Dr Strangelove and his geliebte Fuhrerin in Berlin have been disturbingly quiet of late. When the Italians failed to elect anyone, there was a predictable unleashing of hounds from government MPs and media titles about dire consequences. But the androgynous Merkeschäuble monster remained stumm. The Slog wonders why this might be.
I’m indebted to a well-informed Greek source close to the German Hypocrisy Question (GHQ) for alerting me to this relatively obscure paper released by the Bank of International Settlements (BIS) two months ago. As a summary of debt and and obligation between the eurozone periphery, the German Bundesbank, and international banking, it is in my view without equal.
There are a number of notable facts and views in it, but I’ll shortlist the key ones as follows:
1. Since late 2008, the Bundesbank has been steadily but determinedly reducing what the ezone periphery owes it under Target 2 balances – from €600bn to €280bn. That represents a drop of some 45%….hardly the act of a faithful Fatherland.
2. This is more than just a credit protection against never getting repaid: it also represents a response to the risk of national currencies re-emerging. The Bundesbank has itself on several occasions referred to this as what it calls the redenomination risk. So whatever Berlin says in public about the euro being forever and for everyone, that isn’t what the folks in Bankfurt have been thinking. (So up yours to all those people who thought my Bankfurt Maulwurf belonged to the bonkers minority).
3. However, as fast as Berlin reduces its Target 2 peripheral risk, UK banks in particular have made a dramatic shift from peripheral euro exposure by hedging it with a massive increase in direct claims on the Bundesbank. A Barclays shareholder report in mid 2012 noted that ‘The group is directly exposed to redenomination risk where there is a mismatching between the level of locally denominated assets and funding.’ In the first quarter of 2012, UK banks increased their claims on the German government and the Bundesbank by almost €100 billion….and that trend has continued. What’s more, the increase in claims on Germany as a sovereign is quite a bit larger than the scale of decrease in exposure to the PIIGS. There’s nothing weird about this, it’s just that it has ramifications – one being the interpretation of why Germany’s central bank has the exposure it does to the Target 2 balance. As the BIS paper sums up, ‘it is clear that a substantial part of the increase in Germany’s TARGET2 balance in 2012 resulted from international banks re-arranging their balance sheets to hedge the risk of redenomination.’
4. An explosive interpretation at the end of the paper suggests that outside investor hedging via the German State is ‘something akin to a currency attack’. Personally I find that simplistic, but this too is significant for any analysis of what might happen next in Europe.
My take-out from this is twofold. First, while once again Berlin likes to present its liabilities as something amassed magnanimously in support of the eurozone periphery, the diametric opposite is true: it’s been falling over its knickers for five years to reduce that exposure. But the Berlin facade has been hoist by free markets hedging their bets. They’ve basically run like the clappers for five years to stand still in the quicksand of a European dream turned nightmare.
Second – and not remotely mutually exclusive from that conclusion – the German Government has no room for maneouvre: it is inexorably caught between the gross dishonesty of PIIG élites, and the global banking market determined to protect itself come what may.
Now were I a periphery government official or politician, I’d be thinking about the leverage that reality gives me. The Greek élite is so self-serving and corruptly stupid, it will never get to that point: delayed gratification for them is mainly about having to wait another week for the backhander. But Spain (as we have seen already) and Italy (as we shall see) know that a combo of their size and debt profundity means Germany has its backside on the bacon-slicer. The Italian evil genius Draghi is also fully aware of this…..and, I think, it helps to explain his relatively relaxed attitude to being the provider of last resort: however Berlin wriggles, it can’t escape the Venus Fly Trap.
The only possible course for the Merkeschäuble is to wait and see. But if at any point – for whatever reason either planned or pure happenstance – the Bundesbank discerns a sound way to minimise damage and maximise advantage, Berlin will go for a radical reconfiguration of the eurozone. The ultimate conditions for such a move would be the dissuasion of markets from piling into its Target 2 obligations (via an interest penalty or similar) alongside rigidly-applied austerity in ClubMed.
Those suffering in the South can therefore expect more of the same. Those outside the eurozone should keep a close eye on what the Bundesbank changes in its terms of Target 2 business. And at the same time, perhaps UK political commentators should think about why Berlin and London seem a little closer together of late.