PIMCO | - TARGET2: A Channel for Europe's Capital Flight - 0 views
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Its full name is more than a mouthful. Trans-European Automated Real-time Gross Settlement System is better known as TARGET2 for short. It is the behind-the-scene payments system that conveniently enables citizens across the euro area to settle electronic transactions in euro. And at just over €500 billion, its TARGET2 claim on the Eurosystem is also the largest and fastest growing item on the Bundesbank’s balance sheet, as well as a source of much misunderstanding and debate.
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The allocation of TARGET2 balances among the seventeen national central banks, which together with the ECB make up the Eurosystem, reflects where the market allocates the money created by the ECB. The fact that the Bundesbank has a large TARGET2 claim (asset) on the Eurosystem, while national central banks in southern Europe and Ireland together have an equally large TARGET2 liability, simply reflects that a lot of the ECB’s newly created money has ended up in Germany. Why? Because of capital flight.
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Since the euro eliminated exchange rate risk among its member states, Germany has invested a substantial portion of its savings in Europe’s current account deficit countries. Some of those savings are now returning home. That’s the capital flight.
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The ECB stepped into the void left by foreign investors pulling their savings out of these current account deficit countries by lending their banks more money.
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When large capital flight to Germany occurred before the euro’s introduction, the deutschemark would appreciate against other European currencies. While pegged against the deutschemark, these exchange rates were still flexible. That flexibility disappeared with the euro. When capital flight occurs today, the Bundesbank effectively ends up with loans to the other national central banks that are reflected in the TARGET2 claims on the Eurosystem.
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Debt overhangs persist, growth is mediocre and the governance structure – a common monetary policy without a centralized fiscal policy – is a challenge.
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The ECB has allowed banks to borrow as much money as they want for up to three years. Indeed, at the end of February banks were borrowing €1.2 trillion from the ECB, twelve times the amount of their required reserves. With so much excess liquidity in the money markets, further capital flight is likely to cause a disproportionable share of this money to end up in Germany
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Concerned about the stability of the euro, Germany’s savers are shifting their money into real estate. German residential house prices and rents rose by 4.7% last year, the fastest increase since 1993’s reunification boom. So far, Germans are not leveraging to buy houses. Growth in German mortgages is paltry at just 1.2% per annum according to the ECB as of December 2011, but in our view all ingredients for a debt-financed house price boom are there. Distrust in the euro is rising,
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The ECB’s generous monetary policy will delay the internal devaluation adjustment of the eurozone’s current account deficit countries.
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Mexico’s current account deficit fell by 5.3% of GDP in 1995, according to Haver Analytics, in the wake of capital flight following the government’s decision to float the peso in 1994, while its recession lasted only one year.