Based on recent literature that analyzes the payments system of the eurozone, the text seeks to show how the Portuguese government could use domestic commercial banks and the TARGET2 mechanism to redeem government debt securities held abroad without having to resort to new foreign aid. This procedure would take full advantage of the rules governing cross-border payments inside the euro area and might also pave the way for overcoming the current “austerity” while staying inside the euro.

1. TARGET2 AND THE ROLLOVER OF PORTUGAL’S
PUBLIC DEBT
ABSTRACT
Based on recent literature that analyzes the payments system of the
eurozone, the text seeks to show how the Portuguese government
could use domestic commercial banks and the TARGET2
mechanism to redeem government debt securities held abroad
without having to resort to new foreign aid. This procedure would
take full advantage of the rules governing cross-border payments
inside the euro area and might also pave the way for overcoming
the current “austerity” while staying inside the euro.
INTRODUCTION
TARGET2 is the payments and clearing mechanism that connects the
European Central Bank (the ECB) to the National Central Banks (the NCBs) of
the Member States of the euro. As a consequence of the operation of this
mechanism, every cross-border payment between banks of different countries
of the eurozone generates automatic credit and debit claims – between the
NCBs of the two countries involved in the transaction and the ECB itself.
TARGET2 underlies the smooth working of cross-border transfers of funds
between eurozone commercial banks and it may be thus considered a linchpin
of Europe’s single currency. Its single-platform system guarantees that a euro
deposited in Portugal, Spain or any other Member of the single currency can
move freely and at par value throughout the territory of the Economic and
Monetary Union.
The statistics provide us with a glimpse on the relevance of TARGET2. It
processes an average of 350,000 payments per day, with a total daily value of
about a third of the eurozone’s annual GDP, including high value interbank
payments (more than 90% of the total) and low-value retail payments, related to
transactions involving consumers in the eurozone1.
Of course, a payment on foreign debt is also necessarily a cross-border
payment and this provides us with the reason that TARGET2 has a key role to
play in a crucial question: how to find a realistic solution for Portugal to pay back
1
http://www.ecb.europa.eu/paym/t2/about/figures/html/index.en.html (accessed on January 19, 2014)
1

2. the massive sums it now owes to public and private creditors domiciled abroad
without crushing its economy in the process.
In this text we will present a non-technical description of a strategy that we
suggest the Portuguese Government adopt for fulfilling its debt obligations
towards foreign creditors with the lowest possible cost to the country.
The course proposed here would require that the Portuguese authorities make
a proactive use of TARGET2 (in conjunction with at least one local commercial
bank) with the strategic objective of rapidly freeing the country from the burden
of external debt. Then, after overcoming this burden, the government would be
in a strengthened position to recapture crucial autonomy for steering the
economy and gradually eschew the current foreign-imposed and highly
recessive austerity policies.
This paper has the following sequence. We start by briefly describing the
situation of financial emergency that led Portugal’s government to ask for an aid
package under the guise of intervention by the EC-ECB-IMF (the “troika”) in the
first semester of 2011. We go on to explain how the Portuguese authorities
could have reacted more effectively to the sudden spike in interest rates on
government bonds that occurred in that period: by borrowing directly from a
state-owned commercial bank with the sole purpose of redeeming securities
that were coming to maturity abroad. The funds thus obtained would be duly
transferred to outside creditors via the TARGET2 system. We argue that this
procedure could have provided for an immediate reduction of market pressure
on public debt yields, and thus release Portugal from the need to ask for foreign
aid. We proceed to examine and refute some possible counter-arguments to the
legitimacy and practical possibility of the government using local commercial
banks for providing essentially all of the funding for the rollover of securities
held abroad. We show how the very same procedure that was not used in 2011
can now be adapted for redeeming the outstanding public debt obligations of
Portugal towards foreign creditors, both private and (more importantly) public2.
Finally, we sum up our argument and conclusions. In an Appendix we present
graphs and accounting tables for TARGET2 processes, quotes by key authors
and references.
Let us then start our story by taking a step back in time, to the first quarter of
2011, when Portugal had not yet asked for financial help from the Troika. What
was the nature of the situation that forced the country to make such an unusual
request?
In Portugal, for many years if not decades, tax revenues have been lower than
government expenditures. This underlying tendency for budget deficits was
2
Debts to the troika are governed by English (not Portuguese) law and this feature renders any future
restructurings or re-denominations extremely problematic – see clause 14 (1) of the agreement between
the EFSF and Portugal here: http://www.efsf.europa.eu/attachments/efsf_portugal_ffa.pdf .
2

3. largely a consequence of persistent imbalances in the current account. But it
was strengthened by the sudden collapse of fiscal revenues that was one
inevitable consequence of the economic crisis of 2008. By 2011 a huge gap
between revenues and expenditures was entering its third year with levels
approaching 10% of GDP. One could well imagine a year with 70 in taxes
raised3, public expenditures close to 80, and a deficit of 10 – this in a country
with a GDP of only about 160 (billion) euros.
The Government was thus forced to borrow ever increasing sums from the
markets in order to cover its budget deficit. This is an especially problematic
situation for a country such as Portugal, deprived as it is of full monetary
sovereignty since joining the euro in 1999. In addition to deficit financing,
however, the government also had to borrow massively from the markets for a
second reason: the need to pay back to creditors the debts contracted in the
past. The deficits of previous years had of course generated government debt –
the government had to borrow money in each of those years and the
outstanding debt was reaching a figure close to 100% of GDP4, a significant
part of which was maturing in 2011.
Let us consider a scenario for the year 2011 under which the State would have
to rollover an amount of 20 in maturing debt of which 15 will be payable to
foreign creditors. Adding the sum of 10 needed to finance the deficit to the 20
required for the rollover one arrives at a total amount of 30 for the government’s
borrowing needs during that year; of which a minimum of 15 would be paid to
foreign lenders holding loans approaching maturity.
It turned out in the course of the first months of 2011 that the markets – for
reasons that have to do with the crisis of 2008 and its impact on a eurozone
composed of governments lacking monetary sovereignty and thus automatic
backing from their Central Bank – began to estimate that the risk of Portugal
defaulting on its debts was increasing, and to ask for ever higher interest rates
as a reward for bearing that risk.
This increase in the yields that investors required for buying Portuguese debt
soon put the government in an untenable situation. When the average interest
rate on public bonds increases from an annual 2% to say 10%, this means that,
in future years, the Government will have to pay in interest – for a loan of 30 –
an amount of 3 per year, instead of 0.6 per year as would be the case before
the crisis. The difference – the sum needed to pay an additional 2.4 in interest
each year in the future – will have to come from "savings" (that is, deep cuts) in
public spending in key sectors: health, education, pensions, etc.
3
The numbers in this example are purely illustrative, but if one assigns to them the unit "one billion" – i.e.,
70 billion euros in taxes and so on – we won't be too far from reality.
4
It is now (early 2014) circa 130% of GDP.
3

4. Unwilling to face the prospect of such huge cuts, the Government opted to ask
for the sum of 30 directly to the Troika, with a few more tens (of billions of
euros) added up so as to provide it with guaranteed access to funding for a
period long enough for the markets to eventually calm down in relation to
Portugal and regain the disposition to lend to the country at acceptably low
rates of interest
TARGET2 AND PORTUGAL – DESCRIPTION OF A PROCESS
And now we come to the role of TARGET2 in this question.
We believe that the Portuguese Government, during the critical period of the
first quarter of 2011, could have chosen an alternative approach to the crisis:
that of taking full account of the payments mechanism of the eurozone with a
view to escape from the pressure of the extreme, irrational yields on public debt
that eventually led it to plead for foreign aid.
This alternative would have ultimately required the recourse to TARGET2 and
had to start with a government decision to temporarily eschew borrowing
through debt markets and rely instead on its own public sector commercial bank
– Caixa Geral de Depósitos, or CGD bank. This bank would lend to the
government the amount of 15 needed to rollover the maturing debt held
abroad5.
Since the Government is the owner and single shareholder of the Bank, it would
have the power to dictate the interest rate on the loan. However, we think it
would be wiser for it to refrain from resorting to this prerogative and choose
instead, for the sake of appearances, to get the funds from the bank at the very
same close to 10% rate then prevailing in the markets. Why? For the reason
that, while this rate is certainly high, it will also generate a huge profit for CGD
Bank. And the government, in its condition of owner of the bank, could use
these excess profits later on as a source of funding for the budget.
This CGD loan would create a bank deposit of 15 credited to the Government, a
sum it could use to pay all of the debts maturing abroad during the year 2011.
We shall now use a stylized example to illustrate the accounting steps involved
in this scenario and the role of TARGET2 in it. In the example, the creditor
receiving the funds is Deutsche Bank. It will use said funds to pay off and
extinguish the Portuguese securities it is holding on its books. At that moment in
time – the moment the funds are transferred from CGD to Deutsche Bank –
TARGET2 shows up on the scene, so to speak, in the sense that it will ensure
5
CGD bank could make a direct loan to the Government; or, in the event of the government not wanting to
formally eschew “the markets”, it could buy bonds in the amount required in new issues of public debt at
primary auctions (for example, via the investment banking branch of CGD bank, which has the status of
primary dealer). Such buying in the market would also help to quickly ease and then reverse the upward
pressure on yields
4

5. that this cross-border payment between two countries of the eurozone will be
completed. Absent that intervention of TARGET2 – and assuming that CGD
bank couldn't get that very same day a loan of bank reserves from Deutsche
Bank – the accounting entries for the transfer would be incomplete and the flow
of funds would not take place. This is shown in Table 1 (below) which describes
what the accounting entries of the transfer from CGD to Deutsche Bank would
be without TARGET2 (the missing items will be duly entered by TARGET2 and
are underlined in yellow):
TABLE 1:
Caixa Geral de Depósitos (CGD)
Banco de Portugal (B de P)
Assets
Liabilities
Assets
reserves (-)
govt. deposit (-)
Liabilities
reserves of CGD (-)
Deutsche Bank (DB)
Bundesbank
Assets
Liabilities
Assets
reserves (+)
Deposit ex-govt. (+)
Liabilities
reserves of DB (+)
We are now in a position to see how TARGET2 enables cross-border transfers
of funds between countries of the eurozone. In the case under consideration, it
ensures the completion of the transfer from CGD to Deutsche Bank by entering
an advance of funds from the Bundesbank to the Banco de Portugal. This
advance (loan) pays the interest rate prevailing in the euro area (it was 1% in
April 2011; and it is 0.25% in January of 2014), itself set by the European
Central Bank under its prerogatives on monetary policy.
The reason for this automatic advance of funds has to do with the requirements
of basic principles of double-entry bookkeeping. As we observed in table 1,
Deutsche Bank, upon receipt of the deposit from Portugal, receives
simultaneously bank reserves6 which it deposits at the Bundesbank. This
deposit increases the liabilities of the Bundesbank (because the reserves of
Deutsche Bank, an asset for this bank, are a debt of the Bundesbank); it must
thus enter a new asset to stay in balance – the loan to the Banco de Portugal.
6
An easy way to picture this operation is by imagining the "reserves" as an electronic equivalent of
"banknotes" or "cash". For example, if a customer of CGD bank wants to pay a debt of 500 euros to a
customer of Deutsche Bank, he/she instructs CGD to transfer 500 euros of his/her deposit at CGD to the
German citizen's account at Deutsche Bank. CGD duly transfers the deposit, which will be credited to the
German citizen's account, but must also simultaneously transfer a "banknote" of 500 euros to the coffers of
Deutsche Bank. Only then will Deutsche Bank be in a position to deliver this "banknote", if its client so
requires. (And, until that happens, Deutsche Bank can deposit the "banknote" of 500 euros at the
Bundesbank, receiving perhaps a small interest on this deposit).
5

6. In turn, the Banco de Portugal saw its liabilities decrease: a deposit (reserves)
of CGD bank "migrated" to Germany. The Banco de Portugal will thus balance
its books by taking another debt: precisely, the loan it receives from the
Bundesbank.
At the end of the day, the accounts are all settled with the ECB. The Banco de
Portugal will still be owing a sum of 15 – but to the ECB itself, rather than the
Bundesbank. In turn, the German central bank will remain as a creditor, but of
the ECB instead of the Banco de Portugal. The loan’s interest rate doesn't
change: it is always the rate (MRO) defined by the ECB's monetary policy
stance.
All these accounting steps and entries are taken within the framework of
TARGET2. Through this mechanism, as we observed, the central banks of the
eurozone extend to one another credit lines without limit or need for collateral.
And accounting entries are now complete; in table 2 we see the Bundesbank's
loan to the Banco de Portugal:
TABLE 2:
Banco de Portugal (B de P)
Assets
Liabilities
Bundesbank
Assets Liabilities
Reserves of CGD (-)
Owed to Bundesbank
(+)
reserves of DB (+)
Loan to B de P (+)
And then, in table 3, we watch it being replaced by a loan of the Bundesbank to
the ECB:
TABLE 3:
Banco de Portugal (B de P)
Assets Liabilities
Bundesbank
Assets Liabilities
Reserves of CGD (-)
reserves of DB (+)
Owed to the ECB (+)
Loan to the ECB (+)
European Central Bank
Assets Liabilities
Loan to the B de P
(+)
Owed to Bundesbank
(+)
In both tables, the intervention of TARGET2 is in the items underlined in yellow.
The process has not ended, however. CGD is now in danger of running out of
its stock of Bank reserves; it may lose a total of 15 in reserves if it transfers the
entire amount of the Portuguese government’s deposit to Deutsche Bank. As
6

7. we have seen, bank accounting rules require that every transfer of a deposit (a
liability item) from one bank to another bank be matched by the transfer of an
equal amount of reserves (an asset item). In fact, bank reserves are the
"currency" (the monetary base) that banks must use in order to make payments
to one another.
CGD bank cannot allow itself to run out of reserves, because in that case it
couldn't continue to make payments to counterparties, including foreign banks.
Before the crisis of 2008, Deutsche Bank itself would probably have loaned
back those reserves to CGD at a rate of interest convenient for the German
bank. Ever since the financial crisis broke out in 2008, however, European
banks lost confidence in financial markets and in one another and are no longer
willing to easily lend – as they did hitherto, almost as a matter of routine – bank
reserves in the interbank market, particularly in the overnight market .
Thus, CGD will have to get those reserves through a loan contracted with the
Banco de Portugal7. CGD will deliver as guarantee (collateral) for that loan the
very same government debt securities that it has acquired, with a nominal value
of 15. And the Banco de Portugal will have to accept such a guarantee and lend
the reserves, via either a short-term loan (a "MRO") or a medium term loan (a
"LTRO"). Indeed, if the Banco de Portugal were not forthcoming with that loan it
would risk triggering an immediate interruption of CGD payments to its bank
counterparties, with serious consequences (likely, immediate and generalized
panic) for the Portuguese and European banking markets8.
The following table describes the accounting entries of this last step:
TABLE 4:
Caixa Geral de Depósitos (CGD)
Banco de Portugal (B de P)
Assets
Liabilities
Assets
Liabilities
reserves (+)
Owed to B de P
(+)
Loan of reserves
to CGD (+)
reserves of CGD (+)
7
In other words, there will be an expansion of the monetary base, with Portuguese reserves created "ex
nihilo" by the Banco de Portugal. In a text published by Citi Research in October 2012, Willem Buiter and
Ebrahim Rahbari explain very clearly and concisely this type of expansion: "The ECB controls an interest
rate ... in the euro area. The stock of base money (currency plus central bank overnight credit to eligible
banks ...) and the stock of central bank credit are then determined endogenously, i.e. demand-determined
by commercial banks. (see "TARGET2 Redux", p. 36, our underlines).
8
The need for this type of loan is thus explained by the ECB: "banking communities in some countries that
face net payment outflows need more central bank liquidity than those in other countries where
commercial bank money is flowing in. The uneven distribution of central bank liquidity within the
Eurosystem provides stability, as it allows financially sound banks – even those in countries under financial
stress – to cover their liquidity needs "; and also: "banks throughout the euro area currently have unlimited
access to central bank liquidity, against adequate collateral" – see ECB Monthly Bulletin October 2011, pp.
35-36 and 38.
7

8. This loan of bank reserves from the Banco de Portugal to CGD thus completes
the process unleashed by the initial bank transfer designed to pay off a
Portuguese debt security owned by Deutsche Bank.
PRACTICAL RESULTS OF THE PROCESS
From the point of view of substance, the end result of the several steps we
described above is the following: the Portuguese Government managed to pay
its external debt without having to borrow new funds from abroad.
Until the first quarter of 2011 the Portuguese Government owed an amount of
15 to Deutsche Bank. After paying back that debt it still owes a sum of 15, but
with a very substantial difference – it owes it to a public sector Portuguese
bank, CGD. And that bank will also make a nice profit in this process: it lent to
its shareholder, the government, at 10% and will be paying 1% interest on the
amount it borrowed at the Banco de Portugal (1% was the euro interbank
interest rate in April 2011, remember). It will thus earn a 9% spread in the
operation.
As for the Banco de Portugal, it will end up owing 15 to the ECB as a
consequence of the intervention of TARGET2. But it turns out that the debts
contracted between the central banks of the euro system have a special
feature, which is that their principal (their nominal value) has no schedule set for
payback. According to the rules of TARGET2, the outstanding credit and debit
positions of central banks vis-à-vis one another have no upper bound limit9 and
their maturity date is unspecified. These credit and debit positions are the
automatic reflex of the net flow of payments between the banking systems of
the countries of the euro; at any point in time, they may be increasing or
decreasing depending on the direction of these flows (for example, if German
banks return to their pre-crisis practice of lending bank reserves to their
Portuguese counterparties in the interbank market – or, alternatively, if German
consumers start buying more products from Portugal – there will be an increase
in net cash flows from Germany to Portugal, which will reduce both the credits
accumulated by the Bundesbank in TARGET2 and the debts of the Banco de
Portugal in the same system).
Thus, the money balances of TARGET2 owed by the central banks of the
countries of the European periphery simply cannot, according to the euro’s own
logic, have as destination "being paid". Ultimately, any "payments" will only
happen on the day (a day that, according to the euro treaties, will hopefully
never come) a country leaves the euro. Then and only then could these
9
They cannot have an upper bound, because "putting limits on the size of TARGET2 liabilities…would
throw the common currency area back to the system of fixed exchange rates with those central banks that
face TARGET2 limits being forced to struggle to maintain their stock of internationally fungible reserves" –
see Bindseil and König, "The economics of TARGET2 balances", p. 4. Mr. Bindseil is an economist at the
European Central Bank.
8

9. accounts be paid off – but said payments would necessarily involve one or
several new currencies, of the country or group of countries that would have
exited the euro10.
One important conclusion to be drawn from this example must then be this one:
the Portuguese government can manage to honor its commitments to foreign
creditors without needing to ask for new funds abroad – either to private sector
agents or to sovereign entities.
In addition, the example shows the foreign creditors receiving payments
promptly and on schedule, and such a circumstance would likely put an
immediate lid on the pressure of yields on Portuguese debt. It’s quite likely that
after a period receiving payments on time and with a minimum of fuss, lenders
would conclude that the risk of Portuguese default has become quite low –
much lower than the markets estimated in a moment of panic. This
acknowledgement would soon push the yields towards more sustainable
figures, thus reopening the way for a quick return of the Portuguese
Government to the bond markets.
And even abstracting from this likely beneficial effect on the psychology of the
markets, it is logical to assume that the use of the mechanism that we have
described would have helped by itself to overcome the sense of urgency that
prevailed in Portugal in the first semester of 2011 – a feeling that ultimately led
to the fateful decision to request aid from the Troika.
It is quite clear that had Portugal needed to borrow only a sum of 15 from the
panicking markets of 2011 instead of double that amount, the reduced
borrowing needs would have enabled the government to achieve important net
savings in total future interest charges. In the example we used, the
Government would continue to pay a gross amount in annual interest of 3.
However, since half of this cost (1.5) would be a revenue of the state-owned
bank (CGD) the bank could later on return to its shareholder the profit it earned
on the operation: that is, the amount of 15 lent times 9% (the spread mentioned
above), which would provide a refund to the government of 1.35.
This means that the future annual net burden of interest on year 2011 loans
would decrease from an amount of 3 to just 1.65 (3 minus the profit of 1.35 for
CGD, which will be reimbursed to the Government). This is a substantial
decrease, of almost 50%.
10
Even after (and if) a country exits the euro, this central bank TARGET2 debt might continue to pay
interest only, meaning it would be less burdensome than “normal” government debt with both interest and
payment of principal obligations. In this sense, the scheme that we propose would make it less onerous for
Portugal to exit the single currency, since it replaces a debt with principal by a kind of perpetuity,
tendentially at low interest. On this topic see Karl Whelan, "TARGET2 and Central Bank Balance Sheets",
p. 33-34.
9

10. Certainly, such substantial savings in interest expenses – 1.35 per year that
could now be used for essential items of the budget – would lay open for the
Portuguese Government the choice of altogether discarding the request for help
to the Troika.
Of course, this is a description focused on an event from the past, a form of
counterfactual historical analysis, of what could have happened but didn't
happen. We proceed to show its relevance for the present in the following
sections.
IMPLEMENTATION IN THE POST-TROIKA ERA
Today, despite being subject to an aid program, Portugal still has the option of
using the very same process – TARGET2 and the CGD bank, ideally in
conjunction with other Portuguese commercial banks – to pay that part of its
outstanding debt held by foreign creditors11. Namely, the 22.8 billion euros due
to the ECB, the almost 80 billion owed to the Troika and the circa 40 billion
payable to private creditors in Europe, especially banks (December 2013
figures)12.
The procedure that we have analyzed would substitute internal debt for foreign
debt and replace a problem of chronic dependency vis-à-vis the exterior by a
much simpler one, redistributive in nature, in a new context in which Portuguese
citizens could say to one another that "we now all owe these sums to
ourselves".
Plus, it would let the Government save meaningful sums of money by capturing
a portion of the spread between the interest paid on government bonds and the
low loan rate at which commercial banks borrow from the Banco de Portugal.
We have observed how this spread is pure profit for the banking sector; and we
should now stress that in case the banks involved in the purchase of new debt
issues are either: a) fully owned by the Government (CGD) or, b) partially
owned by other public bodies (such as pension and social security funds that
are under government control – they could quickly become shareholders of
Portuguese banks via new IPOs, particularly of those banks that are already
under state intervention and in desperate need of new capital) the whole or a
part of the spread will revert to the public coffers. And even the remaining part
of that spread may well stay in national hands, to the extent that the banks’
private shareholders are Portuguese.
In addition to this, the constant presence of Portuguese banks as strategic
buyers of public debt in the primary markets would probably exert an upward
11
Even before the bonds reach maturity, if the government wishes to speed up the pace of debt payback.
http://www.publico.pt/economia/noticia/bancos-portugueses-decidem-sucesso-da-troca-de-divida1614784
12
10

11. pressure on bond prices and send yields downwards to lower levels, and this in
turn would contribute to convey the desired image of a virtuous trajectory
towards the long-term sustainability of public debt.
The above-mentioned reasons indicate that the Government, by adopting the
procedure described in order to pay back the debt held abroad, would
strengthen its negotiating position in the European context – and, perhaps most
importantly, capture valuable financial savings that would place it in a much
better position to exit the foreign-mandated policies of spending cuts and tax
increases that have proved so detrimental to the country's economy13.
POSSIBLE COUNTER-ARGUMENTS
Some might counter-argue that an expansion of the CGD bank’s balance sheet
(loans and deposits) as a result of massive lending to the Government would
put at risk the capital ratios required by the Basle agreements; the answer to
this objection is that the Government could use a small part (say, 10%) of the
financial resources obtained in this process to inject new capital in the CGD
bank, if necessary14.
As for another possible objection – that the ECB could react by suspending the
acceptance of Portuguese Government bonds as collateral that may be
presented by the Portuguese banks in order to borrow from the Banco de
Portugal – the simple answer is that the ECB would certainly think twice before
taking such a step, for it would represent a profound change in the rules of the
game and might thus have an extremely negative impact on the liquidity of the
Portuguese banking system, with undesirable repercussions elsewhere in the
eurozone (footnote 6 also addresses this issue).
But even in an admittedly low probability scenario where the ECB did react in
the manner described in the preceding paragraph, the Banco de Portugal would
still have the option of continuing to make advances to the commercial banks
under a so-called ELA (Emergency Liquidity Assistance), which is not subject to
13
It should be noted that the limitation of this procedure to the rollover of outstanding debt means that we
are not facing here a case of "monetization" of new deficits; also, the payment of debt held by banks
abroad would allow Portugal – if necessary – to invoke the "prudential" considerations that, according to
the European treaties, may legitimize the "privileged access" of a government to financial institutions (in
this case, CGD). In fact, by ensuring the prompt payment of Portuguese bonds held by EU banks, the
Government would be contributing to the soundness of the European financial system – a result that might
even lead to the process being endorsed by the countries of "core" Europe, in particular Germany.
14
The Government would have an extra option: that of instructing the social security and pension funds
under its control to become shareholders of CGD, thus enlarging its capital base. Or, as we suggest on
page 10 of the main text, it could decide to be even bolder and have the funds inject new capital in other
commercial banks that are already under some form of State intervention. These banks could then
implement a process similar to that described for CGD by lending to the Government a multiple of
subscribed capital - either by direct advances or via purchases of government bonds in the primary
market. This could "leverage" by up to a multiple of ten the effects of the recent government decision (July
of 2013) to use 4 billion euros of social security funds in support of Portuguese public debt.
11

12. the normal rules on collateral guarantees. This is a phenomenon one did indeed
observe in the case of Greece, where the ECB has already tolerated without
much questioning situations in which the Bank of Greece made massive loans
to the banking system of the country while accepting as "collateral" only the
looser guarantees provided by ELA (Mario Draghi's statements in defense of
the Greek ELA, made on November 8, 2012, can be read here:
http://www.ecb.europa.eu/press/pressconf/2012/html/is121108.en.html ). The Banco
de Portugal would thus presumably also be allowed to implement an ELA and
any guarantees offered by CGD bank would continue to be accepted by the
Portuguese NCB.
And if the Governing Council of the ECB, in an extreme measure that would
contravene precedents already established (apart from Greece, we have the
example of Ireland, which has been granted ELAs since 2009) decided to
instruct the Banco de Portugal to terminate the ELA15 the Portuguese NCB
would have no option other than ignore the ECB’s orders and keep advancing
funds to the banks, because otherwise there would be a risk of total collapse for
the Portuguese banking system due to lack of liquidity.
If this point ever came to be reached, the only way to prevent indirect financing
of the Portuguese Government through the Eurosystem would be for the ECB
to instruct the other European Central banks to cease lending to the Banco de
Portugal. This would mean the cutting off of Portuguese access to TARGET2,
tantamount to the country being expelled from the eurozone.
In practice, however, this would represent a true rogue move, totally outside of
the eurozone's legal framework, since the European treaties do not even allow
for the possibility of “expulsions” from the eurozone. At any rate, it would be
quite inconceivable that such an outcome be determined by an unelected body
such as the ECB (on this subject, see John Whittaker, '”Eurosystem Debts”,
page 6).
Also, and quite in contradiction to those observers who always characterize the
ECB as being under the sway of a strict “hard money” philosophy, facts have
repeatedly shown the ECB taking the initiative in facilitating the access of
national banking systems to funding by the respective central bank. It’s clear
that the ECB usually strives to minimize – quite logically, by the way – the risk
of liquidity crises arising within the European banking systems. As evidence for
15
On March 21, 2013, during the negotiations that led to the intervention of the troika in Cyprus, the ECB
put severe pressure on Nicosia, threatening to cut off the country’s ELA after only 4 more days – unless
Cyprus agreed immediately to the conditions proposed by the troika to grant financial aid. As Cyprus did
agree, we don't know whether the ECB would be ready to implement this ultimatum on the announced
date. Cyprus is a small economy (15% the size of Portugal’s) dominated by its banking sector, with most of
the funding originating from outside the EU. It is doubtful that the ECB would dare to behave in a similar
manner vis-à-vis larger economies that are more closely connected to "core" Europe, because in that case
it would be playing with a possible collapse of a national financial sector (collapse is what we’re talking
about, if there is a sudden suspension of a ELA) that could easily contaminate the entire euro zone.
12

13. this, one could mention the ECB’s decision, back in February of 2012, to
introduce a relaxation of collateral requirements for the banking systems of
seven countries of the eurozone, including Portugal – an instance of a “soft
money” approach that at the time startled many economists, including Willem
Buiter at Citibank.
Taking into account these examples of the near past, we think it highly unlikely
that the ECB would take practical measures to prevent a systematic recourse of
the Portuguese Government to CGD and/or other banks with the purpose of
borrowing the sums it needs to pay back creditors domiciled abroad16.
SUMMING UP THE ARGUMENT
We have seen how the procedures we are advocating here would cause,
ceteris paribus, a decrease in the amounts of government debt owed to foreign
creditors and a corresponding increase in the “TARGET2 debt” owed by the
Banco de Portugal to the ECB. This swap of IOUs would be highly beneficial for
Portugal, considering that TARGET2 debts “are different” in the sense that they
neither have a date of maturity nor an upper bound limit. The only obligation on
these debts is the payment of interest at the MRO rate of the eurozone, which is
right now at a level close to zero.
As we have seen, there are no technical impediments (as opposed to obvious
political obstacles, perhaps due to the absence of a subjective determination to
make full use of the rules of the game of the eurozone, in defense of legitimate
national interests) to prevent the Portuguese Government from taking full
advantage of the openings provided by TARGET2 in order to pay back its
foreign debts.
We believe that once the country’s Government decides to implement the
procedures that we described in this paper the situation will rapidly evolve
towards a substantial restoration of the monetary sovereignty that has now
been completely lost. Portugal will finally be able to pay back the sums it
received from the troika and also reduce, at the same time, the damage being
done to its economy. Plus, it will achieve this result by its own initiative, not
16
In support of our thesis we can mention an example from the recent past (spring of 2012) that shows the
ECB itself successfully mandating the Greek Government to implement a payback mechanism for Greek
bonds held on the balance sheet of the ECB that is quite similar to the one we advocate in the text. The
story went like this: the ECB put pressure on the Government of Athens for it to issue new short-term debt
in the amount of 5 billion euros and sell it directly to Greek commercial banks – this at a time of worsening
crisis in the country (on the eve of a general election), when "markets" were not willing to lend new sums
to Greece. The banks subsequently transferred the Government's new deposits to the ECB, in order to
pay back the (old) Greek bonds on the ECB’s books that were reaching maturity; they borrowed the
necessary funds from the Greek Central Bank, under the ELA. This initiative of the ECB provides an
important precedent, an additional reason for the Portuguese Government to feel confident in using the
country’s commercial banks and TARGET2 on the lines that we propose here. On this subject see:
http://yanisvaroufakis.eu/2013/11/08/ponzi-austerity-a-definition-and-an-example/
13

14. needing to depend on more foreign aid and on the price tag that inevitably
comes associated with it: merciless austerity.
Finally – last but not least – it is important to stress once again that all of this
would happen with Portugal acting entirely under the framework of the
accounting rules of the single currency and not abandoning the euro.
CONCLUSION
TARGET2 guarantees that all the citizens and firms of the eurozone can freely
transfer their euro-denominated bank deposits across the borders of the
countries of the EMU. It is a payment and clearing mechanism between central
and commercial banks designed to give shape to a foundational concept of the
single currency: that a euro must be the exact equivalent of any other euro,
independently of the country where it happens to be located. No wonder
TARGET2 can be used by a Government who wants to transfer deposits
abroad, in order to pay foreign creditors back.
By implementing automatic, limitless and uncollateralized credit creation
between the central banks of the eurozone, TARGET2 has allowed the euro
countries with high trade deficits to continue to finance their net imports even
after the interruption of the normal functioning of interbank markets that
occurred in 2008; and it has also enabled depositors in Italian and Spanish
banks to proceed to transfer without any obstacle hundreds of billions of euros
in bank deposits from those countries into Germany, throughout 2012.
These two phenomena – especially the second one, that is, capital flight –
explain the explosive increase in the cumulative amounts of debits and credits
within the TARGET2 system (shown in a graph of the Appendix) in particular
throughout the year 2012.
In recent times we have seen the system at its best, exhibiting a flawless
capability to accommodate a sudden and massive increase in unilateral crossborder funding flows (as well, subsequently, a limited reversal in said flows); just
like it could deal in the future with massive transfers from Portuguese banks to
accounts in other euro countries with the purpose of paying back debts
contracted by the Portuguese Government in the past. At any rate, the amounts
involved in such transfers, even in the most extreme scenarios, would never go
beyond a few tens of billions of euros per year, i.e. a quantity much lower than
the net sums that have already been successfully processed under TARGET2
in the past.
We can thus conclude that the Portuguese Government, in conjunction with
local commercial banks, has the option of deciding to use TARGET2 in a
strategic and proactive manner, with the purpose of quickly replacing the debts
presently held abroad by new domestic debt, and that such an initiative would
14

15. also reduce interest expenses and help the country escape its current
predicament of subordination to recessionary policies dictated by external
creditors.
In the appendix that follows we present more detailed Tables with the
accounting entries for transfers under TARGET2, a graph with the evolution of
TARGET2 balances from 2007 until the end of 2013 and excerpts from papers
by Peter Garber, John Whittaker and Marc Lavoie that succinctly describe the
possibilities open to countries in the European periphery – alas, not yet properly
exploited by their Governments – in the context of TARGET2.
São Paulo, February 1, 201417
JOSÉ GUILHERME QUEIROZ DE ATAÍDE, CFA
jgqataide@uol.com.br
www.marketbet.com.br
APPENDIX
(EVOLUTION OF TARGET2 BALANCES FROM 2007 to 2013, QUOTES
FROM AUTHORS, ACCOUNTING TABLES AND REFERENCES).
GRAPH 1: Target2 positions
In EUR bn, January 2007-October 2013
DNFL = Germany, Netherlands, Luxemburg, France.GIIPS = Greece, Italy, Ireland, Portugal, Spain
Source: DNB
17
A first version of this text (in Portuguese) was published on December 15, 2012.
15

16. "There is no limit on the extent of the "Other liabilities within the
eurosystem" that a NCB (National Central Bank) can incur; and
these liabilities can be carried indefinitely as there is no time
prescribed for settlement of imbalances (…) a euro-zone
government could, if it had to, continue to finance itself via the ECB
even if it could not sell new bonds to the market because of fears of
default. Under this scenario, a government might sell its bonds to a
local bank, which draws funds from the ECB through its NCB
(National Central Bank), depositing the new securities as collateral
at the NCB. The government could then use the funds to pay private
creditors in other countries who are not rolling over existing debt”.
(Peter Garber, "The Mechanics of Intra Euro Capital Flight", 2010 page 3).
"As long as (a country) remains in the euro, it cannot be excluded
from eurosystem credit, so Germany and any other euro countries
that still have sound finances will keep lending ... If this is not done
via an official loan facility, it will go through the eurosystem
(European Central Bank). The ECB ... is the lender of last resort
whether it likes it or not".
(John Whittaker, "Eurosystem debts, Greece, and the role of
banknotes", 2011 - page 6)
"We can see one way of regaining some currency sovereignty
without disrupting the ECB unwillingness to purchase sovereign
debt: a government that is under pressure from international
financial markets, having trouble in getting foreign financial
institutions to rollover their securities, could direct its domestic
publicly-owned commercial banks to acquire new bond issues at the
price of its choice ... The proceeds of these sales, initially held as
deposits at the domestic bank, could be used to redeem the
securities that foreign banks decline to roll over".
(Marc Lavoie, "The monetary and fiscal nexus of neo-chartalism",
2011 - page 24)
ACCOUNTING TABLES (next pages):
16

17. (The division in two steps is done for convenience of exposition only; in reality,
the process is interconnected in so many ways that it is artificial to separate it in
neat chronological phases).
The process starts with the issuance of a Portuguese Government Bond. In this
example, there is a security of 100 (million euros) that the Government "sells" to
CGD Bank, thereby creating a government deposit in the Bank. The operation
proceeds as follows:
Step 1:
The Portuguese Government will use its new deposit at CGD bank to pay back
a bond, presently an asset on the books of Deutsche Bank in Germany. This
payment is processed via TARGET2; Deutsche Bank acquires a new deposit
liability as well as an asset (reserves that it deposits at the Bundesbank). CGD
does not lose reserves, in net terms, because it compensates for the reserves
that left for Germany by new reserves that it borrows from the Banco de
Portugal. The Bundesbank advances funds to the Banco de Portugal.
CGD
Assets
Banco de
Portugal
Deutsche
Bank
Liabilities
Assets
Liabilities
Deposit
Portugal
govt.
-100
Advance to Advance
CGD + 100 from
Bundesbank
+100
Assets
Bundesbank
Liabilities
Assets
Reserves at Deposit
Advance
to
Bundesbank exBanco
de
+ 100
Portugal
Portugal +100
govt.
+
100
Liabilities
Deposit of
Deutsche
Bank
+100
Advance
from
Banco de
Portugal
+100
Step 2:
End of the day: debits and credits of the Banco de Portugal and Bundesbank
are transferred to the books of the ECB, where each central bank acquires a
net debit or credit position vis-à-vis the ESCB – the "Eurosystem" or ESBC
(European System of Central Banks); Deutsche Bank had excess reserves as a
result of the transfer from Portugal and can now use them to decrease its debt
position vis-à-vis the Bundesbank.
17

18. CGD
Assets
Banco de
Portugal
Deutsche
Bank
Liabilities
Assets
Liabilities
Deposit
Portugal’s
govt.
-100
Advance to Owed to
CGD + 100 ECB +100
Assets
Bundesbank
Liabilities
Assets
ECB
Liabilities
Deposit ex- Credit to ECB
Portugal
+100
govt.
+ 100
Assets
Liabilities
Owed
by
Banco
de
Owed
to
Bundesbank
+100
Portugal
+100
Advance
from Banco
de Portugal
+100
Advance
from
Bundesbank
Advance
to
Deutsche Bank
-100
- 100
Then, at the end of the process, the Portuguese Government’s deposit that was
transferred to Deutsche Bank is used to extinguish the Portuguese bond
previously held by that Bank.
The process led to the following consequences within the Eurosystem: the
Banco de Portugal increased its debt position relative to the ESCB/ECB, while
the Bundesbank acquired a new claim on the ESCB/ECB. This build-up of
debits and credits may continue indefinitely and without limit, within TARGET2.
The tables assume the absence of normally active interbank markets, a
situation that has prevailed in the eurozone since the financial crisis of 2008.
They are based, with adaptations, on Marc Lavoie, "The Fiscal and Monetary
Nexus of Neo-Chartalism".
REFERENCES:
Ulrich Bindseil and Philipp Johann König, “The Economics of TARGET2
Balances”, June 14, 2011
http://sfb649.wiwi.huberlin.de/papers/pdf/SFB649DP2011-035.pdf
Peter Boone and Simon Johnson, “Europe on the Brink”, July 2011
http://www.piie.com/publications/pb/pb11-13.pdf
Willem Buiter, “Is the Eurozone at Risk of Turning into the Rouble Zone?”,
13 February 2012 http://willembuiter.com/roublezone.pdf
Willem Buiter and E. Rahbari, “TARGET2 Redux”, 16 October 2012
www.willembuiter.com/target2redux.pdf
18

19. Bundesbank, “The dynamics of the Bundesbank TARGET2 balance” –
Bundesbank Montly Report, March 2011, pages 34-35
http://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Monthly_Rep
ort/2011/2011_03_monthly_report.pdf?__blob=publicationFile
European Central Bank, “The Implementation of Monetary Policy in the
Euro Area”, February 2011
http://www.ecb.int/pub/pdf/other/gendoc2011en.pdf
European Central Bank, “TARGET2 balances of National Central Banks in
the Euro Area” – ECB Monthly Bulletin, October 2011, Box 4, pages 35-40
http://www.ecb.int/pub/pdf/mobu/mb201110en.pdf
Peter Garber, “The Mechanics of Intra Euro Capital Flight”, December 10,
2010 http://fincake.ru/stock/reviews/56090/download/54478
JKH, “TARGET2 – Window on Eurozone Risk”, September 5, 2012,
http://monetaryrealism.com/target2-window-on-eurozone-risk/
Marc Lavoie, “The Monetary and Fiscal Nexus of Neo-Chartalism”, October
2011 http://www.boeckler.de/pdf/v_2011_10_27_lavoie.pdf
Karl Whelan, “TARGET2 and Central Bank Balance Sheets”, March 17,
2013 http://www.karlwhelan.com/Papers/T2Paper-March2013.pdf
John
Whittaker,
“Intra-Eurosystem
debts”,
March
http://mpra.ub.uni-muenchen.de/38368/1/eurosystem.pdf
30,
2011
John Whittaker, “Eurosystem debts, Greece and the Role of Banknotes”,
November 14, 2011
http://mpra.ub.uni-muenchen.de/38406/1/MPRA_paper_38406.pdf
19