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Analysis

Target-2 and Germany’s election dilemmas

Weak euro stands out in quintet of currency crises

by David Marsh in London

Wed 15 Feb 2017

There is no shortage of potential candidates for the most crisis-ridden currency in 2017. Each of the constituents of the International Monetary Fund’s special drawing right – the dollar, euro, sterling, yen and renminbi – is beset by considerable strain.

The trials assailing the constituents of the IMF’s accounting unit – the ‘quintet of crises’ at the heart of world money – make the SDR itself relatively stable. The fluctuating values of its components more or less balance out, underlined by the 2015-16 SDR-dollar chart below.

 SDR Chart , David , 150217

The multicurrency system on which the world appears to be embarking may turn out to be, eventually, more stable than the various de facto monetary duopolies seen for most of the past 100 years.

The euro may be the most problematic currency in 2017. True, economic growth in the euro area is picking up, thanks partly to injections of liquidity by the European Central Bank as well as rising export volumes helped by the weaker euro. Political and economic factors are likely to depress the currency further against a temporarily strong dollar that will probably dent President Donald Trump’s hopes of boosting US export competitiveness.

Three issues stand out as signalling euro weakness. All these bring great dilemmas for Germany, the pivotal member of economic and monetary union, where voting takes place last (in September) in this year’s scheduled elections in leading EMU economies.

First, the level of Germany’s claims under the ECB’s well-known Target-2 system for settling intra-euro area balances, now transformed into a programme for reallocating surpluses from Germany to less creditworthy parts of the euro area, is signalling possible danger ahead.

Second, the German Bundesbank is paying an unusual amount of attention to the repatriation of gold reserves from New York. This suggests it needs to buttress public confidence at a time of considerable discussion about EMU’s financial arrangements. The Bundesbank has revealed that 47.9% of its 3,378 tonnes of gold are now back in Frankfurt, with 36.6% in New York, 12.8% in London and 2.7% in Paris.

Third, Germany is impaled on a financial and political hook about writing-off loans to Greece as demanded by the IMF. This could spell electoral controversy in view of public opposition to Greek debt forgiveness.
Target-2 occupies a central place. According to latest Bundesbank figures, the German central bank’s claims under the system rose to €796bn at end-January from €754bn at end-December, well above the previous record €751bn in August 2012.

The Bundesbank’s ECB claims make up more than half of Germany’s net foreign assets of €1.5tn, which have themselves increased enormously since the euro was launched in 1999. If EMU broke up, or euro members redenominated their liabilities in a new, lower-valued currency, Germany would relinquish a large part of these assets. Such a loss of German savings would rival the country’s forced write-downs after the first and second world wars.

Both the ECB and the Bundesbank are playing down the renewed Target-2 increase, saying it reflects technical reasons linked to cross-border payments stemming from the ECB’s asset purchase programme. On the one hand, these facts would argue for Germany keeping the system going. On the other, they would suggest that the Germans should try to renegotiate the Target-2 arrangements. At the present rate of increase, the Target-2 balances could be close to €1tn by the German elections in seven months.

Target was developed during the 1990s as a technical transfer mechanism for facilitating payments within the euro area. The innocuous name – Trans-European Automated Real-time Gross settlement Express Transfer – points to its original arcane purpose.

According to Helmut Schlesinger, former Bundesbank president, the system was expected to advance credit simply for overnight settlement. Two decades later it has become an overdraft system under which Germany, through its central bank, extends interest-free credit without any repayment date and without economic conditions to the central banks of heavily indebted nations. Neither politicians at European Council meetings nor the German Bundestag have sanctioned these arrangements.

Mario Draghi, ECB president, stated in 2013 – when the Target balances were starting to fall again after the 2012 surge – that this showed a ‘return of confidence’. Over the past 12 months, as balances have started to rise again, the ECB has devoted little public attention to the issue. This could change in coming months.

David Marsh is Managing Director of OMFIF.

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