My colleague at Tullett Prebon Dr Tim Morgan has written an article about the apparently arcane matter of the ECB's Target2 settlement system which enables debtors and creditors to settle cross border trade within the Eurozone. Most of you may not have heard of Target2 but it is a lot more significant than it seems.
The way this works is if a Spaniard imports something from a German, the money is deducted from the Spaniard's bank account and creates a debit to the ECB from Bank of Spain. The reverse happens in Germany. Simple enough, but here's the tricky bit. The sum of money has to be 'destroyed' in Spain and an equal sum 'created' in Germany. But this reduces Spanish money supply - a liquidity squeeze - which they can't afford to do. Failing to destroy the spent money is a bit like hanging on to money owed to others.
Historically, Target2 balances were very small, but they have grown rapidly as the attached charts show with huge debit balances for Greece (€108bn), Ireland (€96bn) Italy (€289bn) and Spain (€434bn) and a large creditor balance for Germany (c.€750bn) and Finland and the Netherlands. The scale involved is huge. €434bn means that it's more than a year since Spain actually 'paid' for any imports from other Eurozone countries! These balances are much bigger than the proposed Spanish bank bail-out for example and make it clear that some Eurozone countries have grave liquidity problems.
These numbers are not published by the ECB (no surprise there!), but are collated by German economists from individual central banks.
The source is the Institute for Empirical Economic Research at the University of Osnabruck. They believe that Europe is heading for a balance of payments crisis, which is why they collect the data (from national central banks) and publish it here.
The top man is Prof. Hans-Werner Sinn. His book 'The Target Trap', unfortunately only available in German so far as I know, is summarised as follows, which I think makes for interesting reading:
"The Target Trap
The euro project is in the throes of a major crisis. What began as a European peace project has led to dispute and discontent that can only be held in check by heavy borrowing from the savings accounts of citizens of the Eurozone’s core countries. Some euro countries that have lived beyond their means and accumulated high external debt since the introduction of the euro now find themselves on the verge of bankruptcy. Their central banks, in order to solve their economy's liquidity problems, are resorting to the printing press. With the European Central Bank's (ECB) approval, they are withdrawing savings from those countries with more solid economies using a virtual cash dispenser that they were allowed to set up upon joining the euro. The only way to prevent the crisis countries from continuing to do this is to supply them with ever more capital via official bail-out packages. And Germany is not the only country caught in this trap. If there is to be any future for the euro project, tougher budget constraints will have to be re-introduced, and the countries that cannot handle them must be given the opportunity to restore their competitiveness by temporarily exiting the euro."