by Ambrose Evans-Pritchard
Partial Spanish version
Central banks can go bust in a currency union.
The Bank of Italy is flirting with danger,
racking up €364bn in ECB liabilities that
the Italian state cannot easily cover
Vast liabilities are being switched quietly from private banks and
investment funds onto the shoulders of taxpayers across southern
It is a variant of the
tragic episode in Greece, but this time on a far larger scale, and
with systemic global implications. There has been no democratic
decision by any parliament to take on these fiscal debts, rapidly
approaching €1 trillion.
They are the unintended
side-effect of quantitative easing by the European Central Bank,
which has degenerated into a conduit for capital flight from the
Club Med bloc to,
This 'socialization of
risk' is happening by stealth, a mechanical effect of the
ECB's Target 2 payments system.
If a political upset in
France or Italy triggers an existential euro crisis over coming
months, citizens from both the Eurozone's debtor and creditor
countries will discover to their horror what has been done to them.
"t is a variant of
the tragic episode in Greece, but this time on a far larger
scale, and with systemic global implications".
Such a tail-risk is real.
As I write this piece,
four out of five stories running on the news thread of France's
financial daily Les Echos are about euro break-up scenarios.
I cannot recall such open debate of this character in the
Continental press at any time in the history of the euro project.
As always, the debt markets are the barometer of stress.
Yields on two-year German
debt fell to an all-time low of minus 0.92pc on Wednesday, a sign
that something very strange is happening.
"Alarm bells are
starting to ring again.
Our flow data is
picking up serious capital flight into German safe-haven assets.
It feels like the build-up to the Eurozone crisis in 2011," said
Simon Derrick from BNY Mellon.
The Target2 system is
designed to adjust accounts automatically between the branches of
the ECB's family of central banks, self-correcting with each ebbs
and flow. In reality it has become a cloak for chronic one-way
Private investors sell their holdings of Italian or Portuguese
sovereign debt to the ECB at a profit, and rotate the proceeds into
mutual funds Germany or Luxembourg.
"What it basically
shows is that monetary union is slowly disintegrating despite
the best efforts of Mario Draghi," said a former ECB governor.
The Banca d'Italia alone
now owes a record €364bn to the ECB, and the figure keeps rising.
Mediobanca estimates that €220bn has left Italy since the ECB first
The outflows match the
pace of ECB bond purchases almost euro for euro.
Professor Marcello Minenna from Milan's Bocconi University
said the implicit shift in private risk to the public sector -
largely unreported in the Italian media - exposes the Italian
central bank to insolvency if the euro breaks up or if Italy is
forced out of monetary union.
"Frankly, these sums
are becoming unpayable," he said.
The ECB argued for years
that these Target2 imbalances were an accounting fiction that did
not matter in a monetary union.
Not any longer. Mario
Draghi wrote a letter to Italian Euro-MPs in January warning
them that the debts would have to be "settled in full" if Italy left
the euro and restored the lira.
This is a potent statement. Mr Draghi has written in black and white
confirming that Target2 liabilities are deadly serious - as critics
said all along - and revealed that Italy's public debt is 22pc of
GDP higher than officially declared.
It is now 153pc of GDP
and rising, past the point of no return for a country with no
sovereign central bank. Spain's Target2 liabilities are €328bn,
almost 30pc of GDP. Portugal and Greece are both at €72bn.
All are either insolvent
or dangerously close if these debts are crystallized.
of risk' is happening by stealth, a mechanical effect of the
ECB's Target 2 payments system.
If a political upset
in France or Italy triggers an existential euro crisis over
coming months, citizens from both the eurozone's debtor and
creditor countries will discover to their horror what has been
done to them".
Willem Buiter from
Citigroup says central banks within the unfinished structure of the
eurozone are not really central banks at all.
They are more like
currency boards. They can go bust, and several are likely to do so.
In short, they are "not a credible counterparty" for the rest of the
It is astonishing that the rating agencies still refuse to treat the
contingent liabilities of Target2 as real debts even after the
Draghi letter, and given the self-evident political risk.
Perhaps they cannot do so
since they are regulated by the EU authorities and are from time to
time subjected to judicial harassment in countries that do not like
Whatever the cause of
such forbearance, it may come back to haunt them.
On the other side of the ledger, the German Bundesbank has built up
Target2 credits of €796bn. Luxembourg has credits of €187bn,
reflecting its role as a financial hub. This is roughly 350pc of the
tiny Duchy's GDP, and fourteen times the annual budget.
Luxembourg is a huge 'creditor' through the Target2 system but it
too could get into trouble if the France breaks up the euro
So what happens if the euro fractures?
We can assume that there
would be a tidal wave of capital flows long before that moment
arrived, pushing the Target2 imbalances towards €1.5 trillion.
Mr Buiter says the ECB
would have to cut off funding lines to "irreparably insolvent"
central banks in order to protect itself.
The chain-reaction would begin with a southern default to the ECB,
which in turn would struggle to meet its Target2 obligations to the
northern bloc, if it was still a functioning institution at that
The ECB has no sovereign
entity standing behind it. It is an orphan.
The central banks of Germany, Holland, and Luxembourg would lose
some of their Target2 credits, yet they would have offsetting
liabilities under enforceable legal contracts to banks operating in
their financial centers. These liabilities occur because that is how
the creditor central banks sterilize Target2 inflows.
In other words, the central bank of Luxembourg would suddenly owe
350pc of GDP to private counter-parties, entailing debt issued under
various legal terms and mostly denominated in Euros.
They could try printing
Luxembourgish francs and see how that works.
Moody's, Standard & Poor's, and Fitch all rate Luxembourg a
rock-solid AAA sovereign credit, of course, but that only
demonstrates the pitfalls of intellectual and ideological capture.
It did not matter that the EMU edifice is built on sand as long as
the project retained its aura of inevitability. It matters now.
Bookmakers are offering three-to-one odds that a candidate vowing to
restore the French franc will become president in May.
What is striking is not that the Front National's Marine Le Pen
has jumped to 28pc in one poll, it is that she has closed the gap to
44:56 in a run-off against former premier François Fillon.
The Elabe polling group say they have never before seen such numbers
for Ms Le Pen. Some 44pc of French 'workers' say they will vote for
her, showing how deeply she has invaded the industrial bastions of
the Socialist Party.
The glass ceiling is
The wild card is that France's divided Left could suppress their
bitter differences and team up behind the Socialist candidate Benoît
Hamon on an ultra-radical ticket, securing him a runoff fight
against Ms Le Pen. The French would then face a choice between the
hard-Left and the hard-Right, both committed to a destruction of the
That contest would be too
close to call.
Anything could happen over coming months in France, just as it could
in Italy where the ruling Democratic Party is tearing itself apart.
Party leader Matteo Renzi calls the mutiny a "gift to Beppe
Grillo", whose euro-sceptic Five Star movement leads Italy's polls
As matters now stand, four Italian parties with half the seats in
parliament are flirting with a return to the lira, and they are
edging towards a loose alliance.
This is happening just as the markets start to fret about bond
tapering by the ECB. The stronger the Eurozone economic data, the
worse this becomes, for pressure is mounting in Germany for an end
to emergency stimulus.
Whether Italy can survive the loss of the ECB shield is an open
question. Mediobanca says the Italian treasury must raise or roll
over €200bn a year, and Frankfurt is essentially the only buyer.
Greece could be cowed into submission when it faced crisis. The
country is small and psychologically vulnerable on the Balkan
fringes, cheek by jowl with Turkey.
The sums of money were
too small to matter much in any case.
It is France and Italy that threaten to subject the euro experiment
to its ordeal by fire. If the system breaks, the Target2 liabilities
will become all too real and it will not stop there. Trillions of
debt contracts will be called into question.
This is a greater threat to the City of London and the banking nexus
of the Square Mile than the secondary matter of euro clearing, or
any of the largely manageable headaches stemming
Would anybody even be
talking about Brexit in such circumstances?