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July 09, 2018

German panic about Target2

The German debate on the balances of the Target2 payment clearing system continues to rage. There are two reasons for this. On the one hand, the Bundesbank's Target2 credit with the Eurosystem was over €976bn at the end of June, and is within weeks of exceeding the symbolic figure of one trillion. On the other hand, Germans have taken notice of Paolo Savona's plan B for Italy to exit the euro, which involved defaulting on Italy's external debt including its Target2 balance which is under €481bn and growing.

In this context Peter Boehringer, the AfD MP and chair of the Bundestag's budget committee, has criticised Olaf Scholz in a budget debate for making no risk provisions for the possibility of default on Target2 claims. Frankfurter Allgemeine has also spoken to Christian Dürr, the deputy leader of the FDP group in the Bundestag, who says it's about time the finance minister put on the political agenda the threat of a default on the German taxpayer. The position of the CDU group is that the situation will correct itself because of the coming end of the ECB's asset purchase programme, and trust in the eurozone's southern states returning as a result of the ongoing economic recovery.

But the FAZ insists that something needs to be done. Should the Target2 claims - currently undated, unsecured, and paying no interest - be backed by assets? How could Target2 balances be remunerated when the ECB's deposit rate is negative? And can politics interfere with how the ECB organises its payment clearing system without violating its independence?

That's all well and good, but the article is littered with gross inaccuracies and misunderstandings that frame the German debate on Target2.

Let's start with FAZ' observation that the Italian central bank does not have enough gold and reserves to back the German claims. This implies that the Italian Target2 debit is owed to Germany. But any intra-day Target2 balances between the Italian and German central bank are netted out, and become claims between the national central banks and the ECB. What the German conservatives are ultimately pushing for is either that the ECB pledge assets as security to the Bundesbank, or that Italy secures its debit with the Eurosystem.

But there's also the delirious claim that Target2, as a payment settlement system, actually allows Italians, Spaniards and Greeks to buy real estate, firms and bonds in Germany without money created at home at home either through a sale of goods and services or credit from their commercial bank. This is nonsense of the highest order. A payment clearing and settlement system does not magically allow payments to go through if the payer has no money in their account and no available credit line. FAZ implies that Target2 forces the Bundesbank to grant credit at zero interest to southerners. In actual fact, the only credit that the Bundesbank grants in the context of Target2 is to other central banks intra-day, and to the ECB on an ongoing basis. If Italians - or Spaniards, or Greeks - are buying stuff in Germany, it's because they either had the balance in their bank account or their local bank granted them credit. It this is wrong the fault lies with the Single Supervisory Mechanism, not with Target2. 

We keep wondering whether the German economists and MPs that FAZ talks to are actually advocating that the Bundesbank stop clearing incoming payments from Italy. This, by the way, is basically what the Greek capital controls amount to. But those were the result of ballooning emergency liquidity assistance from the Greek central bank to its commercial banks. That is, the locus of the lack of trust was the Greek private banks. What we're talking about here is to shut out the Bank of Italy from the Eurosystem. 

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July 09, 2018

AfD level with SPD

The latest Emnid poll in Germany gives two messages. The parties of the grand coalition no longer have a majority. Together they get 47%. We see that trend as likely to persist, leading to a structural shift towards multi-party coalitions similarly to what is happening in the Netherlands.

The other interesting aspect is the inexorable decline of the SPD. It now polls at 17%, the same level as the AfD, and only barely ahead of the Green Party, which has 12%. CDU/CSU are also weak but still holding up at 30%. The recent government crisis has clearly affected their figures, but probably not by much.  

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July 09, 2018

How the EU could fail

There is no doubt that the combination of Donald Trump, Brexit and the rise of populism in EU member states constitutes a clear and present threat to the EU.

In his FT column Wolfgang Munchau argues that the EU needs to respond to Trump by setting as priorities the two issues that give rise to the transatlantic crisis. The first is the eurozone's large and still-growing current-account surplus. The second is the extraordinary low rates of military spending by three of the EU largest member states: Germany, Italy and Spain. The point is not to appease Trump, but to address the two areas where the EU is at its most vulnerable. The EU is over-reliant on the US for defence. Any meaningful European defence capability would require convergence in military spending among EU member states. And the current-account surpluses make the EU vulnerable to trade sanctions by foreign powers. Munchau notes Germany lies at the heart of both problems, but the solution must be European. This should have a higher priority now than fixing the eurozone. If the EU fails to address this, as Munchau believes it might, more and more people will start to question the value of the EU itself.

We also noted an interesting and related comment by Hans Vollaard, who did some thinking about the dynamics of how the EU could collapse. It would not happen in a big bang, but through a slow decline. It would happen in a way that one could never tell whether the EU had in fact disintegrated. He draws on the work of three academics who have gone to the trouble of building a model specifically for this purpose. Disintegration would occur at the different levels. Companies could withdraw from the EU by moving outside. Member states could exit, but he notes that, beyond Brexit, a full exit of member states is unlikely because of a lack of viable alternatives. However there may be partial exits - in the form of refusing to engage in risk-sharing in a monetary union, non-compliance with EU law, lower budget contributions, and demands to renationalise competences. Some of this is clearly happening already. These partial exits produce a self-fulfilling prophecy, by weakening the EU and making it less effective.

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