The Daily Telegraph’s Jeremy Warner turns his attention to our old friend Target2 (the European Central Bank clearing system that could leave Germany squirming on the end of a very large hook).
The key is this:
Throughout much of the first eight years of the euro’s existence, there was a steady improvement in German competitiveness against the eurozone periphery, resulting in a growing German current account surplus. This imbalance in trade was largely financed by German banks, which were, in effect, lending the periphery the money to buy German goods. German credit also financed major construction and credit booms in some periphery countries. Periphery governments were equally profligate, if not worse, in spending on the German credit card.
Then along came the financial crisis, German banks stopped lending to the periphery and, worse, started withdrawing their credit as fast as they could. With no good use for the money back in Germany, the resulting surplus is placed on deposit with the Bundesbank.
Meanwhile, back in the periphery, the local banking system is left with a steady loss of funding but, because credit cannot quickly be called in, the same amount of lending. To fill the funding hole, the periphery bank borrows instead from the European Central Bank in return for collateral. The ECB, in turn, will obtain the money from the Bundesbank surplus.
Germans are therefore being somewhat naïve in making debt mutualisation a red line issue when it comes to solutions. In fact, the debt has already been mutualised. The ECB has been intermediating the risks all along.
Where things have got out of hand, however, is that on top of this withdrawal of credit by the German banking system, there has also been a frenzied flight of domestic capital from the eurozone periphery. Much of this money has ended up in Germany, or other perceived havens. On top of their own bad lending, Germans are therefore also assuming liability for the bad lending of the periphery nations themselves. This will continue as long as investors think there is any risk of break-up.
Nor does it end there. Via the German banking system, the flight of capital finds itself squeezed, because of ultra-low German bond yields, into the rest of the eurozone core, including France. A country which, in truth, has far more in common with Spain and Italy than it does with Germany thereby ends up with German interest rates, encouraging its newly installed president, Francois Hollande, to believe the markets are sanctioning him to make the economy even more uncompetitive than it already is. While everyone else is being frogmarched into austerity-oblivion, France is haring off in the other direction.
Even assuming that by some miracle, the eurozone periphery manages to claw its way back to competitiveness, the madness of the euro is only setting itself up for an even worse crisis further down the road.
Note also those comments about France: that’s a Titanic not just headed, but accelerating, towards the iceberg.