One of the mysteries, to me, of the Greek crisis has been why there should be any deposits left in the local banks. All those with more euros than they need in order to eat and stay warm and dry should have moved their savings to, say, Deutsche Bank in Frankfurt, while they still can. The answer, of course, is that they have. The Greek system has only survived this slow-motion bank run thanks to the German banks sending it right back to them, via the Bundesbank, through the Trans-European Automated Real-Time Gross Settlement Express Transfer.

What, never heard of TARGET? Do keep up. It’s an international version of the transmission system which allows money deposited in Barclays in Leeds to be drawn out of Lloyds in Luton. It matters not if money is consistently drawn from Luton and consistently deposited in Leeds, since other mechanisms cycle the money round, whether by Lutonians buying things made in Leeds, or by the state’s great tax and spend machine.

TARGET, now Target2 for reasons we need not fuss about, assumes that similar mixing forces would always work inside the eurozone. This was a triumph of hope over experience, and we now know that the hope was misplaced. Essentially, the IOUs have piled up in the Bundesbank, 500 billion euros at the end of last year, and certainly a good deal more now, as the southern European countries have consistently bought more stuff from the Germans than they have sold. Events have proved that it’s possible to have a balance-of-payments crisis inside a single currency zone.

The Bundesbank has recycled the euros through Target2, but its ambitious new chairman is now grumbling publicly about whether he will ever see its money back. The answer, as everyone knows, is that there’s not a chance, but the fiction has to be maintained, even if it means projecting ever more fantastic Greek recovery plans into an ever more distant future. While the Bundesbank worries about its own balance sheet, the ECB is printing euros at a rate to make Sir Mervyn King proud. Mario Draghi’s preferred mechanism is to lend nearly-free three-year money (another 530 billion euros this week) to the banks in the hope that they will buy distressed sovereign debt.

This new carry trade pushes up the price of the debt towards more sustainable levels for the borrowers while allowing the banks to rebuild their shredded balance sheets. What’s not to like? Well, just about everything beyond the very short term. Even the fat margin on the trade will not be enough to rebuild the banks’ balance sheets before they have to repay the 1,019 billion euros the ECB has lent them. Meanwhile, the Target2 machine will continue to pile up assets on the Bundesbank balance sheet as long as Greece (and Spain and Italy) continue to run deficits with Germany. It will start to reverse only when Daimler decides to make Mercs in Thessalonica rather than  Stuttgart.

Suspecting that the Twelfth of Never is some way off, the Bundesbank is increasingly concerned that the 500 billion of Target2 assets may not, ahem, be quite worth face value. Even a modest write-down would wipe out its own reserves and, oh dear, the consequences of that scarcely bear thinking about. The cost to German banks would push some of them into the arms of the state but the preferred remedy, hammering the Greek population into poverty, is as misguided as it is ineffectual. The existing administration there has no democratic mandate, and the relentless pressure for yet another dose of fiscal misery is inviting revolution and hard default, which would be even more painful for the Bundesbank.

We are way past the point where there are palatable answers, but two points are plain as the Parthanon: the delay-and-pray policy just makes the problem worse, and reforming the Greek economy is a necessary but far from sufficient  condition for recovery. Greece must be allowed to devalue while remaining in the EU, with further assistance from other member countries, including the UK. Devaluation would bring that flight capital rushing back, along with Europe’s tourists. Greece is also small enough to serve as a test case for a mechanism which will almost certainly be needed again. Meanwhile, cheap holidays for Germans would erase some of the financial pain they will feel for rescuing their banks. It’s far preferable than inflicting a decade of misery on the population. You could call it Target3.

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