Economics and politics - comment and analysis
30. July 2018 I Heiner Flassbeck - Joachim Nanninga I Economic Policy, Europe

TARGET 2 – or how to stir up the people

A loyal Makroskop reader recently sent me Hans-Werner Sinn’s TARGET article linked here (here a short version in the daily Frankfurter Allgemeine Zeitung (FAZ), in German) and asked a simple question: “Why is this man writing this? (Professor Sinn used to run the Ifo Institute for Economic Research in Munich).

That’s exactly the right question. One asks the same question when Thomas Mayer (former chief economist at Deutsche Bank) sounds alarm bells in the FAZ pretending that Germany’s claims against the other euro countries are being disregarded and that sooner or later the German taxpayer will have to step into the breach in order to replenish the Bundesbank’s equity capital. Even in a very poor piece on German public television (“Plus-Minus” on ZDF), every trick is used to give German viewers the idea that Italy is actually to blame for the supposedly miserable situation.

Alarmist economists

What alarmist economists have in common on the subject of TARGET is that they never explain where the balances actually come from and what Germany has to do with them. On the technical side of the matter, Joachim Nanninga has said almost everything important repeatedly (here most recently) and he has also made it clear that the diverging balances are signs of undesirable developments:

“The Target system, i.e. the processing technology of transnational payments within the euro area, is indeed not a problem, but a well-functioning technical instrument of payment transactions. However, the diverging balances are an explosive alarm signal. But anyone who conducts the debate in such a way that it is a matter of “making German demands for debt repayment” and “debt collecting” that have arisen from a creditor position unfairly imposed on the Germans, is trying to prevent the alarm signals from being correctly interpreted.

These “diverging balances” are exactly what this is about, but that is not the issue that alarmist economists in Germany address. They simply want to create an anti-euro sentiment and raise German passions against a country like Italy in order to divert attention from the real problems that have arisen in the euro zone.

There is no doubt that there are two key economic problems behind the TARGET balances: Germany’s rising current account surpluses with the rest of the euro area (with 80 billion euros alone in 2017, the surplus was higher than in 2016 and higher in the first quarter of 2018 than in the first quarter of 2017) and the associated uncertainty of those in a country like Italy holding euros in bank accounts. In its latest statement (here), the Bundesbank, the German central bank, points to a further effect that has occurred recently in the course of the European Central Bank’s (ECB’s) purchases of government bonds and their distribution to the various banks in different banking centres, but let’s put this on hold for the moment.

“Capital flight”

Let us take a very simple case: an Italian citizen holding 10,000 euros in his account in Italy with an Italian commercial bank becomes dubious about this investment because he says to himself that it is no longer 100 percent certain that Italy will remain in the euro zone in the years to come, given the statements of some members of the new government. It is clear to him that if Italy exits, his euro account in Italy is in danger of being converted into a new Italian currency as a result of any legislative changes. In view of the competitiveness gap between his country and Germany, he can calculate that a new Italian currency would devalue and that he would therefore have to expect to lose some of his savings that were formerly denominated in euros.

What can the Italian citizen do to protect his savings? The simplest measure is to withdraw the 10,000 euros in cash. He can be sure that he will always be able to use these euros to buy goods in the euro zone, because it is very unlikely that an Italian government will take cash from its citizens or prohibit its exchange. Obviously, in this case nothing happens economically in the euro zone, only more cash is needed at a certain point than before.

But the Italian citizen could also transfer 10,000 euros from his Italian bank to a German bank because he is reluctant to hold large sums of cash in euros at home. This is usually referred to as “capital flight”. In this case, he changes the jurisdiction in which his money is held, which protects him against the devaluation of a new Italian currency in the event of his country leaving the euro.

Again, in this case, absolutely nothing of economic importance happens in the euro zone. There has been no change in financial assets, nor has there been any change in expenditure and revenue flows in the real economy. In this case, however, the balances in the TARGET 2 system change.

TARGET logic

The transfer initiated by the Italian citizen leads to the following changes in the respective balance sheets:

1) Debiting his or her Italian account to the amount of the transfer

2) Reduction in the assets of the Italian commercial bank vis-a-vis the Italian central bank in the same amount

3) Decrease of the Italian commercial bank´s liability to the Italian citizen by the same amount (point 3 is identical to point 1)

4) Reduction of the Italian central bank’s liability to the Italian commercial bank by the same amount (point 4 is identical to point 2)

5) A new liability of the Italian central bank to the European Central Bank of the same amount

Nothing has changed in the Italian citizen’s financial assets. His claims are no longer on an Italian bank, but have been transferred to a German commercial bank. The balance sheet of the Italian commercial bank remains balanced: liabilities and assets have decreased to the same extent (balance sheet contraction). The Italian central bank now has a liability to the ECB instead of a liability to the Italian commercial bank (liability swap). The ECB books an asset to the Italian central bank and a liability to the Bundesbank (balance sheet extension).

If this payment transaction does not correspond to an equal amount in the opposite direction, we have here the case of the increase of the TARGET2 balances, for Italy negative and for Germany  positive by the same amount, 10,000 euros. However, nothing has changed in the real economy. More than ever, Germany’s alleged claims on Italy have not changed.

For the German side the bookings would be completed thus:

6) A new ECB asset against the Italian central bank for the amount of the transfer (identical to point 5)

7) A new ECB liability for the amount transferred to the Bundesbank

8) New asset of the Bundesbank against the ECB in the same amount (identical to item 7)

9) The Bundesbank’s new liability with the German commercial bank…

10) A new asset of the German commercial bank against Bundesbank … (identical with item 9)

11) A new liability of the German commercial bank to the Italian citizen…

12) The Italian´s claim is now against the German commercial bank instead of against the Italian commercial bank.

What are the causes?

This example clearly shows that a transaction that has no impact on the real economy in any euro area can lead to a change in TARGET balances. The divergence of these balances and actual economic transactions proves what serious analyses have always said: one cannot conclude from the parallel cycle of the payment system that the real system (the system of expenditure and revenue) is going wrong.

The only thing we can and must do in this case is to ask where the Italian citizen’s insecurity comes from, which triggers his relocation of savings. Here the answer is very simple and we have given it many times: European Economic and Monetary Union (EMU) was wrongly constructed from the outset because no precautions were taken against massive real under- and overvaluations, i.e. the change in the competitiveness of national economies (see an explanation with further information here).

And there can also be no doubt that Germany has made a considerable contribution to this with an undervaluation strategy since the beginning of the 2000s. Germany has violated the principle of stability agreed by all EMU countries by depressing its own wages, and it has undercut the 1.9 percent mark set by the ECB as the Union’s inflation target in accordance with the principle of stability.

The consequences of the real appreciation in Italy, France and other countries and the real devaluation in Germany have been reflected in trade imbalances (current account balances) and shifts in market share on the world market, which cannot be eliminated without the possibility of devaluation and appreciation of national currencies without serious economic and political consequences. As a result, there is considerable uncertainty about the continued existence of EMU, which is causing unrest among savers in the countries which have appreciated in real terms, i.e. lost competitiveness.

Adding fuel to the fire

By the refusal of the majority of its politicians and economists to take any notice of this phenomenon, let alone taking measures to eliminate it, Germany has dramatically increased the uncertainty in those nations that have lost ground with regard to competitiveness, which has contributed to an increase in TARGET balances. And this does not only apply to politicians. The Bundesbank, which is part of the euro system and seems to be trying to smooth the waves in the German public, is itself adding fuel to the fire.

At the end of the article linked above the Bundesbank claims:

   “The Bundesbank assumes that the euro system will continue to exist in its present form. The subject of a country leaving is purely hypothetical. In general, TARGET2 balances are a symptom, the causes for their development lie outside of TARGET2.

    Such measures include in particular the reduction of public debt, structural reforms and a strengthening of confidence in the solvency and resilience of banks. In the medium to long term – to some extent as a side effect – they should then contribute to a reduction in TARGET2 balances by increasing confidence in economic policy in the euro area”.

The first paragraph is correct, but the second is fundamentally wrong. It is not unilateral national measures – such as the reduction of public debt or the meaningless “structural reforms” – that can solve the underlying problem; it is always measures on both sides of imbalances. In Germany this means a clear renunciation of competitiveness (i.e. real appreciation) in favour of those countries which have had to devalue in real terms because they have previously appreciated in real terms. Those who do not talk about the divergences that have arisen and name the culprits (again on both sides) play into the hands of those who, with their rarefied discussions about TARGET – unintelligible to the layman – reinforce prejudices against other countries, divert attention from their own mistakes and ultimately destroy every possibility of European cooperation.


This article was published in German on Makroskop ( and in English on Brave New Europe (