Explaining The European €2.5 Trillion Liquidity Catch 22 Closed Loop

Tyler Durden's picture

If anyone is confused about what the real issue in Europe is, the following two charts should explain it all.

Because stripping all the recent rhetoric and bluster about this insolvent nation or that, the real explanation for Europe's troubles, and the real reason why virtually every country except for Germany, is essentially insolvent (something that has absolutely nothing to do with how much liquidity the ECB can provide, and in fact by making liquidity free to fill transitory needs, the ECB enables even more destructive behavior that does nothing to fix the cause), has to do with the flow of cash. And specifically the transfer of cash within the mercantilist union.

The first chart below summarizes the various individual current account deficits (accumulated over the past decade) within the Eurozone, and how it is clearly in Germany's best interest to perpetuate a common currency, which prevents its legacy currency, the DEM from soaring, and thus crippling intraunion current account flows that benefit Germany. As for external trade flows: the weaker the Euro, the better so Europe can export its stuff to China and the US (hence the need for a perpetual threat of a PIIGS Implosion, which prevent the EUR from rising on endless concerns foa default).

Source: Diapason

Now this plan worked for many years, until about 5 years, the debt capacity of the Periphery started getting filled, and instead, via the Eurosystem Banks hub and spoke system, of which the ECB is at the hub, those countries with current accounts had to start funding indirectly, via TARGET2, the capital deficiency of the big CA deficit countries. The second chart below shows just how far this divergence has gotten.

Source: Goldman

The problem, as we noted last year, is that the system may have crossed a threshold where Germany's explicit funding of the CA deficit transgressors is now far too large for it to be sustainable (as Jens Weidmann has now confirmed).

Alternatively, should the status quo continue, and it very well may with just bailout after bailout in store - in other words the same defection-encouraging game theory stance - the only way it can work is if Germany continues to recycle the CA surplus right back into the European periphery. There is, however, no ceiling to this activity, and in several years, the German TARGET2 "receivable" will be in the trillions, or well greater than its entire GDP.

And that, in a nutshell, is what is happening in Europe.

Everything else is merely noise masking the expansion of the relationship whereby Germany pretends its increasing losses, in the form of recycled sunk Current Account "costs" as a victory.