Three More Reasons to Worry about the Euro’s Future

From the “Doom Loop” to the Black Hole.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

“Despite uncertainty over Brexit — formally triggered last week by prime minister Theresa May — central bankers from around the world see the UK as a safer prospect for their reserve investments than the Eurozone, a new poll reveals”: The Financial Times.

At first whiff, this may smell counter intuitive. After all, it’s the UK that’s supposed to be in the weaker negotiating position over Brexit terms. It also risks losing a sizable chunk of its core industry, finance. Yet according to a survey of reserve managers at 80 central banks, who together are responsible for investments worth almost €6 trillion, the stability of the monetary union is their greatest fear for 2017.

They have good reasons to worry. Here are three of them:

1. The Doom Loop is Back in All Its Glory.

In fact, it never went away; it was just squeezed into temporary irrelevance by the ECB’s mass purchase of Eurozone sovereign bonds. The biggest beneficiaries are Italy and Spain where banks’ balance sheets are overflowing with bonds of their individual governments — all considered “risk free” for regulatory reporting.

In 2012, Spanish banks held a staggering 32% of Spain’s national debt (excluding regional and local debt). At the end of 2016, that figure had shrunk to 22.7%, or €168 billion. This scheme has kept the doom loop in some form of check, but shoveling as much peripheral sovereign debt as possible from peripheral banks onto the ECB’s books is not a sustainable long-term solution — not when the ECB’s balance has already crossed the €4-trillion mark. That’s the equivalent of 38% of the Eurozone’s GDP, well in excess of the Fed’s 23.7%.

The moment the asset purchases slow, however, the Doom Loop kicks in again, as has happened in the last few months. After the ECB announced that it was paring down its asset purchases from €80 billion a month to €60 billion a month, the purchase by Italian and Spanish banks of their respective national bonds began ticking up again.

When rates begin rising, those same banks will begin bleeding losses from their current holdings of government debt. As a new report by Spanish consultancy firm Analistas Financieros Internacionales (AFI) warns, over 70% of the fixed income assets held on the balance sheets of Spain’s biggest banks are prone to price variations, and in the worst case, the solvency of some banks could be called into question. In Italy, as many as one-quarter of the banks are already verging on insolvency. French banks have very limited exposure to French government debt but they are estimated to hold over €250 billion of Italian bonds.

2. Rising Imbalances.

The financial imbalances in the Eurozone are growing and in some cases have exceeded the crisis levels hit in 2012. The best indicator for this is Target2, standing for Trans-European Automated Real-time Gross Settlement System, which, month after month, has tracked the accelerating capital flight from the region’s periphery (Italy, Spain, Portugal, Greece and Ireland) to the core (Germany, the Netherlands, and Luxembourg).

In March, Italy’s Target2-deficit — the total amount the Bank of Italy owes other national central banks in the Eurozone (mainly Germany’s) — widened by €34 billion to a fresh record of €420 billion. At the height of the sovereign debt crisis in 2012, it was just €290 billion. In Spain things are not much better: in February its central bank owed €361 billion, €25 billion more than at the height of its banking crisis in 2012.

The ECB asserts that record T2 balances are pure accounting values and should be viewed as a benign by-product of the decentralized implementation of QE rather than renewed capital flight. Draghi refers to them even as a form of solidarity within the European system — a way for the core to help fund the periphery.

But in a recent letter to Italian EU politicians the same Draghi maintained that such debts should be settled in full should Italy decide to leave the euro. With Target II liabilities of close to 25% of GDP in Italy and above 30% of GDP in Spain, this poses a double-barreled question: how, and in what currency?

3. A Big (and Growing) Black Hole in EU Finances

If the first two problems are primarily monetary in nature and are exclusive to the Eurozone, the third is purely fiscal and affects all EU countries. At the heart of Brussels’ finances is a growing black hole. At the end of last year it reached €238 billion, up from €99 billion in 2002. This is the so-called reste à liquider, or RAL, which is a stock of commitments at the end of each year that have been made in annual EU budgets, but which are deferred for payment in later budgets.

Even under normal situation, this would be cause for concern. But the EU’s current fiscal situation is anything but normal: the bloc is in the process of losing one of its biggest net providers of funds, the UK. As the German economist Hans Werner Sinn recently put it, “Because the UK is so large, its withdrawal is economically equivalent to the withdrawal of 20 of the smallest EU countries – 20 out of 28, which we have in total.”

Other EU countries will have to pick up the slack. Günther Oettinger, the German commissioner, said as much in February. Those countries include Italy, whose public debt amounts to 133% of GDP, among the highest in the world, and it hasn’t even started bailing out its banks yet. In other words, the people in Italy may have to pay more taxes to Brussels while suffering more austerity, in the process becoming even more disenchanted with the euro project, hardly a strong foundation for a long-term future. By Don Quijones.

For the Bundesbank, the War on Cash is a war on personal freedom and choice. Read…  War on Cash Puts ECB, EU on Collision Course with Germany

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  26 comments for “Three More Reasons to Worry about the Euro’s Future

  1. Gershon says:

    But…but…Draghi said the Eurozone crisis was “contained.”

    • Jungle Jim says:

      Didn’t Bernanke say something like that ? Turned out he meant that the crisis hadn’t reached the asteroid belt yet.

      Let me ‘splain it. The rules are different there. If you tell a whopper, you’re a liar. If Mario tells a whopper, he’s a leader. Simple really…..

      • Gershon says:

        I see it so clearly now.

        • Haus-Targaryen says:


          Great article as always. One additional aspect of the EMZ I’d like to point out is the debt binge ClubMed has been on the past 4 years and 9 months (since Draghi’s “whatever it takes” comment).

          In order to maintain solvency over the past half-decade ClubMed (lets not kid ourselves — everyone) has borrowed and borrowed and borrowed. If interest rates, in Spain, for example return to their 100 year averages — they’d be north of 8% on 10 years.

          If Spain couldn’t afford 8% in 2012 they can afford it even less today. It is simply a question of how long can you keep Rainbow land’s (a derogatory term for the EMZ coined by No_Debt @ Zerohedge) interest rates low.

          Further complicating this requirement for the ECB to keep interest rates low is the Euro is a currency without a country. There are 18 different groups of people who have to have their say. Any one of them could decide “nope” and hit the eject button.

          I was sure the Euro was finished in 2012 — and I was wrong. My analysis of the economics of it wasn’t incorrect — but I fundamentally underestimated the political extremes those in FFM and Brussels were willing to go to to preserve their union.

    • d says:

      Come on the F greek crisis still isn’t resolved.

      Yesterday dippy was screaming to all, we get more debt relief in return for pension cuts . And what I was looking for in Germany, then comes out today

      Translated Dippy is blurring BS to the greeks, again.

      The Paper work of the Nasty little Mafiosi at teh ECB may say the crisis is contained. That however is only in the limits of his office, which he will not be occupying after 2019, roll on 2019.

  2. cdr says:

    As I’ve stated numerous times before, the Eurozone ceases to exist shortly after the ECB stops buying enormous amounts of member debt. It’s not complicated. The only uncertainty is the degree of consequence after buying stops. The range goes from horrible to unimaginably bad.

    The real weirdness is why so many people with ostensible brains act as if this is not a certainty. Why does anyone with real money buy eurodebt? This is the only real question.

    • TJ Martin says:

      .. or alternatively whys does anyone continue buying TESLA stock .. put faith in the Trump Bump … keep dumping money into real estate .. purchase petroleum stock .. etc … et al .. ad nauseam ?

      • chip javert says:


        Some answers:

        Tesla is building a product for which there appears to be some demand; it’s a crap shoot and uses taxpayer money, but people are buying Musk’s cars

        Trump bump: the end to productivity-sucking regulations is good for the future of business (save me the moralizing about Republican’s killing kids with dirty water – look at what Obama’s EPA actually did to kids in Flint).

        Real estate: ya gotta live somewhere I’d love to see money laundering (we’re talking about you, China) squeezed out of the market. Why should the USA have an RE bubble just because Chinese don’t trust their government to safe-guard “earnings” from their corruption?

        Petroleum – lots of customers for this stuff. You may have noticed people us it in their cars. That’s not going to change overnight.

        You may prefer to invest in Uber & Snap (go ahead, invest in them), but together they have gone thru billions of shareholder “investment” without producing one red cent of profit. Even millennials run out of other people’s money sooner or later.

        Or, you can just put it under your mattress.

        • Remmy says:

          And because we’re talking about a crazy month in the car business, a word about Tesla. It sold 4,050 new vehicles in the US in March, according to Autodata. All automakers together sold 1.56 million new vehicles in the US. Tesla isn’t even a rounding error in this number. It’s invisibly small. It has lost money every year of its 10 years of existence, including $1.86 billion over the past three years. It might never make any money.

        • Frederick says:

          The bars create a very lumpy surface to sleep on though

        • Dan Romig says:

          Yet Tesla has hit $312 a share today! Current market cap is now over $50.5 billion.

          I have purchased put options on TSLA earlier this year, and made a few bucks, but I held off on buying a few more two weeks ago when it hit $277 on 28 March. My fingers are itching to pull the trigger again, but there’s no real logic or reason (IMO) for the stock price.

          On 2 December 2016 it was under $182 per share.

  3. Gershon says:

    Distressed debt on a massive global scale, yet these rigged, broken, manipulated “markets” keep rising on central bank financial crack cocaine and HFT algos selling to each other.

  4. NotSoSure says:

    What does the Eurodollar market say? Any funding stress? Same story in the end. There’s no problem :)

    • Wolf Richter says:

      No problem as long as the ECB keeps buying euro bonds and euro ABS and euro old-bicycles.

      • Tim says:

        No problem because Mario said he will do “whatever it takes” to save the Euro.

      • Hkan says:

        Getting rich buying old bicycles when streets belongs to banksters….only….as everything else.

        The ultimate goal is within reach.

      • d says:


        The ECB is becoming like china it is trying to bail itself out by printing more and more. Unlike china the ECB can’t do this completely clandestinely, and its books are starting to look worse by the day.

  5. John Doyle says:

    Why are the government bonds of Euro members considered “risk free”? They would have to be monetary sovereign for that to be the case. They no longer have that benefit. A cover up?

    • chip javert says:

      They’re considered “risk free” by regulators because otherwise none of the European banks (or other banks) would buy European sovereign debt. As I understand it, no capital set-aside is required for these (VERY HIGH RISK) assets.

      • Flying Monkey says:

        It is pretty funny. The ECB loans money to banks and they give the money to the Governments to buy Government debt. It seems as bad as the Spanish banks loaning their customers money to buy the bank’s stock.

        The world is mad.

    • MC says:

      EMU (European Monetary Union, also known as “euro zone”) banks have always been allowed to use sovereign bonds issued by EMU government as collaterals for obtaining liquidity from the ECB.
      Apart from Greek bonds (a whole sorry story apart), Italian and Spanish sovereigns are deemed by the ECB as good as collaterals as Dutch and German ones.
      Part of the reason French banks (whose major shareholders include governments themselves) have piled onto Italian sovereign debt is because it pays a notch more than French sovereign bonds but is considered by the ECB just as good despite the difference in rating (France is rated AA and Italy BBB-).
      Just for the record this means Italy’s rating is worse than Mexico’s and Colombia’s…

  6. Alessio says:

    I didn’t really get the Target2. Can someone explain it?

    Thanks a mil :)

  7. R Davis says:

    Any country leaving euro zone must settle bill first: ECB’s Draghi.

    Wouldn’t insolvency & bankruptcy do just as well .. !
    In the few years that I have followed the EU crisis & also from the perspective of article on KTG website.
    I would advise all EU member country’s to declare bankruptcy & leave them to either sink or swim.
    Which is the exact sentiment showered upon them by the EU Group.

    • R Davis says:

      & indeed this the task given to those 2 bobo’s Varoufakis & Tsiprus to do.
      2 men of little or no sense of fun & lacking in moral fiber.
      it would have been a real hoot to watch them run rings around the EU snot .. only that they turned out to be needy & looking to be loved .. OOH !

Comments are closed.