Graphics can often tell a story better than words. For those who think the euro already doomed, the following graphic, drawn from the International Monetary Fund's latest Global Financial Stability Report, tells it all.
What it shows is the now extreme flight of foreign capital from Spain and Italy. As you can see, the graph only goes up to the end of January, but we know that the phenomenon has got, much, much worse since then. This Credit Suisse graphic (below) tells much the same story. Anyone who can has been getting their money out. Likewise, any foreign company doing business in Spain and Italy removes the money as soon as they get paid, driven both by concern over the safety of the domestic banking system and the possibility that these countries might end up leaving the euro. This has been pretty much one way traffic.
^^^click to enlarge ^^^
Since no money system could tolerate such a sustained attack for long, the outflows are compensated for by "target 2" inflows from the European Central Bank, which in turn borrows the money from the eurozone's creditor central banks, in particular the Bundesbank.The process thereby becomes something of a money go round. The foreign investor withdraws his money from the Spanish or Italian bank and deposits it with an apparently "safer" German bank, which in turn lends the money to the Bundesbank, from where it finds its way back through the ECB via the target 2 system to the original Spanish or Italian bank.
It sounds like Alice in Wonderland, but in fact is no different from what happens in the money system within national borders. If there is a sudden outflow of capital from, say, Lancashire, the Bank of England will call on the consequent surplus accumulating elsewhere to plug the gap so as to ensure that the Lancashire banking system can continue to fund itself.
What makes it different in the eurozone is that the same thing is happening between countries. Within countries, there is a general sense of in it together, backed by a common fiscal framework, that makes it tolerable. But when it is between countries unsupported by fiscal transfers, it obviously becomes more problematic.
In Germany and other creditor nations, there is growing concern over the consequent build up of contingent liabilities. Deposits made through German banks are in essence funding Spanish and Italian assets on an ever expanding scale. If these countries left the euro, then Germany would face massive, unfunded liabilities. What's building up is as much a disaster for Germany as everyone else.The flight to safety has prompted a collapse in yields on government bonds in Germany, the US, Switzerland, Sweden, and to some extent the UK too. Naturally, this has also driven up their currencies, except in the case of Germany, where because of the single currency, no such thing can happen.
With the natural remedy of exchange rate adjustment ruled out, Germany thus becomes a deflationary doomsday machine for the rest of Europe, a leviathan which sucks the life blood out of everyone else. It hardly needs me to say it's completely unsustainable. The graphs tell their own story.
