15 February 2017

OMFIF: Target-2 and Germany’s election dilemmas

The euro may be the most problematic currency in 2017; the issues signalling its weakness bring great dilemmas for Germany, where voting takes place last in this year’s scheduled elections in leading EMU economies.

[...]The euro may be the most problematic currency in 2017. True, economic growth in the euro area is picking up, thanks partly to injections of liquidity by the European Central Bank as well as rising export volumes helped by the weaker euro. Political and economic factors are likely to depress the currency further against a temporarily strong dollar that will probably dent President Donald Trump’s hopes of boosting US export competitiveness.

Three issues stand out as signalling euro weakness. All these bring great dilemmas for Germany, the pivotal member of economic and monetary union, where voting takes place last (in September) in this year’s scheduled elections in leading EMU economies.

First, the level of Germany’s claims under the ECB’s well-known Target-2 system for settling intra-euro area balances, now transformed into a programme for reallocating surpluses from Germany to less creditworthy parts of the euro area, is signalling possible danger ahead.

Second, the German Bundesbank is paying an unusual amount of attention to the repatriation of gold reserves from New York. This suggests it needs to buttress public confidence at a time of considerable discussion about EMU’s financial arrangements. The Bundesbank has revealed that 47.9% of its 3,378 tonnes of gold are now back in Frankfurt, with 36.6% in New York, 12.8% in London and 2.7% in Paris.

Third, Germany is impaled on a financial and political hook about writing-off loans to Greece as demanded by the IMF. This could spell electoral controversy in view of public opposition to Greek debt forgiveness.

Target-2 occupies a central place. According to latest Bundesbank figures, the German central bank’s claims under the system rose to €796bn at end-January from €754bn at end-December, well above the previous record €751bn in August 2012.

The Bundesbank’s ECB claims make up more than half of Germany’s net foreign assets of €1.5tn, which have themselves increased enormously since the euro was launched in 1999. If EMU broke up, or euro members redenominated their liabilities in a new, lower-valued currency, Germany would relinquish a large part of these assets. Such a loss of German savings would rival the country’s forced write-downs after the first and second world wars.

Both the ECB and the Bundesbank are playing down the renewed Target-2 increase, saying it reflects technical reasons linked to cross-border payments stemming from the ECB’s asset purchase programme. On the one hand, these facts would argue for Germany keeping the system going. On the other, they would suggest that the Germans should try to renegotiate the Target-2 arrangements. At the present rate of increase, the Target-2 balances could be close to €1tn by the German elections in seven months. [...]

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