Target2 – the Trans-European Automated Realtime Gross Settlement Express Transfer system – started off as a simple payment system for cross-border transactions in the Eurozone.
Its use is mandatory for the settlement of any euro transaction involving the ECB and the national central banks of the Eurozone member states.
It has, however, become something much more – the silent bailout system that keeps the euro afloat. Europe’s political elite know this – they just don’t want the rest of us finding out.
A key underlying problem is that the Eurozone does not satisfy the economic conditions for being an Optimal Currency Area, a geographical area over which a single currency and monetary policy can operate on a sustainable long-term basis.
The different business cycles in the Eurozone, combined with poor labour and capital market flexibility, mean that systematic trade surpluses and deficits will build up – because interregional exchange rates can no longer be changed.
Surplus regions need to recycle the surpluses back to deficit regions via transfers to keep the Eurozone economies in balance. The largest surplus country – Germany – refuses to formally accept that the Eurozone is a “transfer union”, but, deficit countries including Italy – the largest – are using Target2 precisely for this purpose.
In short, Target2 has become a giant credit card for Eurozone members that import more than they export to other members. But note two key differences compared with a normal credit card: the interest rate charged is zero, and the loan never needs to be repaid.
Italy and Spain owe €433bn and €374bn respectively, which they can never pay, and Germany is owed €871bn, which it will never recover.
Target2 is also being used to facilitate capital flight, because residents in Italy, Spain, Portugal and Greece have lost confidence in their banking systems.
Those with bank deposits above €100,000 are liable for an eight per cent haircut if their bank becomes insolvent. The result is that the Eurozone economies – particularly those of the southern member states – are stuck in a Japanese-style deflation trap permanently.
Target2 is clearly not a viable longterm solution to systemic Eurozone trade imbalances and weakening national banking systems.
There are only two realistic outcomes. The first is full fiscal and political union – which has long been the objective of the Brussels political establishment, but is clearly not supported by the majority of Europe’s peoples. The second is that the Eurozone breaks up.
To read David Blake’s piece for City A.M. in full, click here.