Sorrows of the Bundesbank

A set of Target2 numbers is out again, this time published by none other than the German central bank. The Bundesbank’s December receivables vis-a-vis the eurosystem increased only so slightly from November, by a mere 206 million but to an all-time high again, to 754.3 billion Euros. Year-on-year the picture looks a lot more scary, i.e. the increase from last December turns out to be a whopping 170 billion.

This new record reflects the gravest of economic imbalances the eurozone has seen since its commencement. To lend some sense to the magnitude of these divergences, German receivables kept at somewhere around 1.5 billion Euros at the end of 2006 before the financial crisis got into gear. The problem is that there is no corresponding public anxiety about this torrential shift, as it is not even properly understood by the masses.

To remind ourselves, Target2 is an expression of the balance of payments between a country in the eurozone and the rest of the eurozone. As accounts always have to balance within the eurosystem, else the entire currency union would collapse, Target2 money flows that are entirely being facilitated by the ECB have the function of adjusting surplus and deficit countries.

Germany’s receivables are essentially other eurozone countries’ liabilities. Its surpluses are being migrated via the ECB, from the Bundesbank to the likes of Banca d’Italia leaving the German central bank with implicit government bond collateral on the asset side of their balance sheet. What this means however is that Germany is stealthily lending to the periphery 3/4 of a trillion Euros, in addition to all other exposure.

The interesting part here is that, despite the fact that both Italy and Spain have recently been sporting decent current account surpluses, their negative Target2 balance has been increasing undeterred. The ugly truth is that private funds continue to leave the periphery for Germany, by way of capital flight. Bundesbank money needs to replace them at the origin country, at an accelerating path.

The pundits say there is no problem… as long as the eurozone sticks together. To be sure, as long as surplus funds get reshuffled into deficit countries, the system will theoretically function. The questions are 1. whether there is a natural breaking point, 2. whether political shifts will trigger a disintegration of the eurozone, and 3. how long it will take the German electorate to finally figure out the risks and eventually panic.

It is not as easy to point the finger as one thinks. It takes two to tango, and while one side would blame the periphery’s overspending and lack of competitiveness, the other might take grievance with Germany’s surplus madness, and rightfully so. Currently enforced teutonic virtues have Germans relentlessly build up public and private surpluses and see their savings being recycled down south.

There, combined with Mario Draghi’s QE, the funds find no productive home in the respective economies and flee back up north. The more this happens, the more the eurosystem needs to make sure the surplus excesses are sent back to the periphery, and so the wheel keeps turning. The result is that Target2 imbalances mushroom, and the Bundesbank sits on ever more worthless collateral.

What can be done about it? The Keynesians have an easy answer. Get Germany to finally spend more. Forget about the surpluses and run the country on a deficit course that resembles its counterparts. Be a good sport and act in the spirit of solidarity and economic harmony. Relieve the weaker parts of the whole from its inhumane price adjustments and accept more inflation yourself, or so they say.

This obviously is poison to the German mind. Wasn’t the plan to have their country go up in the larger construct and give up the Deutschmark, but in return assert teutonic values when it comes to spending frugality and monetary conservatism. We are way beyond the point of who’s right and who’s wrong. All that’s left now is how to limit the damage, if it is at all still possible.

Consequently, the September election in Germany will be binary. Will Merkel make it once again and stubbornly reaffirm her country’s economic austerity policy, initially at the obvious expense of others in the club, and eventually at the danger of Germany’s demise once those others pull the plug on the induced straight jacket?

Or will she lose and open the path to a Red-Red-Green coalition, comprising Social Democrats, the Left and the Greens? Sigmar Gabriel has already kicked off the campaign over the weekend by denigrating Merkel and her policies, and by proclaiming that he will end the austerity course and fall in line with the rest of the eurozone – at the expense of German virtues and of overextending Europe’s debt swamp.

You don’t say… It’s the stuff tragedies are made of. The Germans are probably the only nation within the zone that truly means well, but it will end up doing horrible things, including to itself.