Don’t worry about Target2

By Felix Salmon
June 14, 2012

Moody’s just slashed Spain’s credit rating three notches — a clear sign that the bank bailout, even though it hasn’t happened yet, is being seen in the markets as decidedly deleterious for Spain’s creditworthiness. Spain’s 10-year bond yield is now 6.75%, up from less than 5% in early March, and approaching the levels at which market access shuts down entirely. Worries over the future of the euro are back — and, like clockwork, whenever those worries appear, people start talking about Target2.

Last week, George Soros warned about the “the Bundesbank’s claims against peripheral countries’ central banks within the Target2 clearing system”; today, in the NYT, Hans-Werner Sinn says that the Bundesbank is owed $874 billion in Target2 money by Europe’s periphery. “Should Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing, while the euro survives, Germany would lose $899 billion,” he writes.

Meanwhile, in a recent report, Jonathan Carmel, of Carmel Asset Management, publishes this chart, with the explanation that “the Bundesbank has replaced the exposure to peripheral debt that the German banks reduced”; he explains that “periphery debt is now the Federal Republic of Germany’s problem”.


These are big and scary numbers, and Sinn in particular is doing his best to scare as many people as possible with their magnitude. Last year, I blogged a Martin Wolf column about Sinn’s theses, and got a lot of pushback as a result. So here’s my attempt at a do-over: my attempt to explain that the chart above really just shows private risks in Germany going down. The line which matters is the blue one, not the green one.

It’s worth backing up here, a little bit. The eurosystem, as it’s known — the system of national central banks, plus the ECB — is highly federalized. The ECB itself sets interest rates, and has a modest balance sheet of its own, but the only banks it deals with are the national central banks. It’s the central banks, like the Bundesbank or the Banco de España, which perform all the liquidity operations, lend money to their commercial banks, and generally keep the euro functioning as a currency.

Every bank in the eurosystem has an account at its respective national central bank — and if you add up all the money in all those accounts, the total is the Target2 balance at the central bank in question. It’s worth mentioning, here, that there’s one thing pretty much everybody agrees on when it comes to Target2: so long as the euro zone stays together, there’s really no problem at all. All the Target2 balances at the various central banks always sum to zero, and the system works efficiently and well.

If a Spanish woman writes a check to her therapist, the money comes out of her account and goes into the therapist’s account. So long as both accounts are at Spanish banks, this is just a transfer from one bank to another, and the Target2 balance at the Banco de España is unchanged. But let’s say our Spanish depositor decides to move €1,000 from Banco Santander to an account at Deutsche Bank. In that case, the balance on her Santander account will go down by €1,000, and the Banco de España will likewise deduct €1,000 from Santander’s account at the central bank. In Germany, €1,000 appears in the Deutsche Bank account, and in the first instance Deutsche Bank will keep that money in its account at the Bundesbank, so the Bundesbank adds €1,000 to Deutsche Bank’s balance.

Essentially, the Banco de España just destroyed €1,000, and the Bundesbank just created €1,000. That’s fine — they’re central banks, and creating and destroying money is what central banks do. But for simple bookkeeping purposes, everything in the eurosystem has to balance. Remember that what we normally think of as assets, banks think of as liabilities. So Deutsche Bank owes €1,000 to our Spaniard — that’s what it means for her to have €1,000 on deposit at Deutsche Bank. In turn, Deutsche Bank has €1,000 on deposit at the Bundesbank, which is to say that the Bundesbank owes €1,000 to Deutsche Bank. And then the chain goes on: the ECB owes €1,000 to the Bundesbank, the Banco de España owes €1,000 to the ECB, and Santander owes €1,000 to the Banco de España, since Santander effectively needed to borrow money from the Banco de España in order to give that money to Deutsche Bank.

This being high finance, obligations to the national central banks here are collateralized, so the Banco de España is holding collateral from Santander which more than covers the €1,000 it’s owed. On the other hand, the Banco de España in turn is not asked to post collateral at the ECB. Central banks don’t do that sort of thing: there’s no need to post collateral when you can just print money whenever you need it.

In any event, it’s easy to see how the Bundesbank’s Target2 balance has been rising of late, as the balances in the periphery have been declining: there’s a flight-to-safety going on, and German banks are (rightly) perceived as being safer than banks in Spain, Greece, and other peripheral countries. Similarly, German banks which lent money to Spanish borrowers — and especially to Spanish banks — are not rolling over those loans. When the loans are repaid, the German banks just keep that money on deposit at the Bundesbank, rather than lending it out again to some country in serious difficulties. Once again, that increases the Target2 balance at the Bundesbank, and whenever that happens, there’s an equal and opposite decrease in the Target2 balance elsewhere.

Now to the naked eye, all of this looks like exactly what it is: money flowing to Germany. It’s people in the PIIGS countries either repaying the money they owe German banks, or moving their money so that it’s on deposit at a German bank. As such, it’s a bit weird that people like Sinn and Soros characterize this money as money which Germany has lent out to the periphery — at heart, the flows are in exactly the opposite direction. But because of the way that bookkeeping works, these flows create internal accounting obligations between the various eurosystem banks, and it’s those internal accounting obligations that Soros and Sinn are seemingly so worried about.

As Karl Whelan says, however, it’s far from clear that those internal accounting obligations are worrisome at all. The eurosystem as a whole is always in balance, and any money which is created in one corner of the euro zone is destroyed in another corner. The only way that these particular chickens could ever come home to roost would be if a country or countries left the euro entirely. And even then, it’s not obvious that the consequences would be particularly bad.

Certainly a Greek exit would be small enough not to worry about at all. Greece has a negative Target2 balance of about €100 billion. What that means is that Greek banks owe the Bank of Greece €100 billion, which is fully collateralized; and that in turn the Bank of Greece owes the ECB €100 billion on an unsecured basis. If Greece were to chaotically devalue and default, then it’s entirely reasonable to assume that the Bank of Greece would default on those obligations to the ECB, and would keep the Greek banks’ collateral for itself, to help prop up as much as possible the nascent drachma.

If that happened, the rump eurosystem — the remaining 16 central banks, plus the ECB — would take an accounting write-down of €100 billion. They have €86 billion in capital, and another €400 billion in capital they can create any time they want, just by revaluing their gold reserves. So coming up with €100 billion wouldn’t be hard — especially since the whole concept of an insolvent central bank is a little bit silly. If the capital of a central bank stopped being positive and started being negative, then in practice nothing at all would change. Central banks can never go bust, because they can print money.

But what if the entire eurosystem fell apart, and every country reverted to its own national currency? In that case, it’s still hard to see how there would be much of a hit to Germany. Germany’s banks, like Deutsche Bank, would see their Target2 balances redenominated from euros into Deutschmarks. And the Bundesbank would have a theoretical claim on the ECB, but at this point the ECB would barely exist. But that’s fine, it could simply declare that all those euros were now Deutschmarks, since the Bundesbank can create as many Deutschmarks as it wants.

The hidden assumption underlying Sinn’s doom-mongering is essentially that if the euro fell apart, German taxpayers would have to write a trillion-euro check to the Bundesbank, to make up for all the money that the Bundesbank would never be able to collect from the ECB. But that just isn’t realistic. Here’s Whelan:

The new Deutschemark would, like the euro, be a fiat currency and there would be no need for all D-marks to be fully backed by hard assets held by the Bundesbank.

If German officials were concerned about the need for the Bundesbank’s balance sheet to show assets greater than liabilities, then they could agree for the Bundesbank to write itself a cheque equal to the value of the TARGET2 credit and to top it up each year with interest. There would be no need to also top up its liabilities, so the Bundesbank’s technical solvency will have been restored without raising any taxes on German citizens.

I suspect some may suggest that a failure to fiscally recapitalize the Bundesbank would produce a currency that people will have no faith in and/or that this will result in inflation. However, this approach would do nothing to change the amount of money circulating in a post-EMU Germany. And a cheque tossed in an empty vault can’t trigger hyperinflation. More likely, because the value of a fiat currency depends largely on the faith of citizens that the quantity of the currency will be kept in limited supply, is that the new Deutschemark will appreciate significantly, with the result being deflation rather than inflation.

To put it another way: yes, the Bundesbank would essentially be printing a trillion euros’ worth of Deutschmarks, which isn’t a very Bundesbanky thing to do, and is in theory inflationary. But if you’re creating a new currency, then you need to print that currency. And so long as German banks kept those Deutschmarks on deposit at the Bundesbank, and remained shy about lending them out to borrowers in other countries, the money supply in Germany wouldn’t actually increase at all.

Here’s Sinn:

Should Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing, while the euro survives, Germany would lose $899 billion. Should the euro fail, Germany would lose over $1.35 trillion, more than 40 percent of its G.D.P. Has the United States ever incurred a similar risk for helping other countries?

Insofar as Sinn is talking about Target2 balances here — and those balances account for the majority of these numbers — I just don’t think he’s right. For one thing, as Whelan points out on his blog, the US did actually incur rather more than 40% of GDP in costs associated with helping other countries. In 1941, the US national debt was less than 40% of GDP; in 1946, it was more than 120% of GDP. Oh, and 400,000 American men died fighting, too. Much of that can reasonably be considered self-defense, but a lot of it was much-needed aid for the rest of the free world.

But more to the point, German depositors wouldn’t lose any money, German banks wouldn’t lose any money, and the German government wouldn’t lose any money. The only entity which might be considered to have lost money would be the Bundesbank — but really the Bundesbank would just have converted all of the euros in Germany to Deutschmarks. If the euro ceased to exist, obligations within the eurosystem would cease to exist as well — indeed, the whole eurosystem would cease to exist, since its entire raison d’etre is to support the euro. All those internal accounting conventions would disappear in a puff of smoke, and every national central bank would be on its own, running its own currency and looking after its own banks.

It’s maybe comforting to think that today’s euros are somehow real and that tomorrow’s hypothetical Deutschmarks are not real, and that therefore if tomorrow those euros ceased to exist and were replaced by Deutschmarks, that there would be a loss of hundreds of billions of euros. But that’s not how fiat currencies work. Tomorrow’s Deutschmark is no more or less real than today’s euro, and in fact the most likely problem with the Deutschmark is not that it would be weakened when the Bundesbank printed lots of it, but rather that it would be such a popular currency that it would soar in value, making German exports uncompetitive.

There’s no doubt that there would be absolutely massive costs associated with a breakup of the euro. But let’s not exaggerate matters by including Target2 balances in those costs. They’re little more than accounting conventions, really: they’re a way of making sure that the eurosystem always sums to zero. If you’re the kind of person who thinks that the Target2 balances are real liabilities, then you’re also the kind of person who thinks that a bank run in Spain, where deposits flee for Germany, is bad for Germany and good for Spain — since it only serves to exacerbate those Target2 imbalances.

By Sinn’s logic, it would be good for Spain or Italy to leave the euro, since they would default on their Target2 obligations and thereby find themselves incredibly rich — they would have borrowed hundreds of billions of euros from the eurosystem, and then would have no need to ever repay that loan. If you believe that, then feel free to take Sinn seriously. But it seems clear to me that if those euros cease to exist, then all that matters are the bilateral relationship which the national central banks have with all the banks in their country. And those bilateral relationships, built on fully-collateralized loans, wouldn’t be affected by Target2 accounting conventions at all.


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I have a hard time understanding why you and Professor Whelan are sanguine about the impact of a disorderly breakup on countries with a large Target2 receivable. You seem to imply that the wealth of the country is not affected by a repudiation of ECB/Eurosystem payables by Target2 “debtors.” At the end of the day, in such a breakup scenario, the consolidated balance sheet of the Target2 creditor country (e.g., Germany) suffers a massive writeoff of a large asset.

While it’s true that the central bank can replenish such asset by printing new money, the right side of the balance sheet balloons on the LIABILITY line in order to do that. The TAXPAYERS’ EQUITY line is still lower by the amount of the writedown. This is a real wealth reduction.

This is no different than if the banking system held sovereign bonds from a defaulting country that repudiates such debt. True, Germany may be able to survive such a hit, like the US after WWII. But why you are distinguishing Target2 receivables from other sovereign debts needs further clarification.

Posted by Ivan_F | Report as abusive

@FS – IMO IvanF is on the scent here, for the most part. Except to the extent the ECB has funded Target2 by QE-created Euros, the repudiation of a debt by any obligor represents a real loss of purchasing power to the contributing creditors – a loss presently un-accounted-for.

IvanF could himself be charged with “excessive sanguinity” for his implicit assumption that Germany could grow its way out of a big hit, like the US did after WWII. US national debt layed flat at like $250Bil for nearly 20 years, while economic growth cut the burden down to size. Pie-in-the-sky to anticipate anything like that these days, idn’t it?

Everybody’s off the mark IMO about the automatic conversion of Euro-denominated accounts and other liabilities into other currencies. People have all kinds of contracts and accounts in all kinds of places denominated in all kinds of currencies. Trying to undo that has “train wreck” written all over it. So does trying to make the Euro entirely disappear. But by all means – give it a try, said Citizen Robespierre-Fox.

OBTW: Cool about JD’s cufflinks, isn’t it? That alone solidifies his high place in Madame Thérèse Defarge’s knitting.

Posted by MrRFox | Report as abusive

@Ivan — this is very different from holding repudiated sovereign bonds, because the money was never lent in the first place! At no point did German taxpayers send this money to Spain, and so it’s a bit rich to say that Spain now owes this money to German taxpayers.

Posted by FelixSalmon | Report as abusive

In your example, the Spanish citizens would still have Euro deposits in Germany and the ECB would print replacement Euros for the default by Banco de España. Double the Euros double the fun, and the inflation!

Also, you omit that like the Fed, the ECB remits its profits back to the member central banks and their governments. So the taxpayers are directly on the hook for a default.

Posted by marketguru | Report as abusive

I would have thought that the additional money created by the Bundesbank to write off the asset is exactly what would be needed to keep the DM lower in value.

Posted by loafer123 | Report as abusive

Thanks for clearing this up. So, after all, there isn’t a trillion euro reason for Germany to prop up the Eurozone – it can just cut its losses right now before it gets in too deep bailing out Spain and Italy.

What’s the best estimate of the cost to German GDP of an immediate Euro break-up?

Posted by sallust | Report as abusive

@Felix: Ah, so you are making the distinction between Target2 liabilities and sovereign bonds because because “money was never lent in the first place.” This may be where the heart of our difference of opinion lies. While it might be true, as you say, that German taxpayers did not explicitly send money to the Target2 debtor country, I would contend that they did effectively engage in what we might call “vendor financing,” which has the same economic effect as making a cash loan in exchange for a purchase of a German good or service. Let’s look at a simple example:

Having been convinced of its reliability and quiet operation, a Greek household (GH) decides to order a brand new dishwasher from Bosch, which manufactures such devices in Dillingen, Germany. GH goes to its local appliance store in Athens and negotiates a financing plan which the store is able to arrange thanks to its own credit line from a local Greek bank (LGB). The store places an order for the dishwasher with Bosch, which gives instructions to send the €500 wholesale purchase price to Bosch’s account at Deutsche Bank (DB). Through the magic of the Target2 settlement system, as you described it, journal entries are made at the LGB (which, for purposes of this example, extends credit to the Athens appliance store to make this purchase), the Bank of Greece, the European Central Bank (ECB), the Bundesbank and DB. As you also properly described in your post, any collateral required to create the credit for this transaction is posted by the LGB to the BoG. Having confirmed the receipt of the €500 credit to its account at DB, Bosch cheerfully ships a shiny new dishwasher from Dillingen to Athens. In a few days the GH has its new appliance, and everyone is happy, for the time being.

Let’s look at this micro transaction from a macro perspective. Germany exports physical equipment it manufactured locally to Greece. Germany receives nothing physical in return. What it does receive is an electronic notation at its local central bank (Bundesbank) from the ECB denoting a Target2 “receivable” representing the nominal value of the exported good. As long as that receivable can be realized for value, Germany is made whole. If, however, the Eurosystem collapses before such realization, Germany will have exported real goods for zero value, and will have suffered true wealth loss. This is a wealth effect similar to having its taxpayers make a sovereign loan to Greece that never gets repaid.

By the way, even if the collateral that was posted by the LGB to the BoG in this example was money good after the Eurosystem collapse, Germany would never realize that value, because the ECB would never realize that value after a Grexit and repudiation of all Greek debts. This is due to the arrangement that delegates the NCBs as the de facto Target2 collateral agent of the ECB. When an NCB goes rogue, it exposes the rest of the banking system to the rogue NCB’s net liabilities to the system.

Professor Whelan’s response seems to boil down to this: If the Eurosystem fails, the German taxpayers won’t feel a thing because their central bank will replace that receivable from the defunct Eurosystem with its own newly-created local currency. By that logic, Germany should immediately ramp up its dishwasher (and other goods) production and export to the rest of the world without worrying about the rest of the world’s ability to pay, because the Bundesbank will cover any losses via printing press. Really?

Posted by Ivan_F | Report as abusive

My guess: LTROs helped to shift private debt into the central banks/TARGET2. Once the Euro breaks up it will go up, as would a new Deutsche Mark. If it goes up to much, the money printed to cover the Target2 losses can be released into the wild and the remaining Euro or the DM can be weakend and I wouldn’t see this inflationary in such a context. Apart, the pressure from German banks has been taken away as the private balance has been shifted to the Bundesbank. All planned in advance?

@FS: “What that means is that Greek banks owe the Bank of Greece €100 billion, which is fully collateralized” – ahem, I am not so positive as you about the value of such collateral

Posted by kollerro | Report as abusive

It would really just help everyone enormously if we would all read up on actual examples of currency unions that fell apart, and what happened there, before we started trying to guess what might happen in this case. As for shipping goods to other republics and not getting paid, this was tried in Russia 1992-1994. Enterprises shipped goods, didn’t get paid, built up arrears, and the CBR then “printed money” to clear the arrears, resulting in hyperinflation.

Now we are being told that the Germans have infinite faith in their currency and will accept unlimited amounts of newly printed Reichmarks in lieu of actual value from e.g. Greece and Spain. Well, that is certainly the triumph of hope over experience now isn’t it.

Posted by johnhhaskell | Report as abusive

@Ivan — I’m with you right until the point at which you call the payment for the dishwasher “electronic notation at its local central bank (Bundesbank) from the ECB denoting a Target2 ‘receivable’ representing the nominal value of the exported good.”

I’m glad you put the word ‘receivable’ in scare quotes there, because it’s not a receivable as most of us understand it. If I get paid €500 for a dishwasher, I’ve been paid €500. On the other hand, if GH owes me €500 for a dishwasher that I sent them, then I have a €500 receivable. The difference is, in one case I have the money, and in the other case I don’t. In this case, I have the money. Therefore, there isn’t a receivable.

The fact is that in this case the GH has paid out €500, and Bosch has received €500. The transaction is done and dusted, there’s no receivable any more. There’s just internal bookkeeping conventions within the eurosystem.

Posted by FelixSalmon | Report as abusive

@Felix I think @Ivan has a point.

Imagine Bosch pays its workers the €500 and they decide to have a feta cheese and retina party to celebrate. In the EU situation they spend the money, and everything ends up in balance again, with the Greek household paying back the loans from their (untaxed) back garden cheese and wine operation.

But if the euro system breaks up first, they do not have any drachma and the Greeks do not accept their marks, so they have to borrow some drachma to pay for their feta, so they end up with a liability. They don’t benefit from the previous export of the dishwasher. They instead have a domestic asset, only useful for buying more BMWs with, which is why this is inflationary…

Posted by JustinCormack | Report as abusive

Yes, Felix, the dishwasher example seems to be double-counting. GH had to find the €500 somewhere and if they didn’t do it by creating goods or services of that value then the money was borrowed and is already included in Greek debt figures. For example, maybe GH is a civil servant and was paid by the Greek government which financed the payment with a bond.

But there still seems to be a problem here, because in order to gauge the true extent of German exposure we have to include bonds that Germans don’t own. Suppose Spanish Household buys a dishwasher with €500 paid by Spanish Government which finances the payment with a bond. The bond is bought by Spanish Bank which obtained the money to buy the bond from Spanish Central Bank by posting the bond as collateral. Is it not the case that ultimately Germany has shipped real goods to Spain in return for its own fiat currency printed by Spain? If Spain should default, how is this different from selling dishwasher for counterfeit currency, say?

Likewise, the argument against inflation needs more work to be persuasive. SH is not transferring its bank account to Deutsche Bank for the pleasure of holding it at the Bundesbank. Eventually it will spend the money, perhaps on a new Mercedes to take back to Spain. How is this different from money that a German spends on the same thing? Why would increasing the money owned by Germans to start with be inflationary but increasing German money by receiving it from a Spaniard not?

Posted by Greycap | Report as abusive

@Felix: You are taking comfort in the micro picture in which Bosch sees that it is paid. This myopia gives you the same false sense of security that is enjoyed by those who reduce Target2 to merely internal bookkeeping conventions. Although Bosch sees a credit in its DB account, and DB sees a credit in BuBa account, and BuBa sees a Target2 credit in its ECB account, the fact remains that Germany as a whole has not received a final payment for a real asset that left its borders. Moreover, it will not receive final payment if the ECB’s remaining capital backstop countries don’t cough up capital to make the ECB whole to absorb the defaulting BoG’s liabilities to the ECB. What had previously been deemed to be “just internal bookkeeping conventions” within the Eurosystem, are exposed as real debts of what has become an external counterparty (BoG) overnight.

BTW, for completeness, in my example the GH did not pay cash for the dishwasher; they took out a loan from the appliance store in order to make the purchase. This was deliberate to illustrate to collateral-stays-in-Greece point

Posted by Ivan_F | Report as abusive

@Greycap, it’s true in your situation that Germany ended up selling the dishwasher in return for Spanish fiat currency printed by Spain. But how is that different from selling a dishwasher for US fiat currency printed by the US? I fear that we’re rapidly devolving into an existential argument about fiat currencies, here…

Posted by FelixSalmon | Report as abusive

Thanks for your post, which seems very appropriate. This information reinforces the idea of ​​the crisis in Europe. They talk about Billions of Euros as candy. All rescue figures increasing more every day. But the most serious of all is that in Europe still believe that this issue is resolved with Euros. That is still not facing the real causes of this crisis. If you give these huge amounts of money and not face the causes will not solve anything.

Posted by Stocktipsinvest | Report as abusive

Thank you Felix, this is very helpful, but I need to make sure I understand.

Basically, you consider two extreme cases:
1) Greece leaves the eurozone: Greece is small, writedowns are small, nothing to worry too much about
2) Euro zone falls apart completely: each nation regains full monetary powers, can print as much as they want of their new national currency.

But what about an intermediate scenario? That’s the one that always worried me with this TARGET2 dimension. What if Spain leaves the eurozone, yet the euro keeps existing? Wouldn’t the losses be very large and matter a lot, since Germany would still have no power to print DMs?

Posted by Nic22 | Report as abusive

“To put it another way: yes, the Bundesbank would essentially be printing a trillion euros’ worth of Deutschmarks, which isn’t a very Bundesbanky thing to do, and is in theory inflationary.”
This is not quite how it works. Just as a central bank can create liabilities out of thin air (a.k.a “printing money”), it can also create assets out of thin air in extreme cases, for ex. in case of a complete collapse of the euro, the T2 claims would experience losses or be worthless resulting in assets < liabilities on the balance sheet, the central bank can cover that by writing a cheque on itself which is equivalent to capitalizing the present value of future seignorage revenue. this is not inflationary (and not a free lunch either) as it doesn’t change the liabilities side.

Posted by alea | Report as abusive

Felix, please do not become hypnotized by the word “fiat”. I am using it in a merely descriptive, not normative sense. Will you read me better if I drop it?

In the US, the supply of high-powered money is controlled by its central bank, the Fed, which has an inflation target. In the case I described, the supply of German high-powered money is controlled by a foreign agent which has no interest in controlling German inflation. See the difference there?

Posted by Greycap | Report as abusive

As the chapter 7 of the IMF’s Balance Of Payments And International Investment Position Manual (BPM6) says:

The IIP is a subset of the national balance sheet. The net IIP plus the value of nonfinancial assets equals the net worth of the economy, which is the balancing item of the national balance sheet.

It’s simple – a country’s net worth is the sum of its nonfinancial assets and the net “international investment position”. If a EA17 nation has its NCB taking loses its TARGET2 claims (i.e., takes a loss), it’s net worth reduces.

It is true that the Bundesbank may be capitalized by the German government – in case – but no amount of domestic transaction can change the external assets (of Germany as a whole).

The whole discussion that it doesn’t matter is based on an even absurd implicit assumption – whether authors realize it or not – that “balance of payments does not matter”.

Posted by Ramanan_V | Report as abusive

you are quite right, it’s a loss and it doesn’t matter in the sense that it is manageable and the world won’t end, but there is clearly a loss of national wealth.
Worth noting that none of the countries whether creditors or debtors has an incentive to get of the euro as the T2 balances are mutualized per capital key (except ELA). A debtor country like Greece is better off claiming its 2.8% of the Eurosystem balance sheet than seizing 100% of junk greek collateral and be left with hard currency liabilities, likewise a creditor nation like Germany owns 27% of the Eurosystem balance sheet and is better off staying with that rather than be stuck with risk exposure on 100% of the T2 claims recorded on its book which would be in weak currencies if Germany exits.
All these scare scenarios about a total euro break up seem to ignore that no EZ government has a mandate to get out of the euro and nobody unlike Yeltsin for the ruble zone is in a position to call it quit.

Posted by alea | Report as abusive

@alea: Glad to see you agree with me that the loss of Target2 receivables would clearly be a loss of national wealth on the consolidated balance sheet. I am still hopeful that @Felix will come around.

On your point regarding whether Greece would be better off walking away from its T2 liabilities or claim its 2.8% of the Eurosystem capital, I suppose a calculation would need to be made on the true value of that equity, since its balance sheet is not marked to market, and maintenance of that position may well require a capital call in the future.

Also, of course there are other variables to be considered for Greece, like whether they can sustain themselves without access to a payment system for an extended period of time.

Posted by Ivan_F | Report as abusive



German citizens won’t feel the pinch – their bank accounts won’t suddenly reduce because of Target. However Germany’s strong external position at least leaves the possibility of sharing the benefits of this wealth in whichever way it decides politically and a partial loss of national wealth takes away some of it.

My point is that it is not necessary to say “it does not matter” rather explicitly. The problems are hard and in a sense good because it leads to a higher integration which is a good thing. But this should come with stronger action from politicians.

And, of course there are those who think that it’s easy to exit but thankfully serious people don’t believe that.

Posted by Ramanan_V | Report as abusive

My two questions are
(1) the idea of “fully collateralized loans”, as @kollero mentioned — Doesn’t anything in Europe go ‘underwater’?, and
(2) “really the Bundesbank would just have converted all of the euros in Germany to Deutschmarks” — Wouldn’t all the euros in say, Italy, want to become Deutschmarks too?

Posted by EPB | Report as abusive

@Alea and @Ramanan, if you want to worry about “consolidated wealth on the national balance sheet”, feel free. But I don’t see anybody comparing countries on the basis of their national balance sheets — because no one has a clue what that number is. Some unknowable number will fall by some unknowable percentage, with no real-world effect? Excuse me if I don’t get too excited about that.

Posted by FelixSalmon | Report as abusive

It is true that national and international accounts kept by the national accountants and the central bank and reported to the IMF (which checks for consistency) has “errors and omissions” and that this can be large at times. But that is no excuse that these numbers are meaningless. For example everyone agrees that Germany is a huge creditor of the rest of the world and the errors and omissions do not change this fact.

“But I don’t see anybody comparing countries on the basis of their national balance sheets — because no one has a clue what that number is. ”

The IMF publishes this every year.

“Balance of Payments Statistics Yearbook” asp?ID=BYIEA2011001

The Euro Area crisis can simply be understood by looking at countries’ external part of this national balance sheet – the one’s in trouble have a huge net liability to the rest of the world (as a percent of gdp).

Posted by Ramanan_V | Report as abusive

Sorry forgot to address.

7:12 PM EDT was for Felix’s comment at 5:53 PM EDT

Posted by Ramanan_V | Report as abusive

@Felix. I think the key to understanding this issue is the concept of the difference between a “German” Euro (i.e. a bank deposit, denominated in Euro, payable in Germany) and a “Greek” Euro (i.e. a bank deposit, denominated in Euro, payable in Greece). In theory perhaps there should be no difference but in practice there is, evidenced by deposit flight. With this concept, the Eurosystem can then be viewed as simply a new iteration of the ERM, with fixed exchange rates (at 1-1) between all currency pairings (“German” Euro, “Greek” Euro etc), maintained by central banks (just like the old ERM).

Under the old ERM the Bundesbank was obligated to support weaker currencies by offering unlimited credit, at interest, in DMs/ECUs to Italy (say) so the Bank of Italy could buy Lira to prop up its currency without exhausting its reserves. The Bundesbank would end up with Lira reserves or claims on Lira as a result of its intervention. If the Lira was devalued, the Bundesbank would suffer a loss.

It appears the current situation is essentially the same, timeshifted forward by 20 years. The Bundesbank has claims on the Bank of Greece, but if the “Greek” Euro is devalued or disappears, the Bundesbank suffers a loss.

I think that in order to convince people that the Target2 liabilities don’t matter and are just an accounting construct, it is necessary to explain why the Eurosystem is not just another version of the ERM. If people are OK with the concept of central banks losing money propping up currencies (e.g. in 1992, Black Wednesday and all that) then it appears that exactly the same applies in 2012. Why can’t the Bundesbank lose money if its “Greek” Euros are devalued in the same was it could lose money when the Lira, Pound, Franc, Markka etc. were devalued?

(In practice the Bundesbank never met its treaty obligations to offer unlimited credit, so that the ERM did not work as intended, but that is immaterial for the purposes of this debate.)

Posted by Glasnevin | Report as abusive


TARGET2 balances have real economic value (in external debt derailing countries) and explain in a way possible losses that eg Deutsche Bundesbank would have to absorb in its balance sheet.
TARGET2 imbalance shows better that there is capital flight out of the periphery to the core, and this is dangerous. Also, periphery trade deficits and overall thesis of banks growing the dependence on the inputs threw TARGET2.
The point however is not the ekthesis on GR POR IRL or SPAIN debt.
The real point is how banks perform.
Banks (especially Greeks that i know of) for 3 years are unable to perform independently. The financing TARGET2 and MRO, LTRO, liquidity is for recycling balance sheets and stay almost unchanged.
But is like being in a gypsum.
Why? Because the nature of banking is associated with maturation. Deposits of customers can be readily available for commitment but also the banks lend to businesses and households and are committed for many years. The result is that banks often face significant liquidity risks.
The GR banks during this crisis lost more than 70 b € in deposits.
The ratio L/D for every euro in most was around 0.9-1.2 which is from the best ratios in most western countries.
But here comes the dynamics of unchanged maintenance which in some cases make things more difficult.
We witnessed a massive rescheduling in loans with cost for banks, a great increase in NPL but also the inability to finance companies, new business schemes and i m talking even for export based companies.
The banks policy was: we try to restructure loans in order to make many customers able to pay but to new loans, we say NO.
Because if they contract new loans more to those eg of 2010-11 the CAR would be in huge deterioration. So less loans than 2010 a not so substantially worst CAR for 2011 even after huge losses with PSI +!
The problem here? By reducing corporations funding especially those many thousands small family led companies -in case of Greece- we made them dissfunctional.
The most important is that a reduction in loans at 10% practically has a huge impact in GDP and reduce it at least 3-4%.
So the TARGET2 impalances might be the one side of the coin, the potentially difficult to assess, the other is the functioning lately of the Spanish banks.
Real issue for europe is to recapitalise effectively banks facing problems with the best possible terms, in order to improve the funding in real economy and gain trust.
Trust is the issue, a practical one. The mechanics of TARGET2 could be a multiexplaining tool for observation and analysis, but not a base for change especially now its structure.

Posted by MS001 | Report as abusive

I am not know for my brains, but for the life of me I can not see how Felix is right.

As I understand it, he is saying that Germany’s target 2 balance is a reflection of people pouring their money into Germany. This is obviously correct. Where he loses me is the fact that he takes it as a given that this is a good thing for Germany (or at least, a neutral thing).

It seems to me that Felix’s basic problem is that he is treating money as an asset when in fact it is a liability. The fundamental reason why people are putting their money in Germany is that they want to have claims against German institution, not Spanish ones (or whoever is the weak horse of the day). These claims against German institutions are very real liabilities. After all, everyone understands that deposits are a liability of a bank notwithstanding the fact that they are created by people moving their money into a bank.

In the USA, the way this flight to safety creates liabilities is very clear. We call it the current account deficient and its exstance increases the US’s external liablites.

Felix obscures this obvious parallel by trying to talk about how the US works internally. But this comparison does not hold water. Everyone (I think) agrees that if the PIGS stay in the Euro there is nothing to worry about on the Target 2 front. The problem comes if the PIGs switch to a different currency.

If you insist on comparing the internal workings of the states to the EU, it would be better to think about what would happen if the US broke up. If for example the west coast was about the leave the rest of America and so everyone in the West coast was pouring their money into East coast institutions. If the breakup was to occur and the west coasts left the currency union, the East coast would wind up owing the West coast all sorts goods and services (because of the claims that the money represents) and the West coast would effectively owe the East coast nothing (because the whole point of devaluation is to devalue other peoples claims on you).

Now granted the East coast can also devalue, but this creates very real costs for people on the East coast. And ditto for Germany.

Posted by apeman1 | Report as abusive


Are you saying that printing a trillion Euros to meet all the various German Banks’ liabilities (*), as the Bundesbank will need to do to replace its lost Target2 assets, is just an accounting fiction with no real-world impact or consequences or even meaning at all; or are you saying that such trillion-euro-printing will have insignificant medium- and long-term consequences (and indeed, may even be good for Germany by helping keep the New-DEM down)?

If you are saying the former, you are mistaken. If you are saying the latter, the matter is open to debate, and indeed not something that should be fobbed off as an accounting (in)convenience and ignored.

(*) to the Spanish depositor who moved his money from Spain; to Bosch who shipped the washing machine to Greece

Posted by m_m | Report as abusive

The analysis in the article entirely misses the point.

When a Spanish depositor moves money to a German account, they get to own German financial assets. Germany, in return, gets a worthless Target2 credit which will be written off when the euro breaks up.

The after the crisis, the Spanish depositor moves their money back into new pesetas in some new European banking system. The Germans have to pay up by exporting more, and end up poorer as a result.

From this point of view it is easy to see why the Germans would want to switch of Taget2 at some point. Presumably at the logical extreme, the rest of Europe could end up owning most of the German economy.

Posted by Hal9k | Report as abusive

So, if I pay my salary into my bank account each month, and if my bank uses that asset to extend my neighbour’s overdrawn account each month, there is no problem because credits/debits are equal … nuts!

Posted by basilshaw | Report as abusive

OK, gang – Felix is out there all by himself, sincerely believing he’s at last found the one true “free lunch”. Let’s cut him a little slack – K?

Next week he’s going to introduce us to the Fountain of Youth and the lost city of El Dorado. He shouldn’t have to be further distracted by this Euro stuff with that on the agenda.

Posted by MrRFox | Report as abusive


“…because the money was never lent in the first place! At no point did German taxpayers send this money to Spain, and so it’s a bit rich to say that Spain now owes this money to German taxpayers.”

In the first instance, the German central bank assumed a new bank reserve liability, ex nihilo.

Nobody assumes a liability ex nihilo without being compensated for it.

So the German central bank requires compensation for assuming that liability.

Suppose the German central bank received Euro cash (or cheque, or electronic funds) for assuming that liability.

Assume it used those funds to pay for the TARGET2 asset it acquires.

That sends the money to Spain, in effect, in return for Spain’s TARGET2 liability issuance.

So (looking through the aggregate ECB TARGET2 clearing mechanism) Spain owes that money to Germany, having issued the TARGET2 liability in exchange for funds as described.

The actual short cut is that Germany accepts the bank reserve liability in exchange for a TARGET2 asset.

But the economic effect is exactly the same as if it had been paid cash for assuming the liability and used the cash to acquire the TARGET2 asset.

Posted by JKH | Report as abusive

I’m not positive I’m understanding this properly, but…

“Greece has a negative Target2 balance of about €100 billion. What that means is that Greek banks owe the Bank of Greece €100 billion, which is fully collateralized; and that in turn the Bank of Greece owes the ECB €100 billion on an unsecured basis. ”

Suppose Greece leaves the Euro. The Greek banks sent their euros to the Greek central bank. The Greek central bank sends newly printed drachma’s back. What then does the Greek central bank then do with the euros?

Wouldn’t they send them to the ECB? What else would they be permitted to do with them?

Posted by TFF | Report as abusive


Posted by JFoxy | Report as abusive

Felix seems to have lost the debate, but isn’t Felix of the same mind as the ECB and cooperating EU banks in this mess? So where do we stand? I don’t like that accounting definitions are so debatable.

Posted by peterfairley | Report as abusive