Sunday, July 12, 2015

Target2, the eurozone and the Bundesbank

One of the things that Germany's grumpy Finance Minister Wolfgang Schäuble has proposed for Greece is to kick them out of the eurozone for five years on a "temporary" basis.

Setting up a "temporary exit" would in effect convert the common currency into a fixed-exchange-rate currency system. That would bring its own issues. But there is an immediate, expensive issue that involves "Target2".

When you start seeing "Target2" in regular news articles, then the doodoo has gotten really deep.

Target2 is the clearance system between the national central banks that the euzozone members use to balance their national income accounts. When, to take a random example, Germany has a net in-flow of funds from Greece due to the decisions of investors and savers, the German Bundesbank books the net in-flow as an asset (loan or the effective equivalent - yes, loans are considered assets in bank accounting).

If the currency zone was well-constructed and stable, this would be a boring accounting procedure since some years the Bundesbank would have a surplus, other a net deficit in currency flows. But since the 2008 crisis, not nearly so much investor's money hasn't been flowing out of Greece into things like real estate speculation in Spain. And savers in places like Ireland, Greece, Italy, Spain and Portugal have been moving euros into German banks and investment funds.

So Germany's Bundesbank now has a huge Target2 asset for net capital inflows, hundreds of billions worth, maybe €500B right now. As countries leave the common currency, the German Parliament will have to recapitalize the Bundesbank for the portion related to that country, which should be written off.

But if the exit is "temporary," Angela Merkel can then extend-and-pretend on recapitalizing the Bundesbank.

The Bundesbank has an English-language page on Target2 (TARGET2 - Balance) that shows its Target2-related balances ("claims") as of June 30 as EUR 531,074,031,152.51. (Please let's not have anyone claiming it was fifty-THREE cents!) I wonder how Angie will explain to her voters that she's left them on the hook for that?

Like all these things, there is a contrary argument that says this really is purely accounting and not real money. I think it all depends on how the claims of other central banks - liabilities on the Bundesbank's side - are structured and how enforceable those claims against the Bundesbank would be. But the asset (future income expected via Target2) would definitely go away.

The unraveling of a major currency fortunately isn't an everyday economic event. So there is some uncertainly involved.

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