Italy Missing the Target

The EU’s bank settlement scheme (TARGET2) is too unbalanced ever to reach equilibrium.

Kiss on the Cheek


Capital is flying out of Italy’s banks since the recent election there, to the extent that a crash landing is now looking probable. Don’t panic because the EU has a mechanism to solve this so that the money comes flooding back to support the country’s financial liquidity, otherwise it wouldn’t be able to keep buying stuff and supporting Germany’s (illegal) export surplus. 640-01361758So the money goes round and round and keeps the euro working – until the dyke fails. Mario Draghi, the ECB’s governor, doesn’t have enough fingers to plug it this time so he’ll need the fat hands of the Bundesbank to help him. The Germans won’t be keen so it looks like the biggest financial crash in history is approaching.

Let’s look at the actual numbers as well as some of the arcane language used to ‘explain’ them.

Target2-1The Italian central bank says it lost €39 billion during May which then whizzed back along the eurozone’s inter-bank plumbing system, the Trans-European Automated Real-time Gross settlement Express Transfer System – Target2* (there’s no target, it’s just an acronym). The loss is a further liability against the Bank of Italy bringing its total to almost half a trillion euros – at that rate it will double in a year. It means that bank deposits in Italy have fled to safer shores, mainly in the Northern eurozone nations. So far, according to JP Morgan research, it’s mainly financial institutions that are withdrawing their deposits from Bank of Italy but if Italians join the run, like Greeks and Cypriots did during their banking crises, neither the Italian nor the European central banks will be able to handle it unless Germany’s joins the rescue.

Target2-3The Bundesbank’s credit under Target2 shot up by €55 billion in May to almost a trillion euros, half of it in Italian debt. In the words of the Daily Telegraph’s business correspondent, Ambrose Evans-Pritchard, “If the figure blows through €1 trillion in coming months there will be Gothic headlines in Bild Zeitung, Die Welt, and the Handelsblatt. A political storm in Berlin is inevitable given that the anti-euro AfD party is now the official opposition in the Bundestag, and chairs the budget committee.

Eurozone interest rates are zero so if Germany did keep topping up its Target2 account it would simply be parking its money where half its foreign assets already lie and where they do them no good at all**. They’d be working for nothing and increasing the stakes against an even bigger crash in which they lose it all. Yet if they refuse they will trigger the crash anyway.

Help!Meanwhile the Italians have little to gain from staying in the euro and less to lose than most others. There’s an old saying, “If you owe a bank $100 that’s your problem, but if you owe it $100 million that’s the bank’s problem”; it works the same in dollars, pounds or euros but the numbers here a far bigger than that. Italy can’t solve its own problems and others aren’t going to help, as they proved in 2011 by refusing to share risk during the Sovereign crisis that affected Portugal, Ireland, Italy, Greece and Spain (the PIIGS). The weight may apparently be on Italy’s shoulders but banks, including the UK’s, are so interconnected today that all will be seriously harmed. Italy’s new government has a partial answer – the mini-BOT.

Like TARGET2, the ‘mini-BOT’ is simply an acronym for a common Italian Treasury bill (Buoni Ordinari del Tesoro), essentially a credit note. It can’t be exchanged for euros but the Bank can ‘pay’ companies for things the state needs and then accept them against taxes and services provided by the state. The Bank can’t simply print more euros, that’s the ECB’s privilege, but can get around the restriction with its own internal ‘money’ (though there are limits to how it can be exchanged between companies and people ). This is Italy’s proposed parallel currency; it was also considered by Greek by finance minister Yanis Varoufakis but prevented by EU pressure. Italy is too big to bullied in the same way. The aim is to stop euros flowing out of government coffers so reducing its borrowing entitlements which it are severely limited anyway under the EU’s deficit rules.

The new ‘money’ lubricates industry and commerce without using euros Italy doesn’t have and can’t print (like the Bank of England can with pounds, for example). Essentially all it buys is time because the government forgoes tax revenue when it gets its credits back. It is therefore a step on the road to leaving the eurozone, which is what Lega wants to do, cautiously. If Italy can do it others will too.

Flying euros 4Target2 (im)balances demonstrate capital flight, for all the liquidity created by the ECB’s “whatever it takes” Quantitative Easing programme; Italian and Spanish companies prefer to invest their share non-domestically. Things will have to change, perhaps by introducing capital controls. That means unplugging Italy from Target2 and likely bringing the system down. Or there would have to be debt forgiveness, which is unlikely since Germany will not agree to losing such gigantic sums (if Italy gets let off, the others will want the same leniency); and even if they did forgive and forget they would not tolerate it happening again so will demand changes that the Italians have just voted to reject. Then again, do votes matter in the EU?

Time bombThe EU’s leaders have always loved a crisis because it creates another opportunity for their magic cure of ‘More Europe’, their main goal. This time, however, they have created a crisis that’s off-the-scale and another of its famous four freedoms will fall – the movement of capital. After that the rest will crumble or quite possibly explode. Britain is better off out but won’t escape the severe after-shocks.

Dimitris Papadimoulis is Vice-President of the European Parliament and head of the Greek Syriza Party’s delegation; he had this to say to the EUObserver, “The eurozone can no longer function as it is today. Both the examples of Greece and Italy test the limits of a system with inherent weaknesses that feeds internal gaps, strengthens deficits and debts in the European South, and surpluses in the European North respectively. Therefore we have to change course, as we will find ourselves for another time confronted with everything that has led Europe to the financial crisis ten years ago.

Clearly not every senior EU figure is complacent, though self-satisfaction is widespread at the top.

Notes for further clarification

*A. This is a simple explanation of how Target2 works and its (frighteningly) wide scope beyond the eurozone, extracted, and lightly edited from:

Eurosystem-1TARGET2 is a payment system owned and operated by the Eurosystem. It is the leading European platform for processing large-value payments and is used by both central banks and commercial banks to process payments in euro in real time. TARGET2 [is] a key building block of financial integration in the EU. It enables the free flow of money across borders and supports the implementation of the ECB’s single monetary policy.

The platform is owned and managed by the Eurosystem. Put simply, it works as follows:

  • Bank A and Bank B both have accounts with a central bank
  • Bank A wishes to make a payment in euros to Bank B
  • Bank A submits the payment instructions to TARGET2
  • Bank A’s account is debited, and Bank B’s account is credited – the payment is settled
  • TARGET2 transfers the payment information to Bank B

TARGET2 is used by EU central banks and their national communities of commercial banks. More than 1,700 banks use TARGET2 to initiate transactions in euro, either on their own behalf or on behalf of their customers. Taking into account branches and subsidiaries, more than 55,000 banks worldwide (and all their customers) can be reached via TARGET2.

**B. Extracted, and lightly edited, from: and other sources.

Eurosystem-2Germany has to lend money so that others can buy its products. What is ostensibly a payment system has become a mechanism for the official financing of structural balance-of-payments gaps of ever greater size.

If a country wants to earn more from the rest of the world than it spends, it has to let its private sector provide financing to foreigners, or alternatively have its central bank do the same thing by accumulating reserves.

Since the euro’s existential crisis of 2011/12, the routine response of those in international banks and global companies seeking to protect themselves in the event of a breakdown of the euro has been to place their euro cash with banks based in Germany (and in Luxembourg and a few others) and ensure their short-term euro liabilities are in the periphery. In most international financial crises, creditor countries use their political power to minimise any loss in the value of their external assets.

Creditor claims are against the ECB but if the eurozone breaks up and the Target debtors go bankrupt, there might be no clear legal basis for the Target claims, as the surplus countries would hold a claim against a system that no longer exists.

Target2 has emerged as the eurozone’s financing entity for ballooning structural balance-of-payments gaps. The present system is unsustainable and needs reform.


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