I expect better from Eurointelligence than to parrot nonsense on Target2. I blasted them for it in Eurointelligence Displays Stunning Ignorance Regarding Target2.

My point today is not to pile on, but rather to add another view from someone I highly respect, Pater Tenebrarum at the Acting Man Austrian Economic Blog.

Via email, Acting Man's Pater Tenebrarum writes:

Hi Mish

You are spot on with the idea that it doesn't matter only "sort of" applies as long as the euro zone's future existence is not coming into question. Let me just point out here: if TARGET2 claims were "fictional", there would be no need to record the data. They are definitely not fictional and in fact, the system does amount to a "stealth bailout" just as Hans-Werner Sinn always says. In essence, when a TARGET2 debit is created between the National Bank of Italy and the the BuBa [Bundesbank], it means either: an import into Italy from Germany has taken place and was paid for, but there was no offsetting gain in the capital account of Italy (no German investor has bought assets in Italy to the same extent), or as you have stated, there was a capital outflow from Italy, but no offsetting trade surplus. In essence - since we are almost certainly looking predominantly at the capital flight case here - German savers now share the risk of an Italian debt default.

Note also, commercial banks are integrated into this web of claims: Italian banks are forced to increase their central bank funding, while German banks can decrease theirs - in fact, the large TARGET2 surplus of the BuBa basically consists of liabilities of the BuBa to German commercial banks, while the TARGET2 deficit of Italy consists of claims of the Italian National Bank on commercial banks in Italy (the central bank does get securities in exchange for its funding, but e.g. Italian government bonds are only useful collateral as long as Italy does not default and remains a member of the euro area).

It should be mentioned that under a gold standard, these claims would have to be settled by gold outflows from Italy, which would then be forced to raise interest rates in order to reverse the flow. In the Federal Reserve system these payment claims are in fact settled between the various Fed districts via a transfer of gold certificates, whereas in the euro area there is no limit whatsoever on how large they can become - there is no settlement mechanism!

It is true that the central bank can "make good" on future deficiencies by "printing money" - but that comes at the risk of completely destroying the currency. I would also note in this context, due to QE, Italian banks may be partly funding their TARGET2 related deficits by running down their excess reserve balances with the central bank - although I suppose that there is a limit to this on account of capital adequacy rules. I would also not go as far as asserting that this makes the whole process irrelevant, since obviously I would then have to assume that creating giant piles of money from thin air has no ill effects.