Europe's Greatest Cover-Up Could Mean The Death Of The Euro

It’s kind of like selling goods to consumers with very bad credit and then being surprised when they don’t pay.

But before I get into that, we all know Greece owes Germany, the ECB, and the IMF a lot of money.

Last week I explained that if they went the "Grexit" route, 75% of Greece’s government debt would’ve been wiped clean. That’s $90 billion to Germany alone and about $250 billion to the rest of the euro zone. It would have hurt, but there’s no avoiding pain at this point, and now it’s only going to be worse.

But there is another level of debt almost no one is talking about.

In fact, we have a harder time getting good information on it because the EU has increasingly hidden it.

However, this debt gets at the heart of why Germany and some of the strongest opponents to a Grexit were so desperate to keep Greece in the euro zone.

This not-much-talked-about debt are the TARGET2 loans Greece (and other euro zone importers) owes the rest of them.

It’s a fancy way of saying "past due accounts receivables." Another way of saying this: “The check’s in the mail." Or: “We’ll pay you when we can."

Fat chance.

The idea is that when German or other euro zone companies sell goods to Greek companies, the Greek companies hand off their payment obligations to the Greece central bank. That central bank then owes Germany’s central bank, which then pays the German companies who sold the goods in the first place.

The problem is that the southern European countries – PIIGS, or Portugal, Italy, Greece, and Spain plus Ireland – import a ton. When Germany sells to Greece, Greece’s central banks collects the money, but doesn’t pay the German central banks. These are called TARGET2 loans.

They’re not really "loans" in the sense that they are involuntary. The German central bank knows that if it pushes too hard for these payments on time, exports will slow or discontinue without such credit extension. It’s either extend credit to these subprime borrowers or lose the sales!

It’s such a huge issue because these economically weaker nations aren’t competitive exporters. They can’t afford these outrageous trade deficits they’re wracking up! They have run increasing trade deficits ever since the euro was created. The currency lets them borrow at a cheaper rate. And the stronger exporting countries are willing to extend credit to keep their gravy train going.

Under this backwards arrangement, Greece owes Germany 100 billion euros, or roughly $109 billion. The broader euro zone – almost totally the PIIGS – owes it 531 billion. That’s almost $580 billion.

This is the most contentious example, but the Netherlands, Luxembourg and Finland are extending credit to these weaker central banks too – though nowhere near the extent of Germany, which holds around 75% of these TARGET2 loans.

The following chart shows the TARGET2 balances across the euro zone. Blue is the extended credit from the four major net exporters. Red is what the five net importers owe them.

 

TARGET 2 Balances Exporters and Importers

 

Before I even get into this, just take the chart at face value. Look at all that credit. It’s disgusting. We didn’t have this kind of foolishness prior to 2008. Now we live in an age where credit is king. Real value is supposed to be king. Cash is supposed to be king. Not credit. This nonsense has got to stop.

The edge of this graph shows the current balance for all TARGET2 loans: 709 billion euros ($774 billion). It actually peaked at 1.06 TRILLION euros in late 2012. Come on!

This gets at why Germany wasn’t in a hurry to let Greece leave the euro zone. And in fact, why it finally insisted they stay.

In government debt, Greece owes Germany 90 billion euros.

If Greece had exited, Germany would have had to write-off that amount overtime. The short-term affects for Germany would have been manageable.

But in addition to the government debt, Greece owes Germany another 100 billion in TARGET 2 loans. That would’ve been written off immediately. That’s much more painful and embarrassing to voters near term – which is the realm politicians live in.

That means Germany could see 190 billion euros – or $200 billion – in default if Greece exited. That’s much more than any other country by far.

To put this in more perspective, Germany’s GDP is about 2.9 trillion euros. 46% of that, or 1.3 trillion euros, is from exports. About 63% of that, or around 840 billion, goes to the euro zone. Exports are paramount to its aging economy that would otherwise already be slowing dramatically longer term!

That means the 531 billion in TARGET2 balances from the euro zone equals 63% of its exports, which means the payments are eight months late.

Any accountant worth his salt would lose his mind if account receivables were just three months late!

This is one of Europe’s dirtiest secrets.

To keep exports going to countries that can’t afford it, the central banks of the exporting nations have to extend high credit to the central banks of the weaker importing nations.

That way the stronger countries import more than they frankly should and the weaker nations live well beyond their means. This is the very imbalance that the euro has created since its inception in 1999.

Talk about denial.

Talk about not addressing the underlying problem.

Talk about kicking the can down the road!

This system won’t last. The euro won’t last. Watch out below in the months and years ahead when it finally cracks, or at best is restructured into a strong and weak version of the currency.

As bad as things will get in the U.S., there’s one bright spot: Thank god we’re not Europe. We will still be the best house in a very bad neighborhood ahead.

Harry

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Mikael Dittmann 6 years ago Member's comment

And now for our neighbors in the west.

US-economy has had a fat live through oil-markets being traded in USD. If all trade went to EUR or any other currency, I am afraid Uncle Sam would collapse in a ground shaking implosion as all the excess USD in the world would be called at real value, to which there is close to none. All the gold reserves on this planet, including the gold not dug out of the ground would not be enough to support the USD floating the market.

Read this article for inspiration

www.globalpolicy.org/.../30447.html

Mikael Dittmann 6 years ago Member's comment

Let's take 2 other angles on this - first on the German arguments and second on what would happen if USD value was called at its real value. The stated consideration on "cost" of writing of the intra-Eurozone balances would be quite embarrassing, but also a one-off hit. I have no doubt Germany would recover from that quite fast. The long term impact from EURO exits would be far worse. All strong EURO economies (and Germany by far the most) have won by letting the PIIGS enter the EURO zone, because that was the only way to make prices comparable and stop these countries from truly reflecting their currensies' value by a continuously devaluate their currencies ("nature" of economics would enforce than if they were free floating). Being in EURO, salaries became more comparable and the inefficiencies in PIIGS vs. the efficiencies of the stronger North/West of Europe, gave the strong economies the upper hand and a clear competitive advantageous development. So Germany CAN compete with PIIGS countries, but the competitive scenario would be VERY different, had PIIGS not joined EURO. THAT is a strong reason for Geramny too keep them in

Rory Keelan 6 years ago Member's comment

Hadn't thought of that. Thanks. Further suggested reading?

Eliyahu Ben Abraham 6 years ago Member's comment

Fact is that Germany was the greatest beneficiary of debt relief in the 20th century. Think of Marshall Plan billions never paid back. War reparations never paid for WW2. Etc. Moreover, Germany 's handling of the Greek debt crisis at the start in 2010 caused Greek debt to balloon. Was Germany deliberately trying to make Greece suffer?

On one point, Harry Dent, you are contradicting the many reports coming out of Germany and the Brussels meeting where the last deal with Greece was decided on. To wit, many reports stated that German finance minister Schaeuble wanted Greece out of the Eurozone. And not only Schaeuble but the Bundesbank governor, and others. As I understand it, Merkel would have gone along with Schaeuble if it were not for opposition to forcing Greece out on the part of Renzi and Hollande and others. Again, I stress that the Eurozone's misguided handling of the Greek debt crisis at the start in 2010, as promoted by Germany, caused Greece's debt to swell and balloon up.

Koen Van Diepen 6 years ago Member's comment

This is the pot calling the kettle black. Europe runs on credit? The US has been borrowing from China for years, and almost defaulted last year!

Koen Van Diepen 6 years ago Member's comment

This is the pot calling the kettle black. Europe runs on credit? The US has been borrowing from China for years, and almost defaulted last year!

Alon Cohen 6 years ago Member's comment

Harry, you are 100% right and there's much more financials black holes in the Euro zone. Greecs' debts are chickpeas compared to the domino effect if it exits from the zone. Have you considered how much the Euro Europe's single currency served the American financial interest.

Anto Emme 6 years ago Member's comment

Sorry, Harry. Your vision is so partial... I am European and even I agree there is unbalance in imports and exports between EU countries (something Germany is really profiting from and despite EU tract acts), your analysis is missing counter face. For instance Italy is also a big exporter (just think of fashion, food, furnitures etc) and those (export) data are totally missing here. Anyway you are right when you say Germany is the real master in EU and just to feed its export. Would have let Greece out, others would have followed, included probably Italy... Regards.

Fatchary * 6 years ago Member's comment

Can't stop thinking that using of PIIGS as an acronym for southern European countries it's very offensive

Denver Walker 6 years ago Member's comment

I rather think a funny acronym is the least offensive thing in this article...?

Angus Mcdougall 6 years ago Member's comment

sorry, but Portugal since the financial crisis has gone from net importer to net exporter. when buyer credit is withheld by the absence of consumer credit from Portuguese national banks, imports quickly slow down. As domestic demand slumps for goods made within Portugal, manufacturers are driven to find export markets. The article above fails to relate to how real economies respond to real market conditions and the withdrawal of excess credit.

Krishna Thanappan 6 years ago Member's comment

getting out of euro wont bring the world to an end......... the greek people will control over their economy by going back to drachma..........they can devalue or revalue their currency according to their economic situation.....so get out of euro... the british were wise and kept their pound and the british people are happy... euro shud have been formed by stronge conomies only... and btw it would be goos for european union to return to good old eec european economic community.......... the eu is big political mistake..... it is sounds fascist