My point here is that the German Constitution substantially restricts the types of actions that the ECB, EFSF or ESM can take. In addition, it seems extremely unlikely that a constitutional amendment could be passed that effectively allows Germany to bailout failed states by monetizing their debts.

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One Last, Big, Under-the-Radar Screen

Frankfurter Allgemeine had a fascinating story recently on the TARGET system. TARGET is the short form for the Trans-European Automated Real-time Gross Settlement Express Transfer System. I did not see this picked up in the North American press.

TARGET is the system that is used for payments among banks. The latest version of this system went live in November 2007 and is called TARGET2. This is a European system rather than a Eurozone system. (Note that Sweden and the U.K. do not participate.) Here's an overview. The system is very similar to the FEDWIRE system in the U.S. In the U.S., the members (regional Federal Reserve Banks) settle twice a year.

All this is routine -- except Germany has racked up a 465 billion euro balance -- they are essentially providing massive credit to Ireland, Greece, Spain, Portugal and Italy -- this is backdoor funding of these troubled countries. For an interesting analysis of TARGET2, read John Wittaker's paper.

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The Endgame

In my opinion, it is up to Germany to save the euro. Unclear is the way that it will unfold. The EFSF does not have the firepower -- even with leverage -- to deal with the fallout. It is also case that the ECB is severely constrained. It is unrealistic to think that they can act like the U.S. Federal Reserve did during the 2008-2009 financial crisis.

In addition, with the problems spreading all over Europe, the credit worthiness of the EFSF is questionable. Frankly, who is going to be contributing among the big four? Not Spain. Not Italy. Maybe France but they would surely lose their AAA status as a result (though they will likely lose it anyway).

It really comes down to Germany. In particular, bilateral actions. Forget the multilateral actions that take over a year to be approved by 17 national legislatures.

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