Mario Draghi – against whom the EU Ombudsman recently opened an inquiry for “conflict of interest” – has openly disowned the “whatever it takes” of four years ago: in a letter a few days ago he candidly admitted that a member country can leave the eurozone, provided it settles its positions in the Target2 system. The fall of the last taboo by the ECB sounds at the same time like a spectacular “free for all” for the weak countries of the eurozone and a near-threat to Italy, whose very high Target2 liability would represent a tremendous loss for the main creditor, Germany, which will not be slow to assess how much it is worth preventing it.
Source: ZeroHedge.
Less than 4 years ago, and shortly after the infamous threat to speculators of “whatever it takes”, Mario Draghi responded to a question from Zero Hedge readers, stating that “there is no plan B” as far as contingency plans were concerned in the event that a eurozone nation left the monetary union. The reasoning was simple: to contemplate such a scenario meant admitting the possibility that it might occur, which is why the ECB desperately wanted to give the impression that Europe’s cohesion was indestructible, at any cost.
Let us fast forward four years, when not only has this particular strategy been completely rejected, but for the first time the ECB President has provided a framework, however vague, showing what could happen in the event of an Exit.
In a letter to two Italian members of the European Parliament published on Friday, and reported for the first time by Reuters, Mario Draghi admitted that a country could leave the eurozone – and so much for his “there is no Plan B” – but before closing the door behind it, it would have to settle its debts with the eurozone’s Target2 payment system.
As was rightly pointed out to us by @KellerZoe, Draghi’s letter to MEPs Marco Zanni and Marco Valli does not state that there is a need to settle the Target2 accounts “before” an exit, but simply says that in the event of an exit the accounts must be settled in full.
“If a country were to leave the Eurosystem, the claims on or liabilities of its national central bank vis-à-vis the ECB would have to be settled in full,” Draghi said in the letter, without specifying in which currency the “settlement” would take place. Nor is it clear what the ECB’s reaction would be if a country did not “settle its accounts in full”: ultimately, the ECB does not have an army to ensure compliance with its policies.
As Reuters confirms, Draghi’s comment constitutes “a vague reference by the ECB President to the possibility that the eurozone might lose members”. We would say not merely a “reference”, but an admission that an Italexit is all too possible, and that the only way the ECB would allow it would be to first make Italy pay its Target2 bill of EUR 357 billion (which, over the last 5 years, various naive economics professors have argued would never be used by the ECB as a bargaining chip in “exit” negotiations and has no political implications; oops).
In truth, the beneficiary of this payment would be the country that relies most on the persistence of the status quo: Germany, which has something like EUR 754 billion of “assets” in the Target2 system, which could be wiped out if one or more eurozone countries were to leave without meeting their payment obligations.
In the letter, Draghi reiterated that the imbalances are due to the ECB’s securities purchase programme, in which many of the sellers are foreign investors with accounts in Germany, and to the resulting rebalancing of portfolios.
Draghi’s admission that “QuItaly” – or “UscIta” as it is called within the country – is an all too real possibility coincides with a wave of anti-euro sentiment in Italy and in other eurozone states, fuelled in part by Britain’s unprecedented decision last June to leave the European Union.
The threat of default on cross-border debts has often been considered a cohesive element of the eurozone during the financial crisis. Since these payments are generally not settled, the weaker economies, including Italy, Spain and Greece, have accumulated enormous Target2 debts, while Germany stands out as the largest creditor, with net claims of EUR 754.1 billion.
The Target2 imbalances have worsened in recent months, when the Harvard economist Carmen Reinhart sounded the alarm about capital flight from Italy. This can be seen in the chart below, which confirms that beneath the apparent calm of low Italian bond yields – even though they have recently been rising – enormous capital imbalances are building up.
Draghi’s admission, to be understood almost as a threat to Italy, may have opened a new Pandora’s box for European stability, in addition to the concerns over Trump, because not only has Draghi confirmed that exit from the eurozone has been explicitly contemplated by the central bank, but he also defines the conditions under which it would be considered and permitted.
Even more importantly, it once again provides the basis for aggressive “negotiation”, which could potentially degenerate into an escalation of acrimonious talks between Italy and Germany, since the ECB has suddenly made clear that Italy’s gain in a “hypothetical” exit from the eurozone would constitute a tremendous loss for Berlin and for Merkel. We are sure that very soon the question of “how much” it is worth for Merkel to prevent such a loss will also emerge. As for what Draghi’s statement means for countries with a much lower Target2 debt, which might also consider leaving the monetary union, the answer is contained in two words: “green light”.
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