Capital flight

We have long suspected it, but now the hard evidence is in. Italy’s wobbles in the wake of its formation of a new government have triggered a renewed capital flight from the periphery to the north, essentially Germany. The Target2 numbers for May are out, and as expected the divergence of German surplus and periphery deficits have been accelerating. It must have finally dawned on even the staunchest of Italian eurozone believers that all is lost and capital flight the only recipe to safeguard individual assets.

Let’s get straight to the numbers. Germany’s surplus hit another all-time high of 956.2 billion Euros. That is a whopping increase of 53.8 billion from April, one of the largest monthly jumps in the history of the eurosystem, and of 98.9 billion year-on-year. Spain’s deficit climbed by 4.32 billion from April, to 393.6 billion. And Italy’s, after an April imbalance of 411.6 and down from 419.8 in March, rose to a new record of 421.6 billion. And it may only be the beginning of a next large move.

In other words, if Italy managed to keep its narrow current account surplus in May, an approximate but whopping 15 billion Euros of funds that were based there would have fled to Germany. This space may not have been the first to forecast this, but it may be pretty close. Germany’s Target2 surplus will hit 1 trillion Euros in short order. To remind ourselves of the meaning of all this, the Target2 mechanism is an expression of the balance of payments between a country in the eurozone and the rest of the flock.

To put things in perspective, from 1999 through 2006 Germany’s monthly positive Target2 balance was no more than 1.6 billion on average…! Net exports to the periphery were in fact counterbalanced by corresponding net capital outflows from Germany which made the accounts sort of even. In the wake of the eurozone’s financial crisis however capital exports dried up, and double surpluses were created by massive capital flight from the periphery to Germany.

As accounts always have to balance within the eurosystem, else the entire currency union would collapse, Target2 money flows that are being facilitated by the ECB principally have the function of adjusting surplus and deficit countries. As private funds flee from the periphery to Germany, these surpluses need to be re-circled back to Italy via the ECB. German Target2 surpluses become Bundesbank receivables versus the ECB that are implicitly collateralised by government bonds of peripheral eurozone countries.

In other words, the Bundesbank is piling up such receivables in terms of foreign assets that aren’t fungible and will to a large part be irrecoverable. Whatever it was we called economic rebound until recently, it has only served exporters, the business conglomerates, and wealthy institutions and individuals. The economy as a whole, however, doesn’t really gain, as goods and services are effectively being squandered in return for these mentioned receivables without a necessary fungibility.

Years if not decades of German trade- and current account deficits would be required to claw back some sort of economic considerations, a scenario that is and will not be realistic in the foreseeable future. Most of these eurozone deficit countries will not be capable of delivering goods and services of such magnitude to any other country, as much as it is inconceivable that there will be investments in that order or ever be an instance of capital flight from Germany into the periphery.

Italy’s new government has finally dashed all hopes to that extent. Growth, as short-lived as it is, can only be manufactured with more leverage that the country can no longer afford. Brussels is certain to watch Rome’s budgets like a hawk. And the ECB is on record that it will pursue a tapering of its balance sheet, something that will cut into Italy’s lifeline to keep the financial system from completely disintegrating. Private capital is destined to continue to flow up north.

So, the only way to sort of save the day is for Germany to bite the bullet in return for quasi-fiscal sovereignty over the eurozone. And we know what that means… A Europe as it should have been implemented when the common currency was inaugurated, with all the bells and whistles, including one fiscal policy in the teutonic image for all, one constitution and legal system, and an effective dissolution of the nation-state.

I know I am smoking dope when saying this. I am aware this is next to impossible in an era of rising populism, and it is not that I am propagating such a structure without reservation. But at this late stage in the process, it has become an existential question for everyone involved. The Euro has irrevocably tied its members down, and unless Europe wants to face the horrors of monetary destruction at one point down the line, the only way is forward, albeit theoretically.

Again, the first leg of the tragedy in all is that Germany is and will be the paymaster against its will. Recall that the Berlin government has all along and decisively argued against Eurobonds, ie debt mutualisation. It may have been avoided on paper, but Target2 is literally the backdoor to making Germany liable for the periphery’s debt anyway. The second leg is that the impending mother of all debt restructurings in Italy will make it impossible for Germany to recoup much of these well-meant advances.

It has been dawning on Italian individuals that the only way to rescue their savings is to abandon ship and get them out of their country, something that is impressively being proven by the numbers. Germans are a little slower in grasping what all this means, and they don’t yet realise that soil is consistently being dug from under their ground. The day of reckoning is closing in on them, however. Angela Merkel will, in the end, have to add another horrific piece to her increasingly checkered legacy.