The eurozone was supposed to equalize trade and interest rates. The Maastricht Treaty supposedly ensures the free movement of goods, capital, people and services. Tensions were supposed to drop. Instead, the eurozone has been a complete failure.
Eurozone Complete Failure
- With Cyprus, there is no longer a free flow of capital. There are now Cypriot euros and other euros. Capital controls are in place.
- There is one interest rate policy set by the ECB but it has been set on the basis of what is beneficial to Germany.
- There are 17 different sovereign bond yield structures. In theory sovereign bonds of Greece, Spain, Italy, Portugal, Germany, (and all the other eurozone countries as well) should all trade at the same rate. In practice here are some 10-year sovereign bond rates: Spain:4.75% Portugal:6.42% Greece:11.71% Italy 4.34% Germany 1.24%.
- Tensions were supposed to drop. Yet in Greece, a neo-Nazi party is now the third largest. Separatist movements are on the rise in Spain.
- Greece and Italy have had technocrat governments forced on them by Brussels.
- European banks are capital impaired and massively leveraged. In Southern Europe, banks are leveraged to their own sovereign bonds.
- Manufacturing imbalances abound.
- There is massive unemployment in peripheral Eurozone. Youth unemployment exceeds 55% in Spain and Greece, and 38% in Italy.
- Property bubbles vary in strength and intensity, country to country.
- Trade imbalances are totally out of control.
Germany’s Net Foreign Assets Exceed €1 Trillion
Let’s take a closer look at point number 10. MarketWatch reports Germany’s account surplus jumps, no one is happy.
EMU was supposed to produce economic stability. Yet, five years after the financial crisis, Europe is a cauldron of uncertainty. The sobering truth about the large current account surpluses heaped up by Germany and EMU’s other prime creditor country, the Netherlands, is that Europe’s monetary set-up has consistently produced much larger imbalances than those that caused the collapse of the Bretton Woods fixed exchange rate system 40 years ago.
The record-breaking run of surpluses has propelled Germany’s net foreign assets to €1,000 billion for the first time, according to latest Bundesbank figures for end-September 2012. Not that Germany’s burgeoning foreign assets are generating any rejoicing in Germany. Quite the opposite.
In an astonishing turnaround in the balance sheet of Europe’s largest economy, nearly 90% of the country’s net foreign assets are held by the Bundesbank, in the form of its currency reserves (including gold) and, above all, the now-celebrated Target-2 loans to the European Central Bank (ECB), representing indirect claims on the weakest members of EMU.
The balance sheet transformation represents a reverse for the Bundesbank, which, after monetary union started in 1999, carried out a major effort, well out of the view of the German public, to reduce its foreign reserves (apart from gold) to make it less dependent on currency and capital market fluctuations. At end-2004, for example, the Bundesbank accounted for just €85 billion or 36% of Germany’s then total net foreign assets of €234 billion.
In the ensuing eight years, the country’s net foreign assets have quadrupled, but the Bundesbank’s total has risen tenfold to a third-quarter 2012 total of €878 billion.
This mirrors a massive reduction of German commercial banks’ exposure to foreign borrowers, led by the euro problem countries. German banks’ net foreign assets fell from a peak of €520 billion at end-2008 to just €8 billion in the third quarter of last year.
Commercial assets have been replaced by official assets: the difference has been made up by the Bundesbank—which accounts for the Target-2 concern. Even though the amounts have fallen from last summer’s peak, latest Target-2 figures for end-March show that the Bundesbank still is owed €589 billion under the ECB lending scheme.
What Cannot Be Paid Back, Won’t
Notice the massive shrinkage of German exposure to foreign borrowers. Mario Draghi’s widely hailed LTRO program provided the means for Northern Europe to unload peripheral Eurozone bonds.
Those bonds were snapped up by the likes of Spain and the result is Spanish banks are more leveraged than ever.
As politicians scramble from one panic to the next, promising that each panic is the last one, those 10 points show otherwise.
When the eurozone breaks up (and it will) a large piece of the €589 billion owed to the German central bank will blow up in smoke. What cannot be paid back, won’t.
Mike “Mish” Shedlock