thomas davison
Party Leader
Joined: 03 Jun 2005
Posts: 4018
Location: northumberland
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 Posted: Wed Nov 21, 2018 7:17 pm Post subject: HOW THE EURO AND THE EU WILL DIE |
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HOW THE
EURO DIES
SURVIVING THE BIGGEST BANKRUPTCY IN HISTORY
Nick Hubble
Chief Strategist, Zero Hour Alert
Four times worse than Lehman Brothers�
Ten times worse than Greece�
Thirty thousand times worse than
the Asian financial crisis�
Contents
Biography 10
Foreword, forewarned, forearmed 12
Chapter 1: A reminder of what�s coming, again 16
The largest financial crisis in history 17
Break the bank of Europe for George Soros-like gains 19
Europe�s Black Wednesday is coming 20
The end of the euro 21
All four factors of the euro�s 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 what�s 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 �Stierscheisse� on the
whole thing? 48
Alan Greenspan predicts the collapse of the euro 50
The inflation solution 51
The monetary version of George Orwell�s
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
eurozone�s failure 62
The rouble zone�s lose/lose proposition compared
to Target2�s 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 euro�s many failures before it even began 72
A short review of Europe�s 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
Italy�s sub-prime problem 87
7
Rising interest rates will force Italy out of the
eurozone 88
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 ECB�s limits and how they�re ignored 104
Why another rescue isn�t on the accounts 106
OMG it�s OMT 107
Revenge of the ratings agencies 108
Draghi fiddles with QE rules while Rome burns 110
Chapter 8: May�s mini-crisis is just a tremor of
the earthquake to come 112
Bond yields are stage-managed 116
Chapter 9: Nine ways Italy�s crisis unfolds 119
1. Italy�s first populist budget in October 2018 120
2. The breakdown of the Italian coalition
government 124
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 Britain�s stakes 142
The Italian connection and Britain�s 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
9
10 | HOW THE EURO DIES
Biography
Nickolai Hubble is the editor of Capital & Conflict and chief
strategist of Zero Hour Alert, which are published by Southbank
Investment Research. He�s 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 didn�t seem so enticing
any more. An internship with his scholarship provider Goldman
Sachs during the height of the financial crisis was quite enough
of that.
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
that�s 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 customers� loan applications were vindicated by a Royal
Commission in 2018.
Nick doesn�t just investigate financial markets and predict crises
and opportunities. He�s also a flying trapeze, juggling and chin
balancing performer and instructor. He�s 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.
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12 | HOW THE EURO DIES
Foreword, forewarned,
forearmed
On New Year�s 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
neighbour�s house. We emigrated to Australia on the subsequent
New Year�s Eve�
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 out�
Or live my life.
Each time I went back to visit Europe over the years, I�d get a
snapshot of the euro�s effects. Thanks to my parents� divorce, this
was about twice a year for weeks at a time. Visiting extended family
and friends across Europe, I saw Germany�s 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 project�s 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 didn�t have to fiddle
about with currencies.
Foreword 13
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 money� Everyone had
a complaint.
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 euro�s 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 you�ll read about
many times in coming chapters, there�s a reason why Brits called
the euro�s predecessor the �Eternal Recession Machine�.
Perhaps, if my family had stayed living in the mountains
overlooking the European Central Bank�s headquarters in
Frankfurt, I�d see things differently today. Like my German
family now, I�d 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. I�ll 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 EU�s and European Central
Bank�s bailout policies. They were promised what�s 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 haven�t taken sides on all this. I�ve just discovered the euro is doomed to fail, and the trigger of that failure is imminent. I�m not trying to warn you, persuade you, or opine about the euro. I just want you to discover what I did.
I�m not panicking, so I hope you don�t.
Kind regards,
Nickolai Hubble
Foreword 15
16 | HOW THE EURO DIES
Chapter 1
A reminder of what�s
coming, again
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 what�s
bearing down on you now.
After 2009, Greece�s 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 Moody�s
estimates the default at US$261 billion.
But we�re not talking billions any longer. We�re talking trillions.
Yet that�s 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
financial crisis.
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 Japan�s top ten banks failed, as did one of its top ten
brokerage firms, sending the country into its first recession in
23 years.
A reminder of what �s 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.
We�re talking about�
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? It�s never happened
before � 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 Brothers� 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 would�ve returned to the worst of 2008.
But this time, it�s 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. It�ll be a bankruptcy that leads to far
worse international contagion than we�ve ever seen before. Our
economic and financial future will be directly affected.
It�ll 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 don�t know exactly what will happen to you.
We�re 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 don�t 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 won�t be enough. The IMF will be swamped. The contagion won�t 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 you�ve already got an intuitive understanding of what I�m about to explain. Because in the 1990s, you lived through part of it�
A reminder of what �s coming, again 19
BREAK THE BANK OF EUROPE FOR GEORGE
SOROS-LIKE GAINS
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.
I�m not surprised Soros was there to profit. After all, the 1992
crash was just a repeat of the same crisis in the 1970s, when
Soros� 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 �rogue speculator� thanks to his profits on
the Asian financial crisis.
Today, we�re 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 system�s failure?
Because this time, it�s going to be far worse.
Britain was lucky in 1992 and the 70s. Lucky because we weren�t
in the eurozone. We still had the pound. So our departure from
the ERM and fixed exchange rates didn�t 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 couldn�t 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 there�s your answer. An eternal economic crisis. Not unlike what southern Europe is experiencing now. In fact, exactly like it.
EUROPE�S BLACK WEDNESDAY IS COMING
What completely mystifies me is why Europe did not heed the blatantly obvious warning of Britain�s 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 you�ll 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. That�s why they repeat the same mistakes. Because those mistakes did at least get someone elected at first�
But you can�t 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 can�t 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 Europe�s 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 Europe�s endless recession machine, it�s just changed its name to the euro.
A reminder of what �s 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, it�s the euro
itself that will fail, not a currency peg like the pound�s.
THE END OF THE EURO
This book is about how the euro dies. I�m talking about the
end of Europe�s common currency. A disorderly bust-up of the
greatest political project in history. It sounds extraordinary, but
it�s nothing new.
There are two key arguments:
The euro was always doomed. For the same reasons that Europe�s
other monetary unions died in the past. A steady build-up of
imbalances that eventually gets out of hand.
Secondly, the eurozone�s 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 � 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 � Europe�s 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 it�s at record levels.
3. Democracy � 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
they�ll do it with a clean slate, not with the trillions in euro
debt they�ve accumulated.
22 | HOW THE EURO DIES
4.
Europe�s rescue is used up � The ECB�s 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 Europe�s debt-pocalypse are why I�ve decided to go public with my extraordinary prediction � the largest bankruptcy in history and the death of the euro.
But there�s something crucial you need to understand.
ALL FOUR FACTORS OF THE EURO�S DEMISE APPLY IN ONLY ONE PLACE
It�s only when you put all four factors together that a major financial crisis is exposed as unavoidable. And there�s only one place that meets the criteria of all four. In coming months, they�re 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 can�t compete economically. It has barely grown since it joined the euro thanks to five recessions.
The ECB�s 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 Brothers� troubles quickly spread around the world, and Thailand�s 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 �s coming, again 23
one of the biggest stakeholders around when it comes to Italy�s
financial health. And so we�ll be among the most harmed.
Unless you�re prepared.
But what makes me so sure I�ve discovered something others
have missed? You�ve probably heard about the death of the euro
and Italy�s debt crisis for years now.
I think I�m 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
out.
But don�t take my word for it. Let�s see if I can convince you�
And let�s get started with what I call the fatal flaw of the eurozone.
24 | HOW THE EURO DIES
Chapter 2
How the Unholy
Trinity is destroying
the eurozone
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 it�s also known as the Impossible Trinity and the Trilemma. And they call it that for a reason. It�s an impossible three-way dilemma. It can�t last � something has to give. And that�s when you get a crisis.
Unfortunately, the entire eurozone is built on a violation of this simple economic law. And that�s 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.)
Capital
Flows
Monetary
Policy
Exchange
Rate
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.
Britain�s miserable experience with the Unholy Trinity is one
reason the country evaded the eurozone in the first place. As
I�ve mentioned, Brits used to call the ERM the Eternal Recession
Machine. And for good reason, which we�ll 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. That�s why Europe�s many currency unions of
the past all failed. Including those in the run-up to the euro.
Here�s 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
the euro.
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 euro�s 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
I�m expecting all three. In fact, one of the three has already begun. As I�ll 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. Let�s start with�
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 �too low for too long� 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 ECB�s one-size-fits-all monetary policy was never blamed for the housing bubbles in Ireland and Spain. Those countries should�ve had higher interest rates when their property markets boomed before the 2008 crash. But Germany�s economy was the �sick man of Europe� 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 Europe�s booming economies with an interest rate that was too low. This financed the housing bubble�s 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 can�t 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. Let�s examine more closely the damage
this does over time.
HOW THE ECB IS DESTROYING
THE EUROZONE
It�s no surprise that Europe has seen the lowest economic growth
of any continent since the introduction of the euro. It�s had the
wrong monetary policy applied, practically everywhere.
Imagine if Mark Carney, governor of the BoE, implemented
monetary policy wildly out of synch with Britain�s economy.
There�d be furore. But in the eurozone, it�s 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
crash. Eventually.
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 ECB�s 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. It�s a reaction to the economic booms and inflation of northern Europe. But southern Europe is still struggling immensely. It can�t 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: �The currency union is a great error, a risky, reckless and mistaken goal that will not unite Europe, but divide it�?
But that�s 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 � the next part of the Unholy Trinity? That�s far simpler.
WHY THE EURO IS AN ETERNAL
RECESSION MACHINE
Usually, exchange rates between economies can adjust for an out-of-control economic boom or bust. Perhaps even for bad monetary policy, like the ECB�s.
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. That�s why the pound fell 17% on Black Wednesday in 1992. And after the Brexit referendum. The exchange rate acts like a pressure valve. It�s 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 can�t work. They need their currencies
to do some adjusting.
But that can�t happen in the eurozone any more. Everyone is on
the euro. So what happens when exchange rates can�t adjust?
We don�t need to theorise about that. You probably experienced
Britain in the years before it abandoned the ERM � 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
crisis.
But it gets worse. Not only does the euro hinder countries� 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 �pro-cyclical� 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. That�s 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 � 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 don�t 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 � an exchange rate that is correct for nobody. The worst of both worlds.
The European Commission estimates Italy�s export industry is three times more sensitive to the euro exchange rate than Germany�s. Which makes Italy�s position worse when the falling lira should be easing the pressure instead. Meanwhile, Germany�s export boom continues unabated, even setting recent records. Ironically, it�s the euro�s 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, �a crime against humanity�. That�s 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. It�s an incredibly valuable pressure valve to have.
But Britain won�t escape the fallout when the euro project fails. And that day is approaching. Because when interest rates and exchange rates can�t 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 it�s politically unpopular in parts of southern
Europe. The ECB isn�t popular either, but it goes with being
inside the eurozone.
So can you guess what part of the Unholy Trinity is cracking
under pressure?
It�s capital flows. Or should I say capital flight? What I�m 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. It�s when
money leaves an economy for safer places, triggering a banking
and debt crisis. It�s like a bank run, but on an entire country.
For now, the ECB is sweeping the eurozone�s 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. It�s the reckoning you�ve
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 doesn�t 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 eurozone�s
32 | HOW THE EURO DIES
financial system. And we�ll 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 one�s own currency � and by �control� I include the generally desirable aim of letting it float freely � 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 state�s 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 � 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 Britain�s needs, but those of a range of different countries � a recipe for �boom and bust� 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
Chapter 3
Target2 and the collapse
of the eurozone
Italy�s 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 didn�t 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 they�re the only one who�s right.
Officials at the ECB simply deny the Target2 balances mean
anything important.
German economists are panicking about a default on the huge
debts other countries owe Germany under Target2.
European analysts argue they aren�t a debt, so there�s nothing to
worry about.
Other analysts argue they�re the most important debts � 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 world�s 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. It�s just that some are
deliberately misleading. And the abstract nature of Target2
doesn�t help matters. Not to mention its obscurity. Which is why
it�s 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 � the level of pressure on the pressure valve
that the eurozone has fused shut.
WHAT IS TARGET2? AND WHAT�S WRONG
WITH IT?
Target2 is the system by which the various European national
central banks, the ECB itself, and Europe�s commercial banks
interact. They settle large transfers of funds using the Target2
system. It�s how they move money around between each other.
The key players are the ECB, the German Bundesbank, the French
Banque de France and Italy�s Banca d�Italia. Nineteen other
central banks are involved, plus four from outside the eurozone.
The BoE doesn�t 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.
Target2�s main aim is to keep the amount of money in each nation
of the eurozone stable. Without it, you�d 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 bug�) of the system.
Target2 is an automated backdoor bailout mechanism for southern Europe with no limit, no costs and no obligation to actually pay up� 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 Target2�s 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 I�m 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 � during
the previous European sovereign debt crisis. Germany�s
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 wasn�t.
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 �trap� poses an immense risk to German �money
and our children�. It�s 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 didn�t 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 country�s 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 BIS� new analysis to me,
summarised the implications (emphasis mine) :
That�s 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 � 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 BIS� 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.
We�re 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 don�t really understand what a credit is supposed to mean in this context, don�t worry. Neither do the experts on the Target2 system. At least they can�t agree. Mostly because it�s 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.
It�s important to note that the Target2 transfer happens automatically. It�s 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 UK�s National Institute of Economic and Social Research,
called these Target2 transfers �lending on a huge scale that no
government has approved. It can�t go on indefinitely.� And, �The
politics are poisonous. The Germans are feeling very exposed.�
They fear a default on the huge volumes of Target2 loans they�ve
made without their own approval.
I�m 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 repaid� More on that below.
I prefer the analysis of Professor Marcello Minenna, a Target2
expert at Bocconi University in Milan: �The 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.�
When Target2 balances are spiking fast, watching those balances
rise is like looking at Europe�s capital flight in a mirror. Why a
mirror? Technically, the Target2 imbalances are a measure of
the euro system�s 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 it�s only a mirror.
Who do you believe?
As we�ll get into next, Target2 balances don�t just reflect capital
flight, they reflect some other things too. Which is why people can
debate about what�s 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 would�ve 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 it�s doing so again now.
But capital flight isn�t 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. That�s what we�re going to do next.
HOW TARGET2 IS ROBBING GERMANY
AND CRUSHING SOUTHERN EUROPE, AT
THE SAME TIME
In economics, it�s rare to encounter a lose/lose proposition. Exchange is mutually beneficial, otherwise it wouldn�t 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 eurozone�s 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. That�s 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 let�s get one step ahead�
TRADE, WITH THE BENEFITS AND
SELF-CORRECTIONS
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
features neither.
Usually, a nation which exports more than it imports acquires
wealth as a result. When you�re 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
�reward� 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 that�s 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 �made in Japan�. 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 foreigner�s 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
EXPORT THUMBSCREW
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
their trade.
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, it�s a lose/lose system.
Here�s 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, they�re receiving an accounting entry at the ECB.
Which represents an abstract sort of loan to southern Europe. A
loan that doesn�t have to be repaid and can�t be called in, sold
or spent.
To be clear, German businesses are getting paid. They don�t
mind what�s going on. In fact, they�re quite happy about how
the system works thanks to Target2�s other effect � 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, it�s 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 that�s 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 it�s a mere intermediary.
46 | HOW THE EURO DIES
What does all this really mean though? It depends who you ask. ECB economists argue it�s nothing more than an accounting entry, so nobody needs to worry. As we�ll 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:
�If you look at the Target 2 balances, Germany�s balance is now 840 billion euros, or 25 per cent of German GDP. It�s money gone and it will show up in low profits from the Bundesbank and presumably higher taxes.
�All these measures that have been implemented to drain German wealth to support ailing banks and prop up Europe� most people won�t realise because it�s so complex.�
Polleit is at least largely correct. Here�s what I think.
Target2 balances are not worth anything. You can�t sell them or call in the debt. So if a nation builds up Target2 balances in return for its exports, well� it�s not really getting anything in return for the stuff it sold to other countries.
Only a reversal of Germany�s 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, it�s 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 would�ve operated like an interest-free loan that is automatically repaid when trade balances reverse. A delayed form of barter. So it�s just a ledger. An accounting entry. Which is why Target2�s supports say it�s just a record-keeping mechanism and not a debt. It�s sort of a weird in-between.
The trouble with this is that the trade cycle correction won�t 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. I�ll explain why
Target2 and the collapse of the euro zone 47
in a moment. But first, realise that this means Germany has
been robbed.
I�ll 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 haven�t
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, it�s 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. That�s why
Germany�s export boom continues unabated, setting records
each year. The Germans can�t help it. It�s 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 you�re confused, I don�t 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, it�s 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 won�t happen because the ticket system prevents this by lending money to the Greeks for free to buy the exports in the first place� |
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