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Sunday, June 3, 2018

At Some Point Germans May Discover That They Are In Deep Trouble

Below are some interesting charts which I picked up in this Zerohedge article.

First, the phenomena which got the problem countries into trouble in the first place - current account deficits: Greece & Co. had been spending much more money outside their borders than they had revenues outside their borders, having to cover the gap with loans from outside their borders. Today, 8 years later, the situation is as follows:


There are current account surpluses wherever one looks. Almost wherever one looks: France seems to have become rather problematic with a current account deficit representing almost 4% of GDP but Greece's current account deficit is now minute compared to what it used to be.

A current account surplus doesn't mean that the domestic economy is in order. All it means is that the country is financially self-supporting as regards its economic activities outside its borders. It has enough revenues outside its borders to pay for all the essential and non-essential imports the country is buying. Theoretically, the country could be barred from any foreign credit and yet, it could continue its cross-border transactions.

The next chart is particularly interesting. The credible narrative had been that the ECB's Target2 payment system - as a quasi unlimited credit card - allowed countries to run current account deficits even though the foreign private banks were no longer funding them. That was certainly true in the early years but following that logic and seeing current account surpluses now, one would expect Target2 claims of the North to decline.

The following chart shows the development of the (in)famous Target2 balances:


The earlier narrative no longer holds because Target2 claims of the North, specifically of Germany, have increased phenomenally even though current account surpluses were recorded in most countries. There is only one other explanation: capital flight. Now here is something to ponder for all those who always blame Germany for bleeding out the suffering South: Germany has run up nearly a trillion Euros worth of Target2 claims so that, mostly, Italy and Spain could transfer money out of their countries (even back to Germany). Should Italy or Spain ever exit the Eurozone, the Bundesbank might say to them "We want you to give us our money back" and Italy or Spain would respond "The money is already back in your banking system, except it's now in our name and no longer in yours!"

Much has been said about the brutal internal devaluations which the South has had to go through. No doubt that's true for Greece but when one looks at Italy, one sees that nominal unit labor costs, the most crucial element of international competitiveness, have actually increased by 10% since the crisis began. The new Italian government intends to increase deficit spending which is unlikely to favorably impact nominal unit labor costs.


And now to the final chart which leads J. P. Morgan to the conclusion that an exit from the Eurozone may be Italy's best option:


Italy's net foreign investment position is only minimally negative which leads J. P. Morgan to conclude that an Italian Euro exit should be a lot less threatening to creditors than a Spanish one. Put differently, with a current account surplus and a walk-away from Target2 liabilities, Italy would owe only very little to foreigners. Well, not quite because the above foreign investment position is a net between assets and liabilities. While the assets/liabilities are not necessarily owned/owed by the same parties, it is still a fact that there are about 3 trillion Euros of Italian financial assets outside the country's borders and foreign creditors would use all legal expertise to get a hold of some of them.

The old saying goes "If you owe the bank 100.000 Euros, you have to be nervous. If you owe the bank 100 million Euros, the bank has to be nervous." Germany has many more reasons to be nervous about an Italian exit from the Eurozone than Italy itself. And here is another thought.

Deutsche Bank, once Germany's financial calling card, is in great difficulties. Should Germany ever be called upon to bail-out Deutsche Bank, they will discover that Deutsche Bank is counter-party in derivatives with a notional amount totalling almost 3 times the GDP of the United States!

Certainly at that point, Germany will stop educating others about reforming their financial sectors and economies.