Almost exactly two years ago, your editor was gearing up to attend the Agora Economics Roundtable in Baltimore, USA.
The backdrop for the meeting couldn’t have been more interesting. The US was gearing up to swear in president-elect Donald Trump that week and the mood on the streets was mixed.
It was my first time in Baltimore…and my first time meeting Agora’s founder Bill Bonner and many of our colleagues around the world.
The idea of the 2017 Agora Economics Roundtable was to gather all the business representatives around the world in one place. In case you didn’t know, Agora has a network of offices and experts all over the world — in the US, Argentina, Brazil, Spain, India, and more.
Yet the highlight of the conference was a meeting with Dr Alan Greenspan, who served as chairman of the US Federal Reserve from 1987 to 2006.
In fact, here is a snapshot of your editor with him:
Selva Freigedo and Alan Greenspan
The most interesting take away from our meeting with Dr. Greenspan was that he made a prediction on where the next crisis could come from: Europe.
Here is what he had to say:
‘Something is going to happen there. My view is it’s either going to be Greece [or] it conceivably could be Italy…but it is extraordinary what is going on in this system while the total assets of the European Central Bank continue to go straight up. What would happen if there was a default of the euro? In the United States, if there were a default on the dollar…for example, if the Federal Reserve went into default, the US treasury would bail it out but… There is no comparable vehicle to help the [European] system. I’m very worried…Mario Draghi, whom I know and he’s a very good guy, is just talking like we’ll do whatever is required. Well at some point somebody’s going to say, “I don’t want to accept euros.”’
His main worry was Target 2.
As he continued:
‘There’s one thing that bothers me considerably, which nobody makes any mention of. There is in the European Central Bank [ECB] a mechanism as it exists of necessity where the European Central Bank is made up of the central banks of the European euro area and there’s a thing called TARGET 2. Do you know what TARGET 2 is? TARGET 2, at this particular stage, is turning out to be an extraordinarily large transfer from Bundesbank to essentially Italy and Spain and most recently the European Central Bank. That means the Bundesbank is lending money to the European Central Bank and…it’s big numbers. We’re talking 7,800 billion euros. This can’t go on indefinitely…’
We have often written about Target 2 here at Markets and Money.
Don’t get put off by the jargon. In essence, Target 2 is a payment system for the Eurozone. It is an accounting system that keeps a tally of what bank owes what during transfers between European central banks.
The problem is that Target 2 is also an unlimited credit facility, backed by collateral from the country’s central bank and its commercial banks. One with no due dates, no interest and no conditions.
You see, as these electronic euros move around the EU, debits and credits build up between EU countries and their central banks.
Here are the six countries with the highest Target 2 balances.
Source: European Central Bank
And the six countries with the lowest Target 2 balances:
Source: European Central Bank
A couple of things to note. As you can see the current system is giving Germany big surpluses, while countries like Italy and Spain have the largest liabilities.
What happens if a country with a large liability decides to leave the European Union?
Well, they will have to pay it back.
Secondly, take a look at the black line that goes across the bottom on the first graph.
This is the European Central Bank’s (ECB) balance.
Since 2008, the European Central Bank’s balance has gone from positive to negative. After Italy and Spain, the ECB has the third-largest liability. How does the ECB’s balance go negative?
Well, because of the quantitative easing (QE) program. That is, the ECB has been flowing money into Europe and lowering interest rates to boost the economies.
If you want to protect your family wealth, you need to know why this financial expert is predicting economic collapse. Find out more here.
Eurozone about to crash?
However, the economic data coming out of Germany and France this week wasn’t good.
Germany, Europe’s largest economy, saw a drop in their industrial production.
From Deutsche Welle:
‘Germany’s “fat years” of higher-than-expected revenue from tax receipts are over, Finance Minister Olaf Scholz warned on Sunday, signaling that Europe’s top economy is set to lose momentum in the next few years.
‘“The good times in which the state kept taking in more taxes than expected are coming to an end,” Scholz told the Bild am Sonntag newspaper. That, he said, restricted the government’s capacity for passing new tax cuts or increasing public investment.’
France is also dealing with the economic effects of the yellow vest protests.
The two largest economies in the Euro are slowing. The third one, Italy, is still dealing with bank weakness.
Countries around the EU are also still dealing with increasing government debt and high unemployment.
And this doesn’t even take into consideration the refugee crisis, banking problems, a defiant US or a hostile Russia.
And, of course, there is also Brexit…which hasn’t happened yet.
Europe is walking the tightrope.
But investors aren’t worried.
‘Europe is the epicenter for recession fears — but investors are cheering.
‘The continent’s biggest companies have started to outperform their U.S. peers on a forward-earnings basis, the cost of insuring against corporate defaults has fallen this year and traders are betting that volatility will decrease.
‘What makes this pivot towards optimism striking is that it runs against recent data. From flagging industrial output in Germany and France to worsening consumer confidence, official measures seem to indicate the economy is facing a rough patch. Investors have so far resisted the downward pull of bad macro news, possibly because they expect corporate results to tell a different story.’
The ECB, much like the Fed, has been flooding the economy with money and has lowered interest rates to record lows.
Now the ECB has ended their QE program in December, and they are looking at increasing interest rates, all to prepare for the next crisis. At the same exact time major economies in the EU are seeing a slowdown…
…and investors aren’t worried.
Editor, Markets & Money