WHAT YOU ALWAYS WANTED TO KNOW ABOUT TARGET2 LOANS BUT WERE AFRAID TO ASK

Greece owes Germany, the ECB, and the IMF a lot of money. But there is another level of debt almost no one is talking about. This not-much-talked-about debt are the TARGET2 loans Greece (and other euro zone importers) owes the rest of them.

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. In 2014, Germany recorded a staggering total trade surplus (exports-imports) of  € 59.5 bn) with Eurozone’s deficit nations (France, Italy, Spain, Greece, Portugal, Cyprus and Ireland) broken down as follows: France (+ € 34.5 bn), Spain (+ € 10.1 bn), Greece (+€ 3.2bn), Portugal (+ € 1.9bn), Cyprus (+€ 0.5 bn) and Ireland (+€ 3.4bn).   

When Germany sells to Greece, Greece’s central bank collects the money, but doesn’t pay the German central bank. 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  either extends 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. The broader euro zone – almost totally the PIIGS – owes it € 531 billion. 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 current balance for all TARGET2 loans is € 709 billion euros

In government debt, Greece owes Germany € 90 billion but in addition to the government debt, Greece owes Germany another € 100 billion in TARGET 2 loans. That means Germany could  have seen € 190 billion in default if Greece had 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  46% of that, or € 1.3 trillion, is from exports. About 63% of that, or around € 840 bn, 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.

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.