Anyone betting that France will make it through the eurozone crisis because it’s a AAA country (just about), might want to a look at this chart and think again:
The chart, courtesy of Eric Dor, director of research at the IESEG School of Management, shows the sudden surge of France-related Target2 debts.
The Target2 system is the Eurozone’s payment system, short for the Trans-European Automated Real-time Gross settlement Express Transfer system. It acts to balance out payment shortfalls and surpluses throughout the system, by transferring funds between respective National Central Banks as and when needed.
The problem the Eurozone is now facing, according to some, is that the number of NCBs with assets or surpluses spare to top up other NCBs is fast diminishing. In fact, some suggest there’s only the Bundesbank really holding the fort:
We should point out the ECB still has full-on debt monetisation supported by ECB debt certificate issuance in its arsenal of monetary tools — though obviously that’s not going to go down well with many of the Eurozone’s more influential inflationista hawks.
Going back to Eric Dor’s chart, it’s clear that something influential happened in July. Something which not only destabilised the balancing system but tipped France, in particular, into the red.
Could it have been the ECB’s July 7 rate hike to 1.5 per cent?
In which case, why would France be so much more vulnerable to rate hikes than other Eurozone members?
The only thing we can think of that might have made French institutions more vulnerable than others was possibly the nation’s convention to structure repurchase agreements around floating-rate terms rather than fixed ones. Known as ‘pensions livrées‘, French repos have usually taken on this floating rate structure because of their substantial use by money market funds.
But that’s literally a shot in the dark.
One thing is sure, says Dor. The amount of loans outstanding to domestic financial monetary institutions at the Bank of France began to rise in earnest come August:
As to how this relates to Target2, Dor explains:
The central bank of the Eurozone is in fact a set of several institutions known as the Eurosystem. It is composed of the European Central Bank and all the 17 National Central Banks of the member countries. A common policy is determined at the ECB for the whole euro area, but euro banknotes are issued by the National Central Banks and the refinancing operations are also decentralized: liquidity is provided by each National Central Bank to the banks of its country.
The banks hold their reserves at the National Central Bank of the country where they are located. They borrow liquidity from the National Central Bank of the country where they are located. Cross border payments between banks of different countries of the euro area are conducted through a system known as TARGET2.
Through this payments system banks can transfer to each other claims on the National Central Banks, known as “central bank money” or “reserves”. Through TARGET2, each cross border transaction between countries belonging to the Euro area give rise to a gross claim of a National Central Bank on another National Central Bank.
Indeed The National Central Bank of the country of the “paying” bank needs to borrow claims on the National Central Bank of the country of the “receiving” bank, in order to transfer these claims to this bank. The National Central Bank of the country of the “paying” bank has thus to borrow reserves from the National Central Bank of the country of the “receiving” bank, before transferring the property of these reserves to this “receiving” bank
At the end of each day, the claims or liabilities of National Central Banks on or to each other are netted and replaced by a net claim or a net liability of each National Central Bank on the Eurosystem.
These daily net claims or liabilities are added to the cumulated TARGET2 balances of each National Central Bank built since the launch of the euro.
Growing TARGET2-related claims on the Eurosystem thus reflect accumulated balance of payments surplus. Rocketing TARGET2-related liabilities of the distressed countries reflect accumulated balance of payments deficits.
While, it’s been pointed out that Target2 imbalances are an imperfect indicator of stealth bailouts — all the positions are, after all, absorbed into the consolidated Eurozone balance sheet, meaning there’s no real national exposure (the system works as one) — the fact that we may be close to a transfer breaking point possibly moves that debate along.
At least from the perspective that the system is currently balanced only by Germany’s ability to attract deposits at the same rate as other Eurozone members are borrowing. It’s a potentially endless churn, at least until those deposits start heading out of the Eurozone system completely or there’s a time-related lag in settlement.
Thus this isn’t so much about stealth bailouts as it is about reaching operational limits. A reflection of the ECB having reached a critical Rubicon crossing point when it comes to its operational policy.
More to the point, the trends themselves present an interesting account of what’s really going on in the Eurozone system. The French flip, being a particularly interesting turning point. Though it’s worth pointing out that Italy’s debtor status worsened around July time too.
Related links:
How Germany is paying for the Eurozone crisis anyway – FT Alphaville
Monetary Policy Implementation: Common Goals but Different Practices - NY Fed
The decline of “safe” assets – FT Alphaville
The eurozone crisis as balance of payment problem - FT Alphaville
