Joined: 03 Jun 2005
|Posted: Wed Nov 21, 2018 7:17 pm Post subject: HOW THE EURO AND THE EU WILL DIE
SURVIVING THE BIGGEST BANKRUPTCY IN HISTORY
Chief Strategist, Zero Hour Alert
Four times worse than Lehman BrothersÖ
Ten times worse than GreeceÖ
Thirty thousand times worse than
the Asian financial crisisÖ
Foreword, forewarned, forearmed 12
Chapter 1: A reminder of whatís coming, again 16
The largest financial crisis in history 17
Break the bank of Europe for George Soros-like gains 19
Europeís Black Wednesday is coming 20
The end of the euro 21
All four factors of the euroís demise apply in only
one place 22
Chapter 2: How the Unholy Trinity is destroying
the eurozone 24
The consequences of a shared monetary policy 26
How the ECB is destroying the eurozone 27
Why the euro is an Eternal Recession Machine 28
The Unholy Trinity has cornered the eurozone at last 30
Chapter 3: Target2 and the collapse of the eurozone 34
What is Target2? And whatís wrong with it? 35
Target2 and the last European sovereign debt crisis
of 2012 37
How Target2 masks capital flight and enables
an automatic backdoor bailout 40
How Target2 is robbing Germanyand crushing
southern Europe, at the same time 42
6 | HOW THE EURO DIES
Trade, with the benefits and self-corrections 43
Target2 is theft, debt and an export thumbscrew 45
What if the Germans call ďStierscheisseĒ on the
whole thing? 48
Alan Greenspan predicts the collapse of the euro 50
The inflation solution 51
The monetary version of George Orwellís
Animal Farm 52
Chapter 4: Europe is a graveyard of monetary unions 55
Historical currency union dissolutions 56
How the Latin Monetary Union failed 57
Timing, size and level of development in past
currency union break-ups 60
The rouble zone is a roadmap for the
eurozoneís failure 62
The rouble zoneís lose/lose proposition compared
to Target2ís 64
Target2 and the transfer rouble as a limitless and
free borrowing mechanism 65
Exporting inflation instead of real stuff 67
Learning from the breakups of past monetary unions 68
The euroís many failures before it even began 72
A short review of Europeís constant currency failures 75
Chapter 5: Why Italy is the weakest link 78
Italy is stuck in the Eternal Recession Machine 83
The sovereign-bank doom loop 86
Italyís sub-prime problem 87
Rising interest rates will force Italy out of the
Chapter 6: Democracy strikes back at the eurozone 91
Repay your debt by spending more 94
Repaying your debts by spending less
(re-enacting the Greek Tragedy) 97
Asking the ECB to repay your debts 100
Chapter 7: The illegal rescue of Europe is almost
used up 103
The ECBís limits and how theyíre ignored 104
Why another rescue isnít on the accounts 106
OMG itís OMT 107
Revenge of the ratings agencies 108
Draghi fiddles with QE rules while Rome burns 110
Chapter 8: Mayís mini-crisis is just a tremor of
the earthquake to come 112
Bond yields are stage-managed 116
Chapter 9: Nine ways Italyís crisis unfolds 119
1. Italyís first populist budget in October 2018 120
2. The breakdown of the Italian coalition
3. The end of ECB QE in December 2018 126
4. German control of the European Commission
in May, or the ECB on Halloween 2019 128
5. Insurgency at the EU in May 2019 (Europe
exits itself) 130
6. Capital controls and capital flight 133
8 | HOW THE EURO DIES
7. The secret German plan to scuttle the euro on
the sly 133
8. The markets puke 136
9. Ratings agencies downgrade Italian debt 137
The least bad option is coming 139
Chapter 10: The contagion effect and Britainís stakes 142
The Italian connection and Britainís fragility 143
Chapter 11: Just another step towards the United
States of Europe? 149
Funk, Werner and the back Delors to a
German Europe 152
Chapter 12: An Englishman, a German and an
Australian write a book about the euro 157
The euro through the German eye 158
A federal Europe through the back Delors and
Brexit out the front door 165
Just a foreign observer, pointing out the obvious 168
10 | HOW THE EURO DIES
Nickolai Hubble is the editor of Capital & Conflict and chief
strategist of Zero Hour Alert, which are published by Southbank
Investment Research. Heís also the international analyst of Jim
Rickards Strategic Investment in Australia and a contributing
editor of The Daily Reckoning Australia.
After finishing his degrees in finance and law at Bond University
in Australia in 2009, working for a bank didnít seem so enticing
any more. An internship with his scholarship provider Goldman
Sachs during the height of the financial crisis was quite enough
Instead, Nick went to work for the company which allows its
analysts to predict the financial crises that investment bankers
cause. The Agora is dedicated to publishing ideas that are too
controversial to get a hearing in the mainstream press. And
thatís where Nick found a very comfortable home.
In 2012 Nick exposed the sub-prime practices of Australian
banks to his readers at The Money for Life Letter. His accusations
that bankers and mortgage brokers routinely manipulate
their customersí loan applications were vindicated by a Royal
Commission in 2018.
Nick doesnít just investigate financial markets and predict crises
and opportunities. Heís also a flying trapeze, juggling and chin
balancing performer and instructor. Heís lived in England,
Ireland, Scotland, Austria, Germany, Australia, Thailand and
Japan, stubbornly refusing to identify with any nationality.
Nick is the only person to have spun a plate on a stick while
playing the bagpipes while swinging on a flying trapeze bar
eight metres up in the air.
12 | HOW THE EURO DIES
On New Yearís Eve in 2002, I was more interested in throwing
firecrackers than the new euro banknotes. My mum tried to
show them to me, but I was busy. My aim was for an explosion in
mid-air. Which involved holding on to the firecracker for as long
as possible and then lobbing it up into the sky at the last second.
One of our firework rockets tipped over shortly before launching.
It took off towards our house. My dad leapt over it, it ricocheted
off some flowerpots in the garden, and then exploded over the
neighbourís house. We emigrated to Australia on the subsequent
New Yearís EveÖ
This book is about why the euro is even more dangerous than
holding on to firecrackers, tipped-over firework rockets, and
moving to Australia.
How can a currency be dangerous? Read the book to find outÖ
Or live my life.
Each time I went back to visit Europe over the years, Iíd get a
snapshot of the euroís effects. Thanks to my parentsí divorce, this
was about twice a year for weeks at a time. Visiting extended family
and friends across Europe, I saw Germanyís economic doldrums
during the Gerhard Schroeder years, housing bubbles in Ireland
and Spain, and the sovereign debt crisis in southern Europe.
Add in the policies of the euro projectís masterminds at the EU,
and I also saw Brexit and the migrant crisis play out first hand too.
Over the years, the only person benefiting from the euro and EU
seemed to be me. I could travel freely and didnít have to fiddle
about with currencies.
But everyone I visited told me about how the euro is causing
them problems. The exchange rate is too high or too low. Interest
rates are too high or too low. The Germans are selling us too
many cars, the Greeks are living off our moneyÖ Everyone had
Only since doing the research for this book have I realised none
of this is new. For more than a hundred years, Europe has tried
and failed to establish monetary unions like the euro. And the
failures are remarkably similar. Discovering this was probably
the most surprising and interesting part of writing this book.
The euroís failure will be nothing new. Depending on how old you
are, I might even say that you should be used to it by now. Even if
you disagree with everything in this book, the history alone begs
the question how anyone could expect the euro to work.
Each time I came back from my trips to Europe, the contrast to
my new home in Australia was stark. The tumbling Aussie dollar
rescued Australia from a recession in 2008. Much as the falling
pound rescued the UK after the Brexit referendum. Meanwhile,
southern Europe is stuck inside the euro. As youíll read about
many times in coming chapters, thereís a reason why Brits called
the euroís predecessor the ďEternal Recession MachineĒ.
Perhaps, if my family had stayed living in the mountains
overlooking the European Central Bankís headquarters in
Frankfurt, Iíd see things differently today. Like my German
family now, Iíd be delighted to see my house rising rapidly in
price. Instead, when I listen to my German family, I hear echoes of
those family and friends living in Spain and Ireland in 2006, who
told me about their booming property investments back then.
The euro used to push irrational exuberance in one part of Europe
and economic misery in another. The regions experiencing the
two swapped over during the financial crisis. Germany became
prosperous and southern Europe is struggling. Iíll explain why
in detail in this book. But in 2018, something changed. If you
listen to both sides these days, everyone is grumpy.
The Germans are worried about the EUís and European Central
Bankís bailout policies. They were promised whatís happening
14 | HOW THE EURO DIES
to their currency and taxes would never happen. Southern Europeans are scrambling for jobs and complaining about the austerity. Nobody told them the euro would mean a slow-motion economic train wreck.
In my last chapter I hope to persuade you that I havenít taken sides on all this. Iíve just discovered the euro is doomed to fail, and the trigger of that failure is imminent. Iím not trying to warn you, persuade you, or opine about the euro. I just want you to discover what I did.
Iím not panicking, so I hope you donít.
16 | HOW THE EURO DIES
A reminder of whatís
On 15 September 2008, Lehman Brothers filed for bankruptcy.
With just over $600 billion US dollars in liabilities, it was the
biggest bankruptcy in history.
The American stockmarket crashed 40% in the two months that
followed. And dragged the world into the financial panic and
recession you remember all too well.
But let me tell you now, that was nothing compared to whatís
bearing down on you now.
After 2009, Greeceís sovereign debt crisis went on for years. The
country defaulted on its debts and then its bailout.
The Greek stockmarket is still down about 75% , despite the best
efforts of the International Monetary Fund (IMF), European
Central Bank (ECB) and EU. Debt ratings agency Moodyís
estimates the default at US$261 billion.
But weíre not talking billions any longer. Weíre talking trillions.
Yet thatís not even the real problem.
On 4 July 1997, Somprasong Land & Development bondholders
voted to default on US$80 million in debt. Over the next two
days, this small default by a Thai property developer triggered
the unimaginable contagion which became known as the Asian
As a result, the biggest ever drop in the American Dow Jones
Industrial Average index forced trading to be suspended for the
day. One of Japanís top ten banks failed, as did one of its top ten
brokerage firms, sending the country into its first recession in
A reminder of what ís coming, again 17
Russia went into default after hiking interest rates to 150%. The
G7 had to create a rescue plan for Brazil. The IMF rescued three
other nations, and three more escaped by the skin of their teeth.
Indonesia went from almost eliminating poverty, to 40% of its
population living below the poverty line within two years.
But this time, the financial contagion of a default 30,000 times
larger than Somprasong Land & Development will dwarf the
knock-on effects of the Asian financial crisis of 1997.
Weíre talking aboutÖ
THE LARGEST FINANCIAL CRISIS IN HISTORY
Can you imagine a bankruptcy ten times the size of Greece and
four times the size of Lehman Brothers? Itís never happened
before Ė those are the two biggest defaults on record.
But this year, records will be broken. And so will stockmarkets,
bond markets, banking systems, pension funds and even an
entire currency itself. Worst of all, there will be a banking
crisis that spreads around the world like in 1997 and 2008
thanks to contagion.
Just as before, Britain will be far from immune. Our stocks
crashed almost 30% in the wake of Lehman Brothersí bankruptcy
on the other side of the Atlantic. Our banking system seized up
and many of our financial institutions had to be rescued.
The Greek crisis saw our stockmarket jolt badly for years, despite
the rescue efforts of the EU, IMF and ECB. Without their efforts,
the world wouldíve returned to the worst of 2008.
But this time, itís one of our largest trading partners which is
faced with bankruptcy, not a small nation or a company on the
other side of the world. Itíll be a bankruptcy that leads to far
worse international contagion than weíve ever seen before. Our
economic and financial future will be directly affected.
Itíll affect your bank accounts, your stocks, your pensions, your
homes, your jobs, Brexit and everything else in your financial
life, and the economic lifeblood of Britain.
18 | HOW THE EURO DIES
To be honest, this crisis will be so big I donít know exactly what will happen to you.
Weíre in uncharted waters, with only past wrecks to guide us. So all I can tell you is that it will be worse than the aftermath of Lehman Brothers. And far worse than the economic chaos of the Greek sovereign debt crisis. The effects will reach even further than during the Asian financial crisis.
All three of those episodes destroyed vast amounts of wealth. Probably a great deal of yours too.
But each example featured a rescue of some sort too. At least eventually. Quantitative easing (QE) eventually reversed the economic and financial consequences of the Lehman Brothers fallout. Greece got its many bailouts from its many benefactors. And IMF rescue packages sorted out the Asian financial crisis.
But what if there had been no rescue? How bad would things have got?
Because this time around, I donít think there can be a rescue. For several simple reasons.
The coming financial crisis will be triggered in a place that cannot be rescued because the rescue there has already happened. There are legal and political limits to any aid. And the problem is simply too big to handle.
QE wonít be enough. The IMF will be swamped. The contagion wonít be containable. Instead of a rescue, the resolution will have to be a default. A default that triggers a crisis worse than the defaults by Lehman Brothers, Greece and the Thai property developer.
British investors are well placed to protect themselves. And even to profit from the coming crisis. In fact, your personal experience as a British investor means youíve already got an intuitive understanding of what Iím about to explain. Because in the 1990s, you lived through part of itÖ
A reminder of what ís coming, again 19
BREAK THE BANK OF EUROPE FOR GEORGE
In 1992, something called the Unholy Trinity came for Britain.
After wild economic policy saw interest rates raised from 10%
to 12% to 15% within hours, Chancellor Norman Lamont finally
abandoned the European Exchange Rate Mechanism (ERM) on
Wednesday 16 September. The pound crashed 17% and the day
became known as Black Wednesday.
The infamous hedge fund manager George Soros was ready for
it. He broke the Bank of England (BoE) and famously bagged a
billion dollars. Meanwhile, Britons bagged a recession. House
prices crashed too.
Iím not surprised Soros was there to profit. After all, the 1992
crash was just a repeat of the same crisis in the 1970s, when
Sorosí career first blossomed. Having experienced the power of
the Unholy Trinity in the 70s, he knew what was coming in 1992.
And again in 1997, when he was singled out by the Malaysian
prime minister as a ďrogue speculatorĒ thanks to his profits on
the Asian financial crisis.
Today, weíre once again faced with the same situation. The same
threats. The same opportunities. And for the same reasons. The
Unholy Trinity is back once more.
Would you like to profit handsomely from another seemingly
impossible breakdown of a currency system? Or would you like
to see your savings and investments crushed under the weight of
the systemís failure?
Because this time, itís going to be far worse.
Britain was lucky in 1992 and the 70s. Lucky because we werenít
in the eurozone. We still had the pound. So our departure from
the ERM and fixed exchange rates didnít cause much trouble.
In fact, in many ways things improved dramatically for Britain
after we left the ERM and floated the pound.
20 | HOW THE EURO DIES
But let me ask you something. What if we couldnít have left the ERM in 1992? What if we were stuck inside the euro instead?
By the time we finally did escape, the ERM was known as the Eternal Recession Machine in Britain. So thereís your answer. An eternal economic crisis. Not unlike what southern Europe is experiencing now. In fact, exactly like it.
EUROPEíS BLACK WEDNESDAY IS COMING
What completely mystifies me is why Europe did not heed the blatantly obvious warning of Britainís Black Wednesday. Nor the struggles of other nations that went through the ERM and abandoned it. Not to mention the economic mess of pegged currencies in the 70s and the Asian financial crisis. In fact, as youíll discover in this book, monetary unions have a success rate close to zero. Especially in Europe.
But European politicians ignored this. The euro became part of a political project. And politicians never listen to economists or history. Thatís why they repeat the same mistakes. Because those mistakes did at least get someone elected at firstÖ
But you canít wish away economics with politics. As much as European politicians decree the euro to be a good thing, it continuously proves them wrong. Putting countries with completely different economies into one monetary sack is downright dangerous. Their economies cannot adjust to booms or recessions. The exchange rate and the monetary policy canít rebalance things. This means a currency peg or a common currency like the euro guarantees severe economic instability.
It took Britain two crises to learn this the hard way before we abandoned Europeís monetary project and stuck with a floating pound. One in the 70s and one in the 90s. Asian countries were forced to abandon their currency pegs to prevent the Asian financial crisis from repeating too.
Instead of heeding these warnings, Europe went right ahead with its project. It dragged the euro into being. And now, southern Europe finds itself a victim of Europeís endless recession machine, itís just changed its name to the euro.
A reminder of what ís coming, again 21
The good news is, this presents you with the same opportunity
that Soros had in 1992, 1972 and 1997. Only this time, itís the euro
itself that will fail, not a currency peg like the poundís.
THE END OF THE EURO
This book is about how the euro dies. Iím talking about the
end of Europeís common currency. A disorderly bust-up of the
greatest political project in history. It sounds extraordinary, but
itís nothing new.
There are two key arguments:
The euro was always doomed. For the same reasons that Europeís
other monetary unions died in the past. A steady build-up of
imbalances that eventually gets out of hand.
Secondly, the eurozoneís reckoning is approaching fast. A specific
default will trigger the end. And the largest financial crisis in
history along with it.
These two arguments are intertwined. And they are true for four
simple reasons, which form the structure of this book:
1. The Unholy Trinity Ė this economic law dates back to the
60s and exposes the fatal flaw of the eurozone. A flaw which
predicts the inevitable demise of the euro.
2. Target2 Ė Europeís backdoor bailout mechanism reveals
that capital flight taking place inside Europe is far worse
right now than during the European sovereign debt crisis of
2012. Watching Target2 is like watching the probability of a
financial crisis in a mirror. And itís at record levels.
3. Democracy Ė at some point, the people have had enough of
the economically sadistic euro project. Just as Britons did in
1992. And the voters in Asian countries did in 1998, when
they gave up fixed exchange rates. Europeans will vote to
leave the euro system, as the British government did. But
theyíll do it with a clean slate, not with the trillions in euro
debt theyíve accumulated.
22 | HOW THE EURO DIES
Europeís rescue is used up Ė The ECBís capital key and issuer limit rules prevent the ECB from bailing out its members by
limiting how much government debt it can buy. And the limit is approaching. Even the new ECB bailout rules are compromised, with ratings agencies poised for a dramatic comeback.
These four horsemen of Europeís debt-pocalypse are why Iíve decided to go public with my extraordinary prediction Ė the largest bankruptcy in history and the death of the euro.
But thereís something crucial you need to understand.
ALL FOUR FACTORS OF THE EUROíS DEMISE APPLY IN ONLY ONE PLACE
Itís only when you put all four factors together that a major financial crisis is exposed as unavoidable. And thereís only one place that meets the criteria of all four. In coming months, theyíre all coming to a head in one country.
The country suffering worst under the thumbscrew of the euro has had enough. Unable to devalue its currency, it canít compete economically. It has barely grown since it joined the euro thanks to five recessions.
The ECBís monetary policy is about to stab its biggest victim in the back by tightening policy and raising interest rates. And a rescue effort is out of the question.
A huge government and private debt burden is slowly crushing the government and the banks. Which is why money is fleeing for the safer banking systems of the north. Put all this together and the conclusion is clear:
Italy will go broke, leave the euro and trigger the greatest financial panic in history.
Just as Lehman Brothersí troubles quickly spread around the world, and Thailandís in 1997, a sovereign debt crisis in Italy will quickly go global. Britain serves Italy as a financial centre and the eurozone is our biggest trading partner. This means we are
A reminder of what ís coming, again 23
one of the biggest stakeholders around when it comes to Italyís
financial health. And so weíll be among the most harmed.
Unless youíre prepared.
But what makes me so sure Iíve discovered something others
have missed? Youíve probably heard about the death of the euro
and Italyís debt crisis for years now.
I think Iím the only one predicting the imminent bankruptcy of
Italy and the failure of the euro for the four reasons mentioned
above. And like I said, you need all four for a proper crisis to play
But donít take my word for it. Letís see if I can convince youÖ
And letís get started with what I call the fatal flaw of the eurozone.
24 | HOW THE EURO DIES
How the Unholy
Trinity is destroying
If you want to understand why the euro will inescapably fail eventually, you need to know about the Unholy Trinity.
In more politically correct textbooks itís also known as the Impossible Trinity and the Trilemma. And they call it that for a reason. Itís an impossible three-way dilemma. It canít last Ė something has to give. And thatís when you get a crisis.
Unfortunately, the entire eurozone is built on a violation of this simple economic law. And thatís why it was doomed from the beginning.
The result will be a global banking crisis thanks to rapid contagion, tumbling asset prices across the board, and the destruction of the euro. The Unholy Trinity says it has to happen eventually. But what is this fatal flaw of the eurozone?
The basic idea is that a country cannot have all three of the following at once: a fixed exchange rate, independent monetary policy and free capital flows. (Capital flows are transfers of money in and out of a country.)
How the Unholy Trinity is destroyi ng the euro zone 25
One of those three has to act as an economic pressure valve.
Otherwise, there will be an economic crisis.
History is full of the economic wreckages of countries who tried
to violate this economic law. Just about every sovereign debt
crisis can be explained in terms of the Unholy Trinity.
A country attempts to fix exchange rates, control monetary policy
and allow freely flowing capital, all at the same time. Eventually,
faced with a resulting economic crisis, it is forced to abandon at
least one of the three. Britain did in 1992 and repeatedly in the
70s, when it gave up fixed exchange rates.
Britainís miserable experience with the Unholy Trinity is one
reason the country evaded the eurozone in the first place. As
Iíve mentioned, Brits used to call the ERM the Eternal Recession
Machine. And for good reason, which weíll get to in a second.
The Unholy Trinity also applies to currency unions like the
eurozone. They make things more complicated, but the idea is
much the same. Thatís why Europeís many currency unions of
the past all failed. Including those in the run-up to the euro.
Hereís how the foundation of the eurozone is built on a bizarre
violation of the Unholy Trinity:
1. Fixed exchange rates between member countries thanks to
2. A messy, semi-independent monetary policy for the eurozone
through the ECB.
3. Free capital flows between countries, which means money
can flood into or flee from parts of Europe, as well as
international capital flows into and out of the eurozone itself.
The Unholy Trinity predicts that one of these three policies will
fail. Either countries will abandon the euroís fixed exchange
rate and return to their own currency, capital flight will see
money leave southern Europe for the north triggering a banking
or sovereign debt crisis, or countries will seek to regain control
of their monetary policy... by leaving the euro.
26 | HOW THE EURO DIES
Iím expecting all three. In fact, one of the three has already begun. As Iíll show you in Chapter 3, it accelerated to record highs in 2018. And that will most likely lead to the end of the euro.
But before we look into that, you need to understand the three seismic forces of the Unholy Trinity that are pulling the eurozone apart. Letís start withÖ
THE CONSEQUENC ES OF A SHARED MONETARY POLICY
The basic idea of monetary policy is to smoothen the business cycle. A country with a struggling economy gets a kick-start thanks to lowered interest rates. A country with a booming economy, high inflation and low unemployment needs to be slowed down with higher interest rates to prevent bubbles, speculation and too much debt.
But what if you persistently set the wrong monetary policy? Deliberately.
Incorrect monetary policy was responsible for the financial crisis of 2008. In the US, the Federal Reserve and its former chairman Alan Greenspan copped the criticism for this. Many commentators now agree that interest rates were kept ďtoo low for too longĒ in the 2000s, inflating the housing bubble with cheap debt. In other words, the central bank financed the sub-prime bubble with low interest rates.
But in Europe, the ECBís one-size-fits-all monetary policy was never blamed for the housing bubbles in Ireland and Spain. Those countries shouldíve had higher interest rates when their property markets boomed before the 2008 crash. But Germanyís economy was the ďsick man of EuropeĒ at the time, requiring low interest rates. So the ECB split the difference and set interest rates somewhere in between.
Politicians call this a compromise. I call it the worst of both worlds. It left Germany with an interest rate that was too high, and Europeís booming economies with an interest rate that was too low. This financed the housing bubbleís excesses in the peripheral countries and kept Germany in the doldrums.
How the Unholy Trinity is destroyi ng the euro zone 27
The reverse has happened since the financial crisis. Germany
is now benefiting from interest rates that are far too low for
its booming economy. The former German finance minister
estimated interest rates should be at 6% for Germany given its
unemployment, inflation and GDP growth.
But the ECB canít raise rates on the struggling Italians and
Greeks. So the 0% interest rates are inflating bubbles across
northern Europe right now. My German grandmother is rather
thrilled about the effect on her property portfolio.
This is one form of the fatal flaw of the eurozone. One monetary
policy for all those different countries means the wrong interest
rate applies everywhere. Letís examine more closely the damage
this does over time.
HOW THE ECB IS DESTROYING
Itís no surprise that Europe has seen the lowest economic growth
of any continent since the introduction of the euro. Itís had the
wrong monetary policy applied, practically everywhere.
Imagine if Mark Carney, governor of the BoE, implemented
monetary policy wildly out of synch with Britainís economy.
Thereíd be furore. But in the eurozone, itís an inherent part of
the system. Because all those countries with their completely
different economies share the same interest rate.
In the countries that are struggling, interest rates are too high.
In the countries that are seeing speculation, inflation and
dangerous debt blooms, the interest rate remains too low.
The ECB is crushing prosperity in the south and financing
irrational exuberance in the north of Europe. Of course,
eventually these things correct. Just as Spain, Ireland and the US
saw their property bubbles burst, Germany will see its economy
Over time, this incorrect monetary policy in each country inside
the eurozone is leading to enormous economic instability and
28 | HOW THE EURO DIES
inequality. Not to mention anti-euro sentiment. Not a good combination for the future of the euro.
In countries experiencing a boom, the ECBís loose policy will lead to economic instability when the bubble bursts. In countries suffering under needlessly tight monetary conditions, it leads to anti-euro sentiment thanks to an eternal recession.
In coming months, the ECB is set to tightening monetary conditions by abandoning QE and raising interest rates. Itís a reaction to the economic booms and inflation of northern Europe. But southern Europe is still struggling immensely. It canít afford higher rates or a lack of support from the ECB.
Do you see why Ralf Dahrendorf, former president of the London School of Economics, said this: ďThe currency union is a great error, a risky, reckless and mistaken goal that will not unite Europe, but divide itĒ?
But thatís just the monetary policy side of things. It shows how a shared monetary policy leads to economic instability and anti-euro sentiment. What about the exchange rate Ė the next part of the Unholy Trinity? Thatís far simpler.
WHY THE EURO IS AN ETERNAL
Usually, exchange rates between economies can adjust for an out-of-control economic boom or bust. Perhaps even for bad monetary policy, like the ECBís.
The Italian lira can fall and the deutschmark can rise to enable Italy to recover economically and Germany to reign in its export and property boom. Thatís why the pound fell 17% on Black Wednesday in 1992. And after the Brexit referendum. The exchange rate acts like a pressure valve. Itís a correcting measure.
In his book The Euro Trap, the economist Hans-Werner Sinn explained how often some countries which are now stuck inside the eurozone made use of this pressure valve:
How the Unholy Trinity is destroyi ng the euro zone 29
From the time the Bretton Woods system collapsed (1973) to the
virtual introduction of the euro (1999), the lira devalued against
the deutschmark by 80%, the peseta by 76% and the French
franc by 52%.
In the EMS period (13 March 1979 to 31 December 1998), Italy
devalued thirteen times and revalued once, France devalued six
times and Spain four times.
These devaluations were signals that a fixed exchange rate
between these countries canít work. They need their currencies
to do some adjusting.
But that canít happen in the eurozone any more. Everyone is on
the euro. So what happens when exchange rates canít adjust?
We donít need to theorise about that. You probably experienced
Britain in the years before it abandoned the ERM Ė the Eternal
Recession Machine. And then there was the 70s, when fixed
exchange rates caused far worse economic chaos. The same
happened in Asia in the late 90s, leading to the Asian financial
But it gets worse. Not only does the euro hinder countriesí ability
to recover by preventing devaluation, it also has the same effect as
a shared monetary policy: it worsens the business cycle, creating
bigger ups and downs, punctuated by crashes. Economists call
this effect ďpro-cyclicalĒ because it adds to the ups and downs of
the business cycle instead of countering them.
The business cycle, with its booms and busts, used to be known
as the trade cycle. Thatís because it was largely an ebb and flow
of import and export booms. The exchange rate and monetary
policy are supposed to smoothen these trade cycles by repricing
imports and exports.
If an export boom gets out of hand, the currency rises, reining it
in. If an import boom gets out of hand, the currency falls, reining
it in. The exchange rate is counter-cyclical Ė it pushes the trade
cycle towards rebalancing. And thereby the economy too. But
how is the shared exchange rate of the euro pro-cyclical instead?
30 | HOW THE EURO DIES
Countries inside the eurozone that are struggling are stuck with an artificially high exchange rate, while countries that are booming donít see their exchange rate rise. At least not as much as it would without the struggling nations holding it back. Just as on monetary policy, everyone is left with an awkward in-between Ė an exchange rate that is correct for nobody. The worst of both worlds.
The European Commission estimates Italyís export industry is three times more sensitive to the euro exchange rate than Germanyís. Which makes Italyís position worse when the falling lira should be easing the pressure instead. Meanwhile, Germanyís export boom continues unabated, even setting recent records. Ironically, itís the euroís policymakers who criticise Germany for this, despite their beloved currency causing it.
I hope you now see the euro for what it is. A politically motivated economic shemozzle. Or as the Italian deputy prime minister called it, ďa crime against humanityĒ. Thatís because his nation used to rely so much on being able to devalue the lira. Just as Britain needed to devalue the pound often in the past.
Britain escaped the Eternal Recession Machine of the euro. Thanks to the floating pound, our currency even absorbed most of the Brexit shock. Like Australia in 2008, our currency saved us from a recession. Itís an incredibly valuable pressure valve to have.
But Britain wonít escape the fallout when the euro project fails. And that day is approaching. Because when interest rates and exchange rates canít adjust, something else happens instead. Something terrifying to Europeans. Something that will trigger the greatest financial crisis in history, just as it triggered the Asian financial crisis and the more recent collapse of Cyprus.
Something that has begun across the eurozone already.
THE UNHOLY TRINITY HAS CORNERED THE EUROZONE AT LAST
If you remember, the Unholy Trinity covers exchange rates, monetary policy and capital flows. The euro is holding steady,
How the Unholy Trinity is destroyi ng the euro zone 31
for now, even if itís politically unpopular in parts of southern
Europe. The ECB isnít popular either, but it goes with being
inside the eurozone.
So can you guess what part of the Unholy Trinity is cracking
Itís capital flows. Or should I say capital flight? What Iím going to
show you now is that money is fleeing out of southern Europe and
into northern Europe at a magnitude that makes the European
sovereign debt crisis of 2012 look boring.
Capital flight is what made the Asian financial crisis of 1997, the
Mexican peso crisis of 1994 and the original European sovereign
debt crisis of 2012 a problem, especially in Cyprus. Itís when
money leaves an economy for safer places, triggering a banking
and debt crisis. Itís like a bank run, but on an entire country.
For now, the ECB is sweeping the eurozoneís capital flight under
the rug in two ways. But neither of those two are sustainable for
political, economic and legal reasons.
What I really want you to understand is that this is the issue
which leads the eurozone to a dead end. Itís the reckoning youíve
been waiting for.
I do realise people have been predicting the breakup of the euro
for a rather long time. It seems like Europe has been a basket
case for years. And most countries in the world are faced with
the problem of rising interest rates and too much debt. In fact,
Britain is one of the worst-off countries if interest rates do go up.
And Japan faces far bigger debt problems than any government
in southern Europe.
But only in the eurozone will this issue come to a head. Because
the Europeans have painted themselves into a corner by creating
the euro. And the Unholy Trinity has finally cornered them.
There is no longer a way out that doesnít involve the destruction
of the eurozone. And a default of record-setting proportions.
Unfortunately, understanding exactly why this is the case for
Europe requires a peek into the inner workings of the eurozoneís
32 | HOW THE EURO DIES
financial system. And weíll have to start with something called Target2.
But first, none other than former Prime Minister Margaret Thatcher kindly summarised this chapter for me in her book Statecraft, which was published on my birthday in 2002:
Without the power to issue and so to control oneís own currency Ė and by Ďcontrolí I include the generally desirable aim of letting it float freely Ė a state can no longer be said to determine its own economic policy.
It can no longer set its interest rates in line with monetary conditions and other requirements: instead, interest rates are set for it by a supra-national authority according to supranational criteria. A stateís ability to cope with economic shocks or to respond to economic cycles is thus very much constrained.
It is, consequently, forced to rely on fiscal means alone to ride out difficulties. But precisely because there has been a fundamental shift of power and authority to the supra-national (in this case European) level, individual countries using the single currency are not going to be allowed to spend, tax and borrow as they and their electors like.
And making the same point in a speech in 2001:
Without its own currency, Britain would lose the power to determine its own economic policy Ö There is nothing very complicated about what is at stake. With a single currency, there would be a single interest rate, set not to take account of Britainís needs, but those of a range of different countries Ė a recipe for Ďboom and bustí indeed. And there would be immense and, in the end, irresistible pressure to allow our budgets to be made by Europe as well.
The attempt of the EU to control national government budgets is central to the second half of this book. And to my prediction for the death of the euro. But you need to understand the pressures building inside the eurozone first.
How the Unholy holy Tri nity is destroyi destroyi destroyi ng the euro euro zone 33
34 | HOW THE EURO DIES
Target2 and the collapse
of the eurozone
Italyís Target2 liabilities hit a new record in August 2017. Then
again in September, and November. And again in December.
And once more in February 2018. And May. And June.
Each time, it made the news. And each time most people who
read the headline had no clue what it meant. In fact, it turns out
most economists and financial commentators didnít know either.
As I write this, a new debate has broken out about Target2. The
argument is between ECB officials, German economists writing
in the hometown newspaper of the ECB (my former hometown),
and analysts in the US and elsewhere who write research reports
and blogs. Nobody can agree on what Target2 actually is. But
everyone is very vehement theyíre the only one whoís right.
Officials at the ECB simply deny the Target2 balances mean
German economists are panicking about a default on the huge
debts other countries owe Germany under Target2.
European analysts argue they arenít a debt, so thereís nothing to
Other analysts argue theyíre the most important debts Ė the ones
that spell trouble for the eurozone.
Only behind closed doors do any officials admit the nature of
the problem. None other than former Federal Reserve chairman
Alan Greenspan told a group of analysts I work with about how
Target2 could trigger the end of the eurozone. You can read what
he said later in this chapter.
Target2 and the collapse of the euro zone 35
Recently, one of the worldís premier banking institutions
confirmed that Target2 balance spikes signal capital flight
within the eurozone and are linked to the risk of sovereign debt
defaults and the breakup of the euro.
You might think all these positions on Target2 are contradictory.
But each of them is technically correct. Itís just that some are
deliberately misleading. And the abstract nature of Target2
doesnít help matters. Not to mention its obscurity. Which is why
itís easier to ignore it and go on with your life.
Well, today is the day you stop ignoring the Target2 headlines.
Because they signal the amount of strain on the Unholy Trinity
inside the eurozone Ė the level of pressure on the pressure valve
that the eurozone has fused shut.
WHAT IS TARGET2? AND WHATíS WRONG
Target2 is the system by which the various European national
central banks, the ECB itself, and Europeís commercial banks
interact. They settle large transfers of funds using the Target2
system. Itís how they move money around between each other.
The key players are the ECB, the German Bundesbank, the French
Banque de France and Italyís Banca díItalia. Nineteen other
central banks are involved, plus four from outside the eurozone.
The BoE doesnít participate.
Within each country, the commercial banks interact with the
system via their national central bank. And each central bank
interacts with others via the ECB. So the ECB is the linchpin at
the centre of the system.
Money loves to cross borders, especially in a monetary union.
Trade, investment and capital flight are some examples of this.
Target2ís main aim is to keep the amount of money in each nation
of the eurozone stable. Without it, youíd have a shortage of euros
in Greece and loads in Germany, thanks to the trade imbalance.
When the Greeks send their money north to buy German cars,
or they send their money to German banks to protect their
36 | HOW THE EURO DIES
savings from Greek bank failures, Target2 is the system by which the money is sent back again to rebalance things. And this is recorded in the form of a loan between the ECB and the two national central banks. The Greeks owe the ECB and the ECB owes the Germans. In the end, Target2 keeps the amount of money in each country stable while the Target2 system records how much money moved.
Unfortunately, doing so creates some rather odd effects. Effects that the creators of the euro seem to have missed. This chapter gives you the detailed explanations. But first, let me sum up my conclusions so you can see how important examining the details will be.
Target2 both enables and masks capital flight inside the eurozone. Every euro that flees countries like Italy and Greece is sent straight back south again, but as a sort of loan. Target2 is the system that makes that happen, automatically. It is not a question of policy or decision making. It is a feature (or bugÖ) of the system.
Target2 is an automated backdoor bailout mechanism for southern Europe with no limit, no costs and no obligation to actually pay upÖ ever. And the lenders in northern Europe have no choice but to go along with the programme (or leave the eurozone).
Target2, like the shared monetary policy of the eurozone and the shared exchange rate of the euro, is pro-cyclical. It makes the boom and bust cycle worse, perpetuating trade imbalances instead of correcting them.
Target2 forces countries with persistent trade surpluses to finance the trade deficits of countries with persistent trade deficits. They have to do this without limit or end, and with no hope of being repaid.
Target2 lending will never actually be repaid. Because it can only be repaid in a very particular way: by reversing the trade balance or capital flight, and sending goods, services and money back again at some later date. Which will never happen thanks to Target2ís other effects on the trade cycle and economy. (The ones that exacerbate the problems by being pro-cyclical instead of
Target2 and the collapse of the euro zone 37
counter-cyclical.) This means the system amounts to systematic
and systemic theft.
Put these effects together and you have the bulk of the avalanche
heading towards the eurozone. Capital flight, perpetual trade
imbalances, perpetual transfers of wealth into a black hole, and
perpetual growth in a promise that will never be kept.
This chapter forms the guts of my prediction about how the euro
dies. But before we dig into what Target2 really is, why not get
the benefit of some hindsight to prove the point Iím making?
TARGET2 AND THE LAST EUROPEAN
SOVEREIGN DEBT CRISIS OF 2012
The trouble with Target2 is that the transfers of funds seem to
be steadily going one way. Out of northern European hands and
into southern European.
This chart from Yardeni Research shows how northern European
nations are financing southern ones:
Notice how the balances diverged and peaked in 2012 Ė during
the previous European sovereign debt crisis. Germanyís
balance spiked into positive territory, while the famous PIIGS
(Portugal, Italy, Ireland, Greece and Spain) saw their balances
go deeply negative.
Back in 2012, when the European sovereign debt crisis featured
the relatively manageable Greece as its centrepiece, Target2
was a major issue. But ECB officials simply pretended it wasnít.
It reminds me of when the sub-prime crisis was nothing but a
small problem in an obscure corner of the US mortgage market.
Next minute, all hell broke loose.
Back in 2012, the Target2 imbalance growth triggered
legal challenges and political campaigns in Germany. An
extraordinarily popular book by a German economist explained
how the Target2 ďtrapĒ poses an immense risk to German ďmoney
and our childrenĒ. Itís always the children.
The German central bank took the ideas seriously enough to try
and refute them. In fact, they were considered comprehensibly
38 | HOW THE EURO DIES
Target2 and the collapse of the euro zone 39
refuted when the debt crisis died down thanks
refuted when the debt crisis died down thanks to the ongoing
bailout of Greece by the Troika (the IMF, the European
Commission and the ECB).
Unfortunately, the Bank of International Settlements (BIS)
eventually confirmed the German economist Hans-Werner Sinn
and his book The Euro Trap were right after all. Its quarterly
review explained why (emphasis mine):
In the period leading up to mid-2012, T2 [Target2] balances grew
strongly due to intra-euro area capital flight. At the time,
sovereign market strains spiked and redenomination
risk came to the fore in parts of the euro area. Private
capital fled from Ireland, Italy, Greece, Portugal and Spain into
markets perceived to be safer, such as Germany, Luxembourg
and the Netherlands.
Indeed, during that period, the rise in T2 balances seemed
related to concerns about sovereign risk.
The BIS research studied the link between the default risk of
southern European countries, the risk of them leaving the euro,
and their Target2 imbalances. But it didnít use logic or sequential
arguments like I do in this book. It used observation of financial
market prices and statistical analysis instead. And found the
three indicators are closely related: a countryís growing Target2
imbalances signal the growing risk of a default and departure
from the euro.
This is evidence that, no matter what ECB officials say, the market
believes Target2 reveals capital flight and strain on the euro.
The statistical analysis of observations of real financial market
action confirm it.
FT Alphaville, which highlighted the BISí new analysis to me,
summarised the implications (emphasis mine) :
Thatís a fairly straightforward admission that had the T2
[Target2] balance system not existed, and private investors
pulled their money from the periphery [southern Europe] the
way they did in 2012, the flows would not have cleared
without a major currency collapse.
40 | HOW THE EURO DIES
What the imbalance amounted to was Germany taking a temporal IOU from the periphery ó a stealth loan by all objective measures.
In other words, the Germans bailed out the PIIGS via Target2 in 2012. Without them, the euro would have failed.
The problem is, the BISí views about what happened in 2012 suggest that Target2 is about to trigger a rerun of the 2012 European sovereign debt crisis. Target balances are hitting records once more.
Weíre back to 2012. But this time, a far bigger nation than Greece is in trouble. So now is the time to understand how it all works.
HOW TARGET2 MASKS CAPITAL
FLIGHT AND ENABLES AN AUTOMATIC BACKDOOR BAILOUT
When money is escaping the dodgy banking systems of southern Europe for safer havens to the north, Target2 is the mechanism by which central banks send money back south, in the form of a credit.
If you donít really understand what a credit is supposed to mean in this context, donít worry. Neither do the experts on the Target2 system. At least they canít agree. Mostly because itís a unique sort of credit. Unless you bother to research the history of the Soviet Union. Which analysts of the European Union seem to very carefully avoid, for some reason. Back to what the credit really means in a moment.
Itís important to note that the Target2 transfer happens automatically. Itís a rule, or bug, of the system. The idea is to keep the amount of money in each nation stable. The trouble with this way of managing capital flight inside the eurozone is that it turns Target2 into a backdoor bailout. A bailout that saved southern Europe from a currency collapse in 2012, as the BIS and FT Alphaville explained.
Target2 and the collapse of the euro zone 41
This is why many economists see Target2 as a form of loan.
Philip Turner, a former official at the BIS and now a professor
at the UKís National Institute of Economic and Social Research,
called these Target2 transfers ďlending on a huge scale that no
government has approved. It canít go on indefinitely.Ē And, ďThe
politics are poisonous. The Germans are feeling very exposed.Ē
They fear a default on the huge volumes of Target2 loans theyíve
made without their own approval.
Iím not sure if Target2 balances can technically be called a loan.
They have some odd features which would suggest otherwise.
Such as never needing to be repaidÖ More on that below.
I prefer the analysis of Professor Marcello Minenna, a Target2
expert at Bocconi University in Milan: ďThe Target2 imbalances
show there is something fundamentally wrong with the
construction of the euro. It is a measure of pressure, and if you
keep adding pressure, the glass will break at some point.Ē
When Target2 balances are spiking fast, watching those balances
rise is like looking at Europeís capital flight in a mirror. Why a
mirror? Technically, the Target2 imbalances are a measure of
the euro systemís automatic response to capital flight, not the
capital flight itself. Failing to make this distinction allows people
to talk past each other when they argue about Target2 endlessly.
One side is horrified by what it sees in the mirror. The other side
reassures us that itís only a mirror.
Who do you believe?
As weíll get into next, Target2 balances donít just reflect capital
flight, they reflect some other things too. Which is why people can
debate about whatís really going on when Target2 balances spike.
But that is what made the BIS study so important. By watching
real financial markets, it linked the default risks of countries,
and their risk of leaving the euro, with Target2 balances. This
suggests it really was capital flight in 2012. Capital flight bad
enough to increase the probability of a default and a departure
from the euro.
42 | HOW THE EURO DIES
Without Target2 to cover up the capital flight, there wouldíve been a crisis that threatened the euro itself.
Do you see how important Target2 is now? It saved us from the biggest bankruptcies in history in 2012, and the death of the euro, by pumping money back into southern Europe. And itís doing so again now.
But capital flight isnít the only problem inherent in Target2. It is the snowflake that triggers the avalanche. By the time capital flight begins, you better be well clear.
Do you blame the snowflake for the avalanche? No, you look at the whole build-up of snow on the mountainside. Thatís what weíre going to do next.
HOW TARGET2 IS ROBBING GERMANY
AND CRUSHING SOUTHERN EUROPE, AT
THE SAME TIME
In economics, itís rare to encounter a lose/lose proposition. Exchange is mutually beneficial, otherwise it wouldnít happen.
When it comes to trade, some politicians distinguish between foreigners and compatriots. In an attempt to buy votes, they introduce policies that harm foreigners and aim to help locals. This is at best a win/lose proposition.
The eurozoneís Target2 system is special. It is a lose/lose proposition. Everyone in the eurozone is harmed by it. But it continues to exist, thanks to politics.
The Target2 system harms the nations of the eurozone in particularly pernicious ways that few people understand. It robs countries with trade surpluses of their wealth, while preventing countries with a trade deficit from rebalancing their trade. Thatís why I call it a lose/lose proposition.
Another way to say it is that Target2 prevents northern Europe from ever realising an immense part of its wealth. And it crushes
Target2 and the collapse of the euro zone 43
the economies of southern Europe by preventing their businesses
from exporting at competitive prices.
If people became aware of this, it would have political
implications. The sort that reverse the political desire to keep
the euro. In all nations, not just those in struggling economies.
So letís get one step aheadÖ
TRADE, WITH THE BENEFITS AND
Understanding how Target2 steals wealth from exporting
nations, while crushing the economies of importing nations,
requires a comparison to normal trade outside a currency union.
When we compare normal trade with how things work inside a
currency union, the losses of being in a union become obvious.
There are two things to focus on. The reward for a trade surplus.
And the self-correcting tendency of trade balances. Normally,
trade features both. Trade in the eurozone under Target2
Usually, a nation which exports more than it imports acquires
wealth as a result. When youíre getting paid more than you spend,
it builds up assets. In the case of trade, these are foreign assets
because you get paid in foreign currency and/or by foreigners.
Those foreign assets are often investments in factories and
companies in other countries. They can be investments in
foreign stockmarkets that people will sell in retirement. Or
just currency holdings. The point is, you accumulate wealth in
exchange for your trade surplus.
Under the trading and currency system known as Bretton Woods,
countries with export booms accumulated gold. That was their
ďrewardĒ for being so productive and selling goods overseas.
This system also forced the countries with persistent trade
deficits to eventually devalue their currency against gold.
Otherwise they would run out of the yellow metal and be unable
to pay up.
44 | HOW THE EURO DIES
Devaluing the currency in this way had the effect of making local goods cheaper for foreigners while imports became more expensive for locals. And that in turn corrected the trade imbalance.
Because of this self-correction mechanism and the real value of gold, the Bretton Woods system was fairly stable.
Until Charles de Gaulle sent French submarines to actually pick up the American gold that France was entitled to under the system. This signalled the beginning of the end for Bretton Woods, and the US peg to gold. But thatís another story.
Under the system that followed, the same two key characteristics held true. Countries with a trade surplus gained foreign assets. And the system self-corrected trade imbalances by allowing exchange rates to move. Most of the world operates under this system today.
A country with an export boom accumulates foreign assets as their reward. The Japanese bought Australian and London property with all the dollars and pounds they got in return for goods labelled ďmade in JapanĒ. The Chinese do it today. Funnily enough, the people who worry about foreigners buying up property often drive Japanese cars and wear Chinese clothes, thereby financing the foreignerís purchases.
Just as important as accumulating foreign assets is that currencies are mostly free to fluctuate to adjust for these flows of money and goods. The system is constantly trying to self-correct through moving currencies.
A country with a trade surplus sees its currency rise, making its goods more expensive to foreigners, while imports became cheaper. The German deutschmark and the tourists it funded are the famous example of this. Meanwhile, southern Europe kept devaluing the lira and drachma to get its export industries going again, as you read about earlier.
The point being, eventually, trade flows reverse and rebalance.
This is how trade operates, for the most part. But not when it comes to trade inside the eurozone.
Target2 and the collapse of the euro zone 45
TARGET2 IS THEFT, DEBT AND AN
Inside the eurozone, under Target2, the reward for exporting
more than you import is a fudge. And there is no self-correcting
impulse built into the system that allows countries to rebalance
This combination spells political and financial trouble in export
nations like Germany. And economic trouble in trade deficit
nations like Greece, which eventually leads to political trouble
too. Once again, itís a lose/lose system.
Hereís what happens. The moment Germany is supposed to
accumulate foreign assets in the form of euros by exporting
more than it imports within the eurozone, those euros are sent
back south again via Target2 instead.
Instead of accumulating gold or foreign assets, the Germans are
accumulating huge Target2 balances. In exchange for their cars
and wrenches, theyíre receiving an accounting entry at the ECB.
Which represents an abstract sort of loan to southern Europe. A
loan that doesnít have to be repaid and canít be called in, sold
To be clear, German businesses are getting paid. They donít
mind whatís going on. In fact, theyíre quite happy about how
the system works thanks to Target2ís other effect Ė keeping
Greek competition from being able to compete by preventing a
currency adjustment. Back to that soon.
Instead of private businesses and individuals in Germany being
left high and dry by the Target2 fudge, itís the German central
bank (Bundesbank) that shoulders the burden. And thereby the
nation as a whole.
The Bundesbank handles transfers from around the eurozone,
so thatís where the net effect of Target2 ends for Germans. In the
form of a huge accumulation of Target2 balances which southern
European central banks owe the Bundesbank via the ECB.
Remember, the ECB is the linchpin, but itís a mere intermediary.
46 | HOW THE EURO DIES
What does all this really mean though? It depends who you ask. ECB economists argue itís nothing more than an accounting entry, so nobody needs to worry. As weíll discuss more later, Target2 balances might only matter if the eurozone fails. The renowned German economist Thorsten Polleit explained what the economic and political implications are in his view:
ďIf you look at the Target 2 balances, Germanyís balance is now 840 billion euros, or 25 per cent of German GDP. Itís money gone and it will show up in low profits from the Bundesbank and presumably higher taxes.
ďAll these measures that have been implemented to drain German wealth to support ailing banks and prop up EuropeÖ most people wonít realise because itís so complex.Ē
Polleit is at least largely correct. Hereís what I think.
Target2 balances are not worth anything. You canít sell them or call in the debt. So if a nation builds up Target2 balances in return for its exports, wellÖ itís not really getting anything in return for the stuff it sold to other countries.
Only a reversal of Germanyís trade balance would allow things of real value to flow back again. If Germany began importing more than it exports to eurozone countries, the Target2 balances would head back towards zero. Germany would receive Greek olive oil in exchange for its cars, itís just that there would be a bit of a delay in the process, without payment in the meantime.
If trade imbalances inside the eurozone were to reverse, the Target2 system wouldíve operated like an interest-free loan that is automatically repaid when trade balances reverse. A delayed form of barter. So itís just a ledger. An accounting entry. Which is why Target2ís supports say itís just a record-keeping mechanism and not a debt. Itís sort of a weird in-between.
The trouble with this is that the trade cycle correction wonít happen. Because there is no self-correcting tendency allowing European countries to rebalance their trade without a crisis. In fact, the replenishment of money in their economies under the Target2 system prevents this rebalancing. Iíll explain why
Target2 and the collapse of the euro zone 47
in a moment. But first, realise that this means Germany has
Iíll explain it differently to highlight the problem. Exporting
nations like Germany receive abstract Target2 balances in
exchange for the very real cars and wrenches they export. But,
remember, those Target2 balances are also an expression of
money flows back into southern Europe to keep the total amount
of currency circulating there the same. Target2 flows replace the
euros that were sent north to pay for German cars and wrenches.
The problem with this is that, in the end, the importers havenít
lost anything of value when they purchase foreign goods from
eurozone countries. Not on the national level. When they sent
their euros north, the money came flowing straight back again
via Target2. Alongside the German cars and wrenches.
Technically, the Target2 balances are a debt, or something
similar to one. So the southern European nations have borrowed
the money to buy the cars. But that debt costs the borrower 0%
interest and it need never be repaid.
Because the euros being sent north every time a Greek person
buys a German car come straight back again via Target2, itís a
free car at the national accounting level. Northern European
nations are, in effect, financing the trade deficits of southern
European nations. Involuntarily, for free, and in a way that
prevents a rebalancing of trade.
The circle repeats, with no correction in sight. Thatís why
Germanyís export boom continues unabated, setting records
each year. The Germans canít help it. Itís a self-perpetuating,
self-financing trade flow. With no limits. Just a build-up of a
weird sort of debt that will never be repaid.
If youíre confused, I donít blame you. The system does not
make much sense, which is why it is so difficult to explain and
understand. My two points here are so interconnected, itís hard
to disentangle them.
Let me simplify. The Germans are being given a ticket in
exchange for their exports. The ticket entitles them to buy Greek
exports. But only once the Greeks export more to Germany than
48 | HOW THE EURO DIES
the Germans export to them. Which wonít happen because the ticket system prevents this by lending money to the Greeks for free to buy the exports in the first placeÖ