balance in its economic relations with the rest of the world" (Proposals for an International Currency (or clearing) Union, February 11, 1942). This would allow the war-ravaged world to return to an era of unfettered free trade rather than isolationism, especially the sort that prevailed in the inter-war years in which narrow bilateral clearing agreements were the norm.
What is interesting is that unlike Target2's open ended granting of credit, Keynes envisioned that the ICU would set explicit limits on any country's deficits. Here is (presumably) Keynes:
Measures would be necessary to prevent the piling up of credit and debit balances without limit, and the system would have failed in the long run if it did not possess sufficient capacity for self-equilibrium to prevent this. (Proposals for an International Currency (or clearing) Union, February 11, 1942)It really is too bad that the architects of the Euro never bothered to read that gem. Here, for instance, are the specific fine-print defining the maximum ICU debit:
The amount of the maximum debit balance allowed to any member-State shall be determined by reference to the amount of its foreign trade, and shall be designated its quota... The initial quotas might be fixed by reference to the sum of each country's exports and imports on the average of (say) the three pre-war years, being either equal or in a determined lesser proportion to this amount, a special assessment being substituted in cases where this formula would be, for any reason, inappropriate. Subsequently, after the elapse of the transitional period, the quotas might be revised annually in accordance with the actual volume of trade in the three preceding years.
A charge of 1 per cent. per annum will be payable to the Reserve Fund of the Clearing Union on the average balance of a member-State, whether credit or debit, in excess of a quarter of its quota; and a further charge of 1 per cent. on the average balance, whether credit or debit, in excess of half its quota. (ibid)The keen reader will notice that in the above quote Keynes advocated levying penalties and limits not only on debtors to the system but also on creditors. These penalties were sure to be "valuable inducements towards keeping a level balance", as Keynes put it. Eichengreen draws attention to a more self-serving motive for Keynes's plan. Envisioning large US surpluses after the war (and large UK deficits), Keynes wanted to devise a way that would soften the effects of these imbalances on the UK by giving the nation time to rebalance, while at the same time penalizing the US for its large credit position. It was not to be, of course, as the ICU never came into being, displaced by the IMF and (to a degree) the Marshall Plan.
In addition to imposing a 1% charge per annum on surpluses above one-half of their quota, listed below are Keynes's specific proposals on credit limits:
A member-State whose credit balance has exceeded a half of its quota on the average of at least a year shall discuss with the Governing Board (but shall retain the ultimate decision in its own hands) what measures would be appropriate to restore the equilibrium of its international balances, including—
(a) measures for the expansion of domestic credit and domestic demand;
(b) the appreciation of its local currency in terms of bancor, or, alternatively, an increase in money-wages;
(c) the reduction of excessive tariffs and other discouragements against imports;
(d) international loans for the development of backward countries.I doubt modern Germany would accept a 1% penalty on its massive Target2 balance, or that it would let itself be shoehorned into increasing wages or expanding domestic credit so as to help its neighbors solve their Target2 imbalance problem.
As for debtor countries, Keynes envisioned that countries would not be able to increase their debit balances by more than one quarter of their quota without the permission of the ICU Governing Board. In the case of debit balances in excess of one-half of its quota, the Governing Board could force the country to reduce the value of its currency or impose controls on capital outflows. When debit balances exceeded three-quarters of the quota, the Board could put the debtor nation under a form of financial shunning in which
it may be asked by the Governing Board to take measures to improve its position and, in the event of its failing to reduce its debit balance below the figure in question within two years, the Governing Board may declare that it is in default and no longer entitled to draw against its account except with the permission of the Governing Board. Each member-State, on joining the system, shall agree to pay to the Clearing Union any payments due from it to a country in default towards the discharge of the latter's debit balance and to accept this arrangement in the event of falling into default itself.Anyhow, the point of all this is to show how the ECB is bereft of any form of control over its clearing members in comparison to what the ICU Governing Board would have exercised over its own members had it been established as per Keynes's plan. This may be one of the problems in forming a currency union. In order to motivate the political will necessary for the creation of any sort of international clearing union, prospective members can only be enticed to join by proposing systems with weak central control over member nation finances. But in order for a currency union to work, strong and systematic rules must be set in place prior to the system's debut. Thus the more robust ICUs of the world are destined to never get off the ground, whereas shaky propositions that should never get off the ground (like the ECB) do get off the ground.