After Jean-Claude Juncker’s recent ‘State of the Union’ speech, there were a couple of fabulous articles here on BrexitCentral. Rupert Matthews MEP wrote that “Unfortunately, it came amid a welter of Euro-waffle, bland statements of the obvious” – I would add, just like glossing over the rot in your front door with paint. All shiny on the outside but going to fall to bits in a year or two. Juncker mentioned youth unemployment but did not mention the causes. He’s been doing that for years now. Nothing new there. Juncker then moved onto aeroplanes which he laughably thinks should be priced in euros – as if that would make a difference to the rot. If only, we priced in aeroplane bills in euros, everything would be fine. Does Juncker not know how foreign exchange actually works? You can convert the euros that you have just received for that aeroplane, to dollars, in a blink of an eyelid – and at almost no cost, if you are a big company. There will be a line of banks waiting, day and night, on the phone, for you to do your foreign exchange transaction with them. It takes seconds and costs something like 0.015% to trade – nothing like the egregious rates given at airport Bureaux de change counters. That is not 1 pence on a pound, but 0.15 pence on a pound. Just to give some context: $1,800 billion trade in the foreign exchange markets, on average, every day. Making bills in euros will not make the foggiest bit of difference to big companies. It’s just like booking a hotel on booking.com. Go to the top of the page and the site will allow you to instantly change your preferred currency and convert your hotel bill to an equivalent rate anywhere in the world. The same thing happens at the airport duty free shop when they ask you with which currency you would like to pay. Whilst making totally banal statements about aircraft bills, Juncker missed something much much more dangerous going on behind the scenes in the Eurozone. It’s called Target 2. It doesn’t really matter if you understand the ins and outs of Target 2. Here is the link to Wikipedia if you are interested in a turgid, boring and highly complicated, thirty-minute read. Target 2 is the ‘Trans-European Automated Real-time Gross Settlement Express Transfer System’. That’s euro-waffle for a payments system, settling transactions between banks. The above chart instantly tells you that something is wrong in Euro land. Any chart that has pretty much flat lines on a graph for many years and then suddenly veers off – one line dramatically upwards and two lines dramatically downwards – suggests that something bad is happening. One is positive (credit) and two are negative (deficit). I am sure you can guess which countries are involved without even knowing what the chart was about – Germany a surplus, Italy and Spain a deficit. Germany now has nearly €1 trillion of credits against those two countries. And no one is quite sure why it is happening. The European Central Bank wants to explain it as a result of quantitative easing, otherwise known as money printing. The German economist, Hans-Werner Sinn, who started to raise the alarm about this is 2011, says it is current account deficits accumulating. Germany is exporting lots, whilst Italy and Spain are importing more than they export. It may well be both these causes. The system is so complex and so opaque that no one really knows what is going on. As Sinn wrote for the Süddeutsche Zeitung in 2011: “Target deficits or surpluses were not explicitly itemised, being usually buried in obscure positions of central bank balance sheets.” However, an article in the Financial Times by Marcello Minenna, the head of Quantitative Analysis and Financial Innovation at Consob, the Italian securities regulator, suggests something else is happening. Money and securities are leaving Italy and Spain and going to Germany. People, companies and institutions are taking savings, cash and investments out of Italy and Spain and moving them to Germany. If the euro is supposedly the same in all Eurozone countries, the question is: why? The answer is obvious. People are nervous. People are worrying that perhaps a euro is not the same in all countries. It’s the conundrum of when is a euro not a euro? Gresham’s law states that ‘bad money drives out good’. He meant this in the time of coins – always put the fake one in the supermarket trolley and hold the real one in your pocket. The same thing applies now, but to capital. Smart capital or people with a brain, start moving money long in advance of an event. People are starting to prepare for the break-up of the euro. Alan Greenspan, the former head of the American Federal Reserve Bank, has also issued a warning that it will be Target 2 imbalances that finally break the euro. Unlike America, there is no US Treasury to come to the rescue of the European Central Bank. Likewise, if the Bank of England were in trouble, the British Treasury would come to the rescue. They are effectively the same thing in the event of a crisis – one bails out the other. But if the ECB starts to be in trouble, do you think Germany is going to want to bail out a central bank whose problems, it perceives, to have been created by Italy and Spain? I think not. The only saviour, big enough to intervene to save the system, would – once again, like in World War Two – be America. But would America really want to save the ECB? Maybe one day someone will say: “Non, euros are not accepted here. Only dollars please”.’ This is already happening as we speak in Turkey and Argentina. The first signs of a crisis are already brewing. Unlike 2008, this is not going to be a stock market crisis or a housing crisis – which were all effectively private debt problems. This time it is going to be a bond crisis driven by government debt. Worldwide there is a loss of faith in governments and capital is already moving – out of weak countries, into strong ones, out of public debt and into private assets. As with the terms subprime and collateralised debt obligations (that no one except financial specialists had ever heard of before 2008), expect to suddenly hear a lot more about Target 2 in the next couple of years.