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What Germany threatens if Italy no longer wants to pay

Since the euro crisis, the Bundesbank has financed the balance of payments deficits of southern euro countries vis-à-vis Germany as part of the Target2 interbank payment system.

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What Germany threatens if Italy no longer wants to pay

Since the euro crisis, the Bundesbank has financed the balance of payments deficits of southern euro countries vis-à-vis Germany as part of the Target2 interbank payment system. If more money flowed from there to Germany than in the opposite direction due to current account deficits or capital flight, the Bundesbank lent the money back.

In this way, to date, it has accumulated 1.2 trillion euros in claims on the Euro System – the European Central Bank (ECB) and the national central banks – which serves as the clearinghouse for Target2 payments. Obligations of 660 and 500 billion euros respectively have accumulated for Italy and Spain.

To the end, this was a perfect arrangement for the debtor countries. Since receivables and liabilities bear interest at the refinancing rate of the ECB, they received the financing from the beginning of 2016 until mid-2022 at no cost. The Bundesbank – and thus the German taxpayer – assumed the risk of these countries leaving the euro, with which the claims would probably be lost in whole or in part.

Without this arrangement, the capital markets would have stolen a hefty risk premium from debtors. This is changing with the increase in the ECB's refinancing rate.

With the current interest rate of 1.25 percent, the transfers from the euro system to the Bundesbank amount to almost 16 billion euros. A little over ten billion euros must be deducted from this, which goes to the banks as interest on the central bank money generated with the bond purchases at a deposit rate of 0.75 percent. But the bottom line is that more than five billion revenues remain for the Bundesbank.

For the debtor countries, the calculation looks different. The Banca d'Italia now has to transfer eight billion interest costs annually to the euro system. In addition, there are three billion interest payments to the banks for the reserves held at the Italian central bank. As a result, the state loses eleven billion euros a year.

But it will hardly stay that way, since the key interest rates of the ECB still have to make a lot of progress in order to be able to do something to stop inflation. If the refinancing rate had to rise to 4.5 percent to prevent the euro from falling against the US dollar, payments would rise to 43 billion euros a year. After four years, the reserves and equity of the Banca d'Italia would be exhausted.

I recently referred to the potentially catastrophic losses of the euro system from the bond market crash. With all central banks affected, there will be a quick consensus to use creative accounting to cover up the consequences. After all, the rules that states impose on commercial banks do not apply to their central banks.

However, if there are transfers between central banks as a result of the interest rate hikes, unity is likely to be over quickly. The southerners would probably protest violently against these payments.

If it is not possible to bend the rules again - in such a way that no payments are due to Germany - the designated Italian Prime Minister Giorgia Meloni could possibly come up with the idea of ​​presenting the Germans with massive demands for reparations for the Second World War, like Poland .

Thomas Mayer is founding director of the Flossbach von Storch Research Institute.

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