You will recall the post on Thursday last week when I took issue with the massive increase in Germany’s Target2 balance in March. The Bundesbank is usually the first among the eurozone countries to report monthly balances, and it had released a spike of 114 billion Euros to a new total of 935 billion, just shy of the trillion mark, the break of which has long been predicted in this space. The suspicion then was that only a significantly larger negative Target2 in the periphery could be the culprit.
We also thought about those 114 billion in more detail. What is the current account surplus likely to be for March? Maybe around 20 billion? So, what about the remaining 95? It smells like a massive resurgence of capital flight from the south to the north. Corona seems to have been the wake-up call for citizens and enterprises alike that Italy is being brought to its knees, and savings and liquidity are in dire need to be rescued from potential capital controls or even bank closures.
We now know the truth. The Banca d’Italia reported their numbers this week, and Italy’s Target2 liabilities spiralled by a whopping 107 billion, to a current total of 492 billion Euros. Spain was rather tame in comparison and saw their Target2 liabilities climb by only 29 billion, to a new total of 407 billion Euros. But the message is crystal clear: The eurosystem is in grave disequilibrium, to the tunes of a trillion Euros, and there is nothing on the horizon that could trigger a counter-balancing of sorts.
It should now be obvious that capital flight is in full force. Italians, in particular, do not trust that their country will survive within the eurozone and the currency union. Whoever is in a position to transfer his funds to a bank domiciled in Germany, the Netherlands, or Austria will do so, as long as they can. Eurocrats and self-declared pundits, who consistently pointed to Target2 as a mere accounting mechanism absent of any consequences as long as the eurozone stays together, have conspicuously fallen silent.
Italy is a basket case and on the brink of breaking point. However, we must not get this wrong. This isn’t Greece we are talking about. Italy’s politicians possess vast negotiating power, some of which has been flashing up when debating the viability of corona bonds. While nominal debt mutualisation by issuing joint liability instruments has so far been averted, Rome is keenly aware that just the threat of an Italexit would send the shivers down Berlin’s spine.
As also pointed out last week, breaking up the eurozone would leave the Bundesbank exposed to a trillion of receivables vis-a-vis the ECB that are neither fungible with periphery debt nor recoverable to any material extent. It would inevitably destroy German national wealth in unprecedented and unimaginable size, and throw the country itself into an existential crisis if not push it right to the brink of bankruptcy. So, essentially, Target2 is already debt mutualisation of sorts.
In addition, what cannot be helpful for the domestic financial system in Italy is the fact that currency in circulation has more than tripled since the monetary union commenced 20 years ago. The total outstanding has eclipsed the 200 billion mark. Isn’t it odd that in a world that is propagating cashless economies Italians are hoarding 205 billion Euros in cash? And isn’t it amazing that Italy’s economy was running more or less ok on 1/3 of the cash in circulation 20 years ago?
Hmm… one is left to wonder how much of it is being stashed under Italy’s mattresses. It is another testament to individuals not trusting their banks and anticipating some form of restrictions that would prevent them from accessing their money. Now, imagine Rome pushing a tad too hard on being bailed out by its eurozone neighbours, and future negotiations that are a given to be had were to end in a serious deadlock, even more capital flight would occur and more cash to be withdrawn from banks.
A scenario like that equates to a death knell for the eurozone, and most certainly for Italy’s economy that has already been brought to a corona-induced standing still – on the basis of the Banca d’Italia having more than quintupled its balance sheet, mind you. In other words, whatever Italy’s contribution to nominal growth to the eurozone has been since 1999, it was simply bloodless, to begin with. Now with corona, not even the ECB’s consistent and generous lifeline will be enough for the country to cope.
People seem to have forgotten that during the 30 years before monetary union Italy permanently depreciated the Lira, and the Deutschmark appreciated, by a total of 80%, to safeguard Italy’s competitiveness versus Germany. Ever since the Lira was fixed against the Euro in 1999, the currency union’s noose around Italy’s neck has gotten tighter and tighter. At one point soon, and absent an all-encompassing bail-out by the north including the mother of all debt restructurings, the people will have their say.
And when the populists take over, their only option is to cut the noose. It’s only a question of time.
