As soon as any major country exits the Eurozone (and possibly some lesser ones), a cascade of defaults, unparalleled in history will commence.

The only way to stop such a cascade would be if the ECB guaranteed (printed) enough euros to cover losses. Meanwhile, the already high Eurozone default risk keeps rising.

From Eurointelligence via Email.

German Target2 Surplus is fast approaching the one trillion

Each month, Germany’s Target2 surplus has been rising. The Bundesbank yesterday published the data for end-February, showing a new record of €814bn, up by a further €20bn during the month. This level is now significantly higher than it was during the peak of the eurozone crisis. We would assume that the rise in the German surplus will be offset by parallel rises in the deficits of Spain and Italy, which were €350bn and €364bn in January. The rise is in part explained by the ECB’s asset purchasing programs – the sales of Italian bonds by London-based investors often clear through Frankfurt, but the investors generally do not reinvest in Italy, but elsewhere. In other words, the QE program is the direct cause but it hides an underlying trend of capital flight out of Italy of the same scale as during the crisis.

Frankfurter Allgemeine, which watches over the Target2 surpluses like a hawk, has a revealing comment by Jens Weidmann. The Bundesbank has generally tried to distance itself from the position of some German economists, who have emphasised the importance of the Target2 system. That’s still the official position. Weidmann said that he agreed with Mario Draghi that a country that exits should settle its Target2 liabilities in euros. But then he made an important qualification:

What that looks like in practice, and whether a government was willing or able to meet these claims, is a wholly different issue altogether.

We see it exactly the same way. Any exit would cause so much financial stress, and give rise to such political recriminations on both sides, that it is inconceivable that these balances would ever be paid up. This is why a euro exit invariably constitutes a series of massive defaults – without parallel in economic history.

Default Cascade

Some may be wondering what is it that would cause a cascade of defaults. The answer pertains to the Eurozone treaty which designates the ECB itself cannot cover defaults or bail out nations.

If the ECB cannot print (ultimately I believe they would), then taxpayers would have to come up with a way to fund the insolvent national central banks.

For example, if Italy Italy left the Eurozone and paid back €364 billion of Target2 liabilities in Lira at a 40% discount to the Euro, where does the money come from?

And might not Italy be tempted to just declare the entire amount null and void?

Clearly, such discussions are on the table.

Assuming Italy walked, and assuming the ECB did not paper over the losses, then the remaining countries would have to come up with the euros, perhaps in accordance with EFSF or ESM weights.

Where would Spain, Greece, France, etc. come up with their share of such a mess?

The answer is they wouldn’t.

And that is precisely what Jens Weidmann, president of Germany’s central bank meant when he stated:  “What that looks like in practice, and whether a government was willing or able to meet these claims, is a wholly different issue altogether.

Here is a bit of laughable propaganda on bailouts.


Fatal Eurozone Flaws

  1. No fiscal union: No currency union without a fiscal union has ever survived
  2. Target2
  3. Treaty requires unanimous approval to make anything but a minor change
  4. Single interest rate policy cannot possibly be suitable for countries with varying degrees of productivity

There is no way to fix this mess, and no way to stop the imbalances from growing until it all blows sky high in a massive cascade of defaults (or papered over by the ECB in a treaty violation).

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Mike “Mish” Shedlock