TARGET2 Again

A few years back the then president of the Munich-based Ifo Institute made headlines when he referred to the German balance of the TARGET2-System as as a Euro-denominated Credit Card Gold for the suffering Eurozone periphery that helps them to finance their debts on the shoulders of Germany. The immediate result of this statement was an intense debate about the status of TARGET2, and what this is all about. There is no doubt that Sinn did a great job in turning attention to a system that until then was only known to true nerds. TARGET stands for Trans-European Automated Real-time Gross Settlement Express Transfer -System. TARGET2 is the updated version which came into being in May 2008. TARGET2 balances are the liabilities and claims of national central banks within the Eurozone against the European Central Bank that are the result of cross-border payments settled in central bank money. This payment system works in the following way, as the ECB explains: Let us assume that Bank A and Bank B both have accounts with a central bank. A payment in euro is to be made from Bank A in Eurozone country X to Bank B in Eurozone country Z as reflex of an underlying transaction. In this case, 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. When a country’s banking sector receives a cross-border inflow of Euros, its claims incenses, respectively in case of net liabilities, its liabilities decrease. When a country’s banking sector experiences an outflow, then we see the opposite effect.

TARGET2 balances were small over a long period but polarized in the course of the sovereign debt crises of the Eurozone. Germany’s Bundesbank piled up more and mire claims, up to a maximum of Euro 715 bn in 2012. Only after Draghi’s ‘whatever it takes’-statement did those claims recede. The build-up of enormous claims by the German Bundesbank was to a strong degree due to the accelerating capital flight within the Eurozone where investors were in an urge to move capital from risky bank systems into safe haven banking systems, and for a number of years this was the German system. Only when Mario Draghi declared openly the ECB to be a lender of last resort, at any price or whatever it takes, did the risk level decrease and did significantly reduce intra-Eurozone capital flight . The result was a reduction of German claims. This has changed again. Since 2015 and in particular more recently German claims started to rise again, and reached a new height of Euro 815 bn early in 2017.





The question is, why? The successor of Sinn at the Ifo Institute, Clemens Fuest, claims to know the answer by stating that we are back in the intra-Eurozone capital flight mode. The Bundesbank, the ECB and also the Bank of International Settlement defy such an argument and explain the rise as a technicality that is caused by the APP (Asset Purchase Program) of the ECB. Indeed, the way the APP is working, namely through national central banks, speaks for the latter interpretation. This does not mean that intra-Eurozone capital flight is off the table. Given the slight improvement in economic data and the statement of Draghi that the deflation ghost has been successfully defeated one would expect that slowly the rise of German claims slows and turns around. But then, there are critical elections looming, and depending from the outcomes we may quickly see a return of capital flight, this time then not to Germany but to the outside of the Eurozone. DSo, much to watch out for.