How safe is Germany, really?

As the principal creditor to the eurozone, Germany is seriously exposed to the European monetary system, making a German exit from the eurozone perhaps more likely than a Greek or Spanish exit.

TARGET2 is the acronym for the European payments system, designed to lubricate intra-euro trade with cash. It has now become a diabolical self-perpetuating machine for financing capital flight, as well as Germany’s nightmare.

You might have been wondering how the banks of Greece, Spain, Portugal, Ireland and Italy have been funding the massive capital outflows that have been going for a year or so now, as their citizens employ the inexorable logic of the bank run: that is, the more other people take their money out of the country the more rational it is for you to do the same. Well, it’s easy – in fact it happens automatically, no forms need to be filled in, and in central bank funds what’s more.

But as a result, Germany’s central bank, the Bundesbank, now has at least €644 billion, or about 25 per cent of the nation’s GDP, and rising, on deposit with the European Central Bank.

The acronym stands for the Trans-European Automated Real-Time Gross Settlement Express Transfer System. The "2” is because this version succeeded Target 1 in 2007.

If, say, a Greek firm orders something from a German manufacturer, the euros get from the importer to the exporter via a circuitous and typically European route. The firm’s bank in Greece establishes a debit with the Bank of Greece, which in turn has a debit with the ECB. The bank of the German manufacturer earns a credit with the Bundesbank, which in turn has a claim on the ECB.

The system is like one of the those beautiful ball-bearing rolling machines where everything clinks into place and the credits and debits constantly net to zero as the happy eurozone members trade with each other, as envisaged by the EMU designers.

And it all worked nicely up until 2007, when the financial crisis meant that depositors in Greek, Irish, Spanish, Portuguese and Italians banks began to lose confidence in their institutions. Suddenly TARGET2 was accommodating one-way capital flows rather than just trade flows.

This doesn’t show up in the ECB’s balance sheet, where credits and debits balance out. But it does show up in the balance sheet of the Bundesbank, which, at last official count, had €644 billion in claims against the ECB, which is 25 per cent of Germany’s GDP. An article in the Financial Times last week by Satyajit Das said this figure is now up to €800 billion, or 30 per cent of German GDP. The central banks of Finland, Luxemburg and Netherlands are also substantial creditors of the ECB, but nowhere near as substantial as the Bundesbank.

By law, the Bundesbank is only liable to the extent of its share of the ECB’s paid up capital, which is 27 per cent. But the question now exercising the minds of the rapidly expanding group of people with German bank deposits is: what if the Banco de Espana, or Banca d’Italia or Bank of Greece were unable to pick up their share of the tab?

So far the bank runs in Europe’s periphery countries have been steady rather than a headlong panic, although it did all seem to get a bit panicky last week.

A client letter by Barclays Capital a couple of weeks ago said: "Please note that as deposits flow out of Greek and Spanish banks and into "safe” German banks, this has the odd effect that Germany is more exposed to the periphery nation. And this is accelerating.”

Money is also pouring into German government securities, as well as German banks. Last week a two-year bund auction went off at zero interest. The 10-year bund rate got as low as 1.5 per cent.

However, as discussed, Germany is the principal creditor of the eurozone; it is the modern embodiment of the old idea that if you owe the bank a thousand dollars, you have a problem, but if you owe the bank a million dollars, the bank has a problem.

Germany’s problem is that has found itself unwittingly exposed to the European monetary system to the tune of perhaps 30 per cent of its GDP, thanks to the automated payments system it helped set up with the EMU. What’s more, unless it does something, this exposure is only likely to increase rapidly in the weeks and months ahead.

What can be done? TARGET2 certainly can’t be dismantled without destroying the euro itself. The only thing Germany could do is leave the eurozone itself, which is why that is perhaps looking more likely than the exits of Greece or Spain.

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