Back in December, Goldman Sachs entered the fray of what has since become the most sensitive topic for Germans (courtesy of this particular exponentially rising chart), namely the German funding of Europe's current account via the TARGET2 balance. Since then much has been said, up to and including a letter that Jens Weidmann sent to Mario Draghi expressing a concern about the "net receivable" status of the German central bank vis-a-vis the periphery. Unfortunately, since then the Bundesbank added another nearly EUR100 billion in net deficit balance, which has hardly helped the German people sleep better at night. So in the meantime, one question has arisen: "how much more can the TARGET2 imbalances increase?" The scientific and, non-scientific answer, comes from Goldman Sachs: "a lot."
How far can the imbalances increase?
The short answer is: a lot. After all, German banks still hold claims of more than €100 billion against peripheral banks and more than €300 billion against the periphery in total (all sectors, see Chart 2). Moreover, banks in the periphery hold deposits of around €2 trillion.
How much of this money will be transferred to bank accounts in the core is difficult to say. The ECB’s two 3-year LTROs should have, all else equal, reduced the capital flight from periphery to core to the extent that fears of an immediate liquidity crisis of the banking sector in the periphery were a major driving force behind these flows. There is little evidence, so far at least, for this. In any case, we think it is reasonable to assume that genuine concerns about the solvency of peripheral banks are also playing a role here and these concerns are unlikely to go away any time soon regardless of ECB liquidity operations.
But lest Goldman be perceived as stoking more money run fears, here is its follow up that is so disingenuous, one wonders just how naive, gullible and stupid the author must have been:
Rising financial risks? Compared to what?
The net claims of the Bundesbank against peripheral central banks do not pose a genuine financial risk as long as peripheral central banks are part of the Euro area. This is not to say that the generous liquidity provision does not also imply a higher financial risk for central banks. But these risks are unrelated to TARGET2 and are shared among all Euro area central banks according to their capital quota. It is only if countries were to step out of the Euro area that the remaining central banks would have claims against these central banks that would probably need to be written down (depending on the extent to which these countries would be able to repay Euro liabilities, which would then be foreign-denominated liabilities for these countries).
However, it is important to note in this respect that core countries already faced significant exposure vis-à-vis the periphery even before TARGET2 imbalances started to increase (Chart 2). Although this financial risk was concentrated in the banking sector, it is reasonable to assume that a significant part of potential losses would have ended up on public balance sheets if an orderly adjustment had not been accompanied by ECB liquidity operations and the TARGET2 imbalances. Thus, comparing the financial risk of the current TARGET2 imbalances in the event of a Euro breakup with a pre-crisis situation, without taking into account the risks that already existed, is necessarily distorted.
Uh, of course we are talking about a euro breakdup: if Goldman does not understand this, they need to plant at least another head of a central bank in addition to the ECB: namely the Bundesbank. Because the question is just what the bill to the German taxpayers will be when everything falls apart, up to and including the euro. And that question Goldman was already kind enough to answer: "a lot"