A Complete Guide to European Bail-Out Facilities – Part 2: Target2 & EFSF / ESM

Today we present the Target2-system and the fiscal bail-out facilities in our series on European efforts to bail out itself.
For new readers,
check out part 1 

  1. Tran-European Automated Real-time Gross Settlement Express Transfer System – TARGET2

In order to facilitate cross-border financial transactions within the currency union an interbank payment system was constructed with the various national central banks as intermediaries.

A Spanish construction company, say, needs a new crane and buy one from one of the major German crane manufactures. We can assume the construction company got a loan from one of the rapidly expanding Spanish banks which can be used to buy German goods. The bank on the other hand cannot fund itself in international money markets and domestic savings cannot keep up with credit demand. However, they can issue a commercial paper which can be used as collateral for a loan with the Banco de España. The transaction is thus helped by the “temporary” credit line provided by Banco de España as part of the Target2 system.  As an offset to the monetary financial institution (MFI) loan on the Banco de España balance sheet we find a Target2 liability.

The European Central Bank (ECB) is obviously balanced as the Banco de España liability is perfectly matched by a Bundesbank Target2 asset.

Euros created on back of dubious Spanish collateral are transferred to the German bank via the Bundesbank which get a Target2 asset as an offset.  The German bank uses the claim on the Bundesbank to create a deposit for the German exporter.

This is how a Target2 imbalance is accumulated. However, in “normal” times the German exporter would save his money or invest directly in international claims. Somehow, the capital would find its way back through the chain cancelling the previous Target2 transaction.

However, if the Germans in this case were afraid of the solvency of its counterpart and capital flows dried up, Target2 claims and liabilities would never cancel. As a matter of fact, there is nothing inherent in the system that prohibits infinite Target2 claims and liabilities from accumulating.

Within the Federal Reserve System for example, any imbalance between regional Federal Reserve banks must be settled annually. No such thing exits within the ESCB-system.

Target2 T-account illustration

Source: Bawerk.net

A long story short, the Target2 system made possible a massive unfunded capital transfer from the north to the south. The unsustainable capital consumption in the south and the pretense of saving in the north were allowed to reach unimaginable proportions.

We have looked through every one of the seventeen NCBs in order to see just how big this unintended bail-out was at the height of the crisis. Den Rest des Beitrags lesen »