Germans Really, Really Love the Euro

(Bloomberg) -- As worries over the future of the euro zone heat up, the union's biggest member is doubling down on the single currency in an underappreciated way.

Germany's central bank is by far the biggest issuer of cash in the bloc, with the Bundesbank the source of more euro banknotes in circulation than all of its peers combined. The size of the imbalance is underscored by new data from the European Central Bank, showing nations' contributions towards the Eurosystem's consolidated financial statement.

Each national central bank, or NCB, has a notional banknote allocation that's tied to its share of Eurosystem capital. At the end of last year, there were 1.1 trillion euros ($1.25 trillion) in circulation, breaking down like this:

That accounts for how euro cash would be distributed in theory. In order to find out how much cash is actually issued you have to make adjustments that take into account variations in demand, which push the number higher in some countries and lower in others. The adjustments look like this: 

The Bundesbank has, since the introduction of the euro in 2002, put a net 327 billion euros into circulation above its on-paper allocation. By combining the figures in the two charts, we arrive at a true picture of the origin of banknotes in the European economy:

In total, 592 billion of the 1.1 trillion euros worth of banknotes in circulation at the end of 2016 started life at the Bundesbank.

When contacted to explain how Germany's central bank had become the euro area's most prolific issuer, the European Central Bank said:

"The issuance of euro banknotes is an entirely demand-driven process, and none of the NCBs can control the migration of its issued banknotes. As a result, the number of returned banknotes to NCBs can exceed the number of banknotes issued by them. For example, German tourists travelling to Spain take euro banknotes issued by the Deutsche Bundesbank with them to Spain, which are finally lodged at the Banco de Espana."

As the Bundesbank is obliged to meet demand for euro banknotes, the reason for its outsized issuance volumes lies entirely with people withdrawing euros from their German bank accounts. They then spend a certain proportion of those notes in other euro-area countries, as the ECB's vacation example shows. The national central bank in the destination country then finds itself with a surfeit of currency, which can lead to — in the case of the Banco de Portugal, for instance — a central bank having negative net-cash issuance. 

While these figures reflect the benign movement of currency across European borders, there is a potential sting in the tail for the Bundesbank. If a national central bank uses more than its allocation, it has to pay interest on the overuse, at the ECB's main refinancing rate. Right now, the ECB rate is zero percent, so there is no cost — but that might not always be the case.

Should the ECB, over time, raise benchmark interest rates to 2 percent, for example, that would impose an annual cost of 6.5 billion euros on the Bundesbank. This would be paid to national central banks such as Spain and Portugal, who are underusing their allocation. 

It is important to note that there is no real way for this trend to reverse without significantly changing the behavior of the people of Germany. As long as they love cash, they will continue to build a liability on the Bundesbank's balance sheet, which the Bundesbank can do little to stop. 

One more thing worth noting from the data is the position of Luxembourg's central bank. It has an allocation of less than 3 billion euros and yet has put over 96 billion euros into circulation, and in this case it doesn't seem like holiday makers are to blame. When contacted for comment, the central bank said that it doesn't know where cash issued to commercial banks in Luxembourg was destined to travel.  

To contact the author of this story: Lorcan Roche Kelly in Dublin at lrochekelly@bloomberg.net.

To contact the editor responsible for this story: Tracy Alloway at talloway@bloomberg.net, Isobel Finkel