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The crash, when it comes, will affect everyone in the developed world and most probably most people in the developing world. It will affect banks and companies operating in financial markets. It will affect companies and personal bank accounts, financial instruments, pensions, share valuations houses and most other assets.
The financial crash is likely to be 3 – 6 times as severe as the recession which was caused by the Lehmann Bros bankruptcy.
The leaders of the European Union should have known that the failure of national economies was inevitable, further they saw the problems developing and they should have taken corrective action immediately. They did in fact, take action, but they took the wrong action.
In the event, they allowed EU countries, which over the last 10 years have had zero GDP growth and in some cases to accumulate debts of 130% of its annual GDP, to continue building debt. Debts of 130% of GDP, is considered to the point of no return, from which a country will never be able to repay its debts.
They should have been released from the shackles of the Euro and to allow them to returned to their original devalued currency.
As an example, Italy has debts of 130% of GDP which amounts to €2.3 trillion, its adult unemployment rate has been 10% for the last 12 years and many of its youth are moving to other countries to seek work. This is unsustainable, but is allowed to continue until the EU’s negotiations with the UK are completed.
Let us now consider why the problem has arisen.
If a group of countries have a fixed monetary policy, a fixed exchange rate and free movement of money in, out of or within the group of countries, sooner or later the weakest countries in the group will face financial disaster.
In this case, Italy has been able to accumulate that debt burden, because the ECB has lent the Euros to it to cover any deficit. The money was required if Italy (and or other Euro countries) has a budget deficit or if Euros were moved from Italy (and or other Euro countries) to Eurozone countries or to any other jurisdiction.
The money that has been provided to Italy by ECB, which is described as Target2 payments, has been lent to the ECB by Germany, the UK or other EU countries with sound economies. To date the UK has provided the ECB with €150 billion.
The author is unaware of any arrangements which will ensure that the €150 billion are returned to the UK by the end of March 2019.
Italy is close to the limit where the ECB is no longer allowed to lend it any more money. Further the AfD which is in coalition with Angela Merkel have stated that they will not support any more Target2 payments within the EU.
The problem facing the EU is that Italy is unable to survive independently and it is too large for the EU to bail out. It is therefore very likely at Italy will declare bankruptcy and return to the lira sooner or later. But without external assistance Italy is likely to be forced into taking a decision on this matter within the next 18 months.
The Italian economy was the world’s 8th largest economy in 2017. Their debt is too large for the EU to rescue and therefore it will create a recession which will be 3 – 5 times the size of the Lehmann recession.
The UK should be able to survive the recession if it is totally out of the EU but it is doubtful that it could survive if it is still in or partially in the EU.
The European Central Bank (ECB) is the central bank of the 19 European Union countries which have adopted the euro. Its main task is to maintain price stability in the euro area and so preserve the purchasing power of the single currency.
Target2 is the real-time gross settlement (RTGS) system owned and operated by the ECB’s Eurosystem. TARGET stands for Trans-European Automated Real-time Gross settlement Express Transfer system. It is the second largest bank clearing system in the world.
The ECB defines and implements monetary policy for the euro area and carries out a number of other tasks, including banking supervision.
The ECB has a keen interest in ensuring that payment systems and other market infrastructures function smoothly and effectively, to maintain financial stability in the euro area. This makes TARGET2 a key building block of financial integration in the EU. It enables the free flow of money across borders and supports the implementation of the ECB’s single monetary policy.
The EU monitors the free flow of money across borders. When more money flows out of a country than comes in, (as will happen when capital is being moved from a financially weak country to safer havens) the ECB will replace the shortfall to rebalance the books of the weak country.
The ECB has a limit as to how much may be transferred to a country per month and it also has an overall total which a country may receive. Currently the ECB is breaking its own rules by transferring to Italy amounts which exceed the total amount allowed by the EU. Further it is now close to its total overall limit.
In layman’s language, Italy is close to declaring itself to be bankrupt.
Target2 is a highly complex subject. The author has tried to explain a very complex issue in simple language.