As you are well aware, Target2 balances, or imbalances, have been a focus of this space’s commentaries. For the longest time, I have been warning of the Bundesbank’s receivables vis-a-vis the eurosystem to climb to an unsustainable level. What the punditry has so far neglected as a technical mechanism to re-channel surplus funds back to deficit countries through the ECB will lead to nothing less than a financial catastrophe in case of Italy or Spain leaving the eurozone.
Germany’s Target2 balance had hit yet another all-time high in June, at 975 billion Euros and rapidly been closing in on the 1 trillion threshold. Be reminded that we were at around 100 billion 10 years ago. Strictly speaking, these are non-collateralised receivables versus the ECB but essentially backed by periphery government paper. An exit from the eurozone would cause a massive haircut on those bonds and render the Bundesbank with hundreds of billions of losses.
In other words, the flip side to this coin is basically made up by the negative balances of Italy and Spain recording approx. 480 and 400 billion, respectively. The divergences are mainly caused by capital flight, ie private periphery funds being transferred to German jurisdiction and bank accounts, and the effects of the ECB’s asset purchasing program, with the Banca d’Italia acquiring Italian government bonds from German investors and triggering an undesired outflow of capital.
All the more surprising that in July the German Target2 balance did not rise any further toward the 1 trillion mark. Instead, the number unexpectedly dropped by a whopping 63 billion, to 913 billion! What happened? Did the real economic scenario improve to an extent that capital flows reversed? Does that mean the worst is over and the grave divergence is making its way back to a more normalised eurosystem? Sighs of relief have been audible across the part of the eurocracy that is fluent in financial affairs.
Now, can this really be it? To be sure, it would be a boon to all politicians who still haven’t understood the Target2 mechanism, or they do and are loathe having to one day explain to their electorate what it might entail if things go sour. It is also strange that the German number has almost been reset to a significantly lower level just before the 1 trillion mark has been hit or exceeded. It would surely have been a much bigger public outcry if it had.
At the same time, isn’t Italy in an even worse economic and financial state with its new government, and wouldn’t the private money have every reason to keep transferring funds out of the country? Of course! So, it would be foolish to hang one’s hat on this number and call the distortions off as if nothing ever happened. There must be another reason, and the only way to find out is to syphon through the detailed set of official ECB data,
here.
Looking at those numbers there are a couple of immediate observations to be had. One, Italy’s and Spain’s negative balances did actually not shrink in July, which looks like a contradiction in terms. The migration of numbers should be in sync with Germany on an inverted basis. It tells us that capital flows have everything but reversed. So where did Germany’s positive number retreat from, and is it not a testament that distress within the eurosystem is alive and kicking?
Two, one might suspect that the ECB’s Target balance moved by this kind of margin. Yes, the ECB is running its own Target2 mechanism vis-a-vis the eurosystem. The currently negative number of 252 billion that is being accounted for in July represents the cumulative fund outflow due to asset purchases on the ECB’s central account according to the member states’ key. The Bundesbank could theoretically have bought assets from the ECB and reversed its uptrend in the Target2 balance.
Unfortunately, this does not seem to be the case, as the ECB’s negative balance appears to only gradually be increasing month by month. Also, I am not even sure such action would be covered by a legal mandate the Bundesbank holds… which bring us to observation number 3. The Netherlands’ central bank surprisingly bumped up its positive Target2 balance in July, by an unusual 43 billion Euros. Real trade movements cannot have caused an adjustment of such magnitude.
Without being privy to the inner workings of this dynamic it creates an impression that capital was exported from the Bundesbank to the De Nederlandsche Bank in a one-off transaction in July. No reason to sound conspiratorial here, but this is how it presents itself. Is it possible that this apparent burden on the Bundesbank’s shoulders has been relieved to an extent by creative accounting between central banks, particularly during a period of political tensions within Germany?
Be that as it may. Fact remains that the July reduction of the German Target2 balance is not based on real economic improvement. A look at the details should make us certain. If anything, it will introduce doubts about the transparency of released data and a grave concern that the truth may be disguised for political reasons. The eurozone is still very much on track to overstretch itself, and one day we will have to deal with the reckoning.
