Why the PIIGS Need to Stay in the Euro Zone…

There’s a payment system in the euro monetary zone (EMU) called TARGET2. The acronym stands for the Trans-European Automated Real-time Gross Settlement Express Transfer System.

That’s a mouthful, and why everyone just calls it TARGET2.

This system is a platform that central banks across the EMU use to settle financial transactions between and among the countries. If someone in Greece buys a BMW, the money is sent from the Greek BMW dealership to the Greek central bank, which now holds someone else’s money (it belongs to BMW in Germany) so Greece shows a liability, or a negative TARGET2 balance.

At the same time, BMW in Germany gets a payment from the German central bank (the Bundesbank) that represents the money the Greek BMW dealership owes and that the Greek central bank now holds. The Bundesbank is now short that money so it carries a positive TARGET2 balance.

These two balances offset each other in the TARGET2 system when Greece transfers the funds to Germany. And that, as they say, is where the fight started…

TARGET2 balances used to be a small affair. There was a smattering of balances, both positive and negative, among the countries of the euro zone that reflected normal business transactions.

However, in the last year, something ominous has happened. Certain central banks have stopped paying their TARGET2 balances. Of course, you can guess who owes a bunch of money, and who is owed a bunch of money.

Over the last two years the German receivable, or positive TARGET2 balance – the money other central banks owe the Bundesbank – has skyrocketed to over 600 billion euro.

The German central bank has already paid out over 600 billion euros to companies in that country, and now it is anxiously awaiting its hard, cold cash from the debtor nations.

At the same time the negative balances of Greece, Ireland, Spain and Italy have also exploded. Remember, these are balances that represent payments the central banks of Greece, Ireland, Spain and Italy have received from private companies and now owe out to other central banks, like the German Bundesbank.

What if they don’t pay? What if, say, the Greek central bank simply uses the money for other purposes, or maybe they already have.

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If Greece – followed by the other PIIGS. – leaves the euro zone, the country will immediately adjust what it owes other countries. Either Greece would change the currency it will use to pay debts from euros to drachma, or worse, Greece would simply not pay at all. Obviously, either of those outcomes is bad.

What Germany must decide is, “What’s more painful?” Continuing to work on failed bailouts that put the German people deeper in debt on behalf of countries like Greece and Spain, or simply to say ‘Nein!’ and take the pain of an immediate default on items like TARGET2 receivables?

Unfortunately, it is entirely possible that Germany goes a third way, which is both continuing to fund failing bailouts and eventually dealing with bigger defaults by the debtor nations.

It’s a strange world where the strongest seemingly need the weakest to stay afloat.

Our view?

They are both already sunk; they just don’t know it yet.


Rodney

 

 

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Categories: Economy

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.