From: US GIO To: Undisclosed recipients:; Subject: Macro Skinny: a non-technical primer on TARGET2 Date: Mon, 20 Aug 2012 18:43:46 +0000 Inline-Images: image00 1 jpg; image002.png; image003.png Macro Skinny JP.Morgan A non-technical primer on TARGET2 What is TARGET2? Allowing 10,000 monetary financial institutions (MFIs) in the euro area to transact with each other on a bilateral basis would be a mess - it would give rise to 50 million different transaction routes! So like in the airline industry, it makes more sense to route transactions through a system of hubs: a `main hub' connected to 17 national hubs (the national central banks), which are in turn, each connected to the local banking system. TARGET2 is the 'main hub' in the euro area payment system. If a Spanish resident buys a BMW or German stocks, the payment will be routed from his local Spanish bank account to the Bank of Spain, then to TARGET2 (the main hub), then to the Bundesbank and finally to the German resident's local bank account'. Admittedly, every cross-border transaction stretches over three "connections" (TARGET2, plus the two central banks). However, TARGET2 is essential as it fulfills several important functions. First, it routes transactions more efficiently, which helps lower transaction costs. Second, it allows for better monitoring. Thus, helping to regulate and protect the payment system from systemic risks and fraud. Third, it functions as a "meter" for measuring the net flows of payments between each euro area member and the rest of the Eurosystem. How does TARGET2 relate to the European crisis? It is this third capability of TARGET2 that makes it so interesting in the context of the European crisis. Not unlike the way an electricity meter measures the net flow of electricity between one European country and the rest of the European grid — TARGET2 balances sometimes show a deficit, and sometimes a surplus. A TARGET2 deficit arises when the outflow of euros (pay