Main index Financial Markets index About author

A Defaulting Eurozone Country Can Print Euros

Julian D. A. Wiseman

Abstract: Sovereign defaults are always messy, but a eurozone sovereign default could cause even more damage, spread widely but not thinly over a still rich part of the world.


Publication history: only at Usual disclaimer and copyright terms apply.

Contents: Introduction; The Counterfeiting; £ at the Bank of England; € in TARGET2; The Legal Structure of TARGET2 (Multiplicity of systems, Central banks have perfect credit, Insolvency doesn’t apply to a central bank, Which jurisdiction?); Some Unanswered Questions; Conclusion.


For the purposes of this essay, pretend that a Eurozone sovereign, country X, is at risk of default. This sovereign might be any of the current Eurozone member states (AT, BE, CY, DE, EE, ES, FI, FR, GR, IE, IT, LU, MT, NL, PT, SI, SK), or a non-member connected to TARGET2 (DK), or any future such sovereign (presumably then a member of the EU).

Also assume that the defaulter would act selfishly if doing so had a chance of being profitable.

This essay shows that the structure of TARGET2 allows such a selfish defaulting €-zone sovereign to help themselves and their friends to unlimited quantities of EUR.

The Counterfeiting

So country X knows that default is imminent, and—every man for himself—decides to take what can be taken.

It will prove impossible to unwind all, or even most of these payments. So a large quantity of euro will have been transferred to country X. Of course, there would be legal challenges. But many of these challenges would have to happen in the courts of country X, and suing bankrupt countries in their own courts is not usually productive.

Who has been robbed? Arguably, the offence is more like counterfeiting: money has been created, thereby diluting the wealth of those holding money, and diluting the wealth of creditors. Indeed, if done in enough size, the diminution of the value of euro money could be substantial.

The European Central Bank is surely aware of the risk of such mischief. With its back to the wall the ECB would surely be willing to spend lots—lots!—to avoid it. Market participants might think that this reduces the likelihood of default. But if, in a moment of stubborn mutual destruction, country X is allowed to default, and does this robbery first, the recovery rate in devalued euro would be minimal.

Alas for country X this freshly minted money cannot be used to prevent default. It is only because country X is defaulting that it is willing to create huge quantities of obligations. Money can be printed, but never enough to catch that tail.

The remainder of this essay explains how the legal structure of TARGET2 fails to prevent a hostile central bank counterfeiting lots of euros.

£ at the Bank of England

It will help the explanation to start with a simple example of the legal side of payment system, to which the eurozone can then be contrasted. GBP, sterling, £, is a currency with a single unified central bank, for historic reasons called the Bank of England (‘BoE’).

Say that a million pounds is to be paid, for whatever reason, from somebody banking at Barclays to somebody banking at the Royal Bank of Scotland (‘RBoS’). Barclays’ customer instructs Barclays to make the payment. Barclays lowers the balance in the customer’s account by this amount. Barclays, via the CHAPS payment system, instructs the BoE to transfer the money from Barclays’ account at the BoE to RBoS’s account at the BoE. This instruction to the BoE also contains information about which account at RBoS is the beneficiary, and RBoS increases the balance in that account. The payment is done.

Observe that there are two layers. Ordinary folk bank with banks; banks bank with the central bank. In £ the supreme type of money, also known as final money, is central-bank money. And banks can keep making payments until the money runs out and the BoE stops lending more.

€ in TARGET2

Next say that a million euro is to be paid from somebody banking at Société Générale (‘SG’) in France, to somebody banking at Danske Bank in Denmark. (Denmark is not a member of the Eurozone, but the Danish central bank is connected to TARGET2). So Société Générale’s customer instructs SG to make the payment. SG lowers the balance in the customer’s account by this amount. SG sends a payment instruction on TARGET2, to which both the central banks are connected. The Banque de France lowers the balance of SG’s account by this amount, and the Danmarks Nationalbank increases the balance of Danske Bank by the same amount. Finally, Danske Bank increases its customer’s balance by the same, and the payment is done.

But wait: how does the Banque de France pay the Danmarks Nationalbank? It doesn’t. There is no single supreme money in the eurozone. The national central banks do not settle these things between themselves. For as long as they are all solvent and trustworthy, this works well. But it does mean that a bust country X can make payments that it cannot pay, and if those payments are to agents of country X then country X would have paid money to itself.

The Legal Structure of TARGET2

So let us explore the legal structure of TARGET2. The relevant document is Guideline of the European Central Bank of 26 April 2007 on a Trans-European Automated Real-time Gross settlement Express Transfer system (TARGET2) (ECB/2007/2). It includes the wording of contracts governing TARGET2.

TARGET2 is a multiplicity of systems

Annex II, Title I,
Art. 3, ¶5-6

5. TARGET2 is legally structured as a multiplicity of payment systems composed of all the TARGET2 component systems, which are designated as ‘systems’ under the national laws implementing the Settlement Finality Directive. TARGET2-[insert CB/country reference] is designated as a ‘system’ under [insert the relevant legal provision implementing the Settlement Finality Directive].

6. Participation in TARGET2 takes effect via participation in a TARGET2 component system. These Conditions describe the mutual rights and obligations of participants in TARGET2-[insert CB/country reference] and the [insert name of CB].

So TARGET2 is not a legal entity, indeed it is not even a single thing. It is a multiplicity of systems, each of which is under the control of a central bank.

TARGET2 pretends that central banks have perfect credit

Annex II, Title IV,
Art. 16, ¶1 & 3

1. A participant may limit the use of available liquidity for payment orders in relation to other TARGET2 participants, except any of the CBs, by setting bilateral or multilateral limits. Such limits may only be set in relation to normal payment orders. …

3. By setting a bilateral limit, a participant instructs the [insert name of CB] that an accepted payment order shall not be settled if the sum of its outgoing normal payment orders to another TARGET2 participant's PM account minus the sum of all incoming urgent and normal payments from such TARGET2 participant's PM account would exceed this bilateral limit.

Observe that the model underpinning TARGET2 assumes that central banks have perfect credit.

Insolvency doesn’t apply to a central bank

Annex II, Title IX,
Art. 34, ¶1

A participant's participation in TARGET2-[insert CB/country reference] shall be immediately terminated without prior notice or suspended if one of the following events of default occurs:

(a) the opening of insolvency proceedings;

Annex II, Title I,
Art. 1 (Definitions)

— “participant” […] means an entity that holds at least one PM account with the [insert name of CB]

The rules about insolvency apply to a participant; a participant holds a Payments Module account with the relevant central bank; and presumably a central bank is not deemed to have a PM account with itself. So insolvency doesn’t apply to a central bank.

Which jurisdiction?

ECB/2007/2, §IV,
Art. 12, ¶1 & 3

1. In the event of a dispute between Eurosystem CBs in relation to this Guideline, the affected parties shall seek to settle the dispute in accordance with the Memorandum of Understanding on an Intra-ESCB Dispute Settlement Procedure. …

3. In the event of a dispute of the type referred to in paragraph 1, the parties’ respective rights and obligations shall primarily be determined by the rules and procedures laid down in this Guideline. In disputes concerning payments between TARGET2 component systems, the law of the Member State where the seat of the Eurosystem CB of the payee is located shall apply in a supplementary manner, provided that it does not conflict with this Guideline.

This leaves grounds for unanticipated cunning and ensuing argument. What would happen if country X, on the edge of default, did the following.

What now? The courts of country Y can rule that the outgoing payment, underpinned by dodgy collateral, is either valid or not. If it is valid, then the half the money remaining in country Y is good money. If invalid, then the shell party in country Y is bust, and its liquidator will challenge the payment back to country X. But that case is heard by the courts of defaulting country X, whose laws could have been ‘adjusted’ unfavourably to the pursuit of such cases.

In determining the validity of payments the important rules will typically be the local legislation implementing the 1998 Settlement Finality Directive and the Financial Collateral Arrangements Directive (implementation of which is a requirement: see Annex II, Title I, Art. 3, ¶5 quoted above). But local legislation and legal precedent might vary, so the authorities of country X could further complicate matters by sending the money through shell entities in multiple TARGET2 jurisdictions.

Some Unanswered Questions

This reasoning leaves unanswered some nasty questions.


Sovereign defaults are always messy, but a eurozone sovereign default could cause even more damage, spread widely but not thinly over a still rich part of the world. The ECB surely knows this, which is why it has been insisting on no-default. The ECB really means it.

— Julian D. A. Wiseman
19th June 2011

Main index Top About author