Two identical countries A and B share a common (paper) currency C. The demand for currency is 5% of annual (Nominal) GDP.
Suppose B decides to quit the currency union and print its own currency. There are two different ways it could do this:
1. Convert and destroy. The people in B convert their C notes into their government's newly-printed B notes, and their government then destroys the C notes it has collected. The two countries carry on as before.
2. Print and spend. The people in B convert their C notes into B notes, and their government spends the C notes in country A. Or the government in B prints and spends the new B notes, and the people in B spend their unwanted C notes in country A. ("Spend" could include buying assets, including financial assets, and not just spending on newly-produced goods). Either country A now faces a doubling of the price level, which imposes a 5% of NGDP inflation tax on the people of country A, or else the government in country A increases taxes or sells assets worth 5% of GDP to prevent the supply of currency doubling.
By following the "print and spend" option, instead of the "convert and destroy" option, country B imposes a one-time tax of 5% of annual GDP on country A.
I haven't been following their disagreement very closely, but I think I'm agreeing with Hans-Werner Sinn and disagreeing with Karl Whelan. Institutional details like Target2 just encloud what is at root a very simple story.
It is extremely unlikely that the government of a country like Greece, in current circumstances, would follow anything like "convert and destroy".
But Greece is a small country, and 5% of a small country's NGDP is an even smaller percentage of a bigger country's NGDP. And it will be an even smaller percentage if Greeks continue to hold Euros as well as Drachmas. But magnitudes aside, it has the same effect as one more default.
If country A suspects that country B is planning to follow a "print and spend" exit from the common currency, it might want to jump ship first, so it is country B that makes the transfer to country A. There are incentives for a "currency run" at the supra-national level. Last one left holding the common currency is the sucker.
Of course, if there is initially a recession caused by an excess demand for the medium of exchange, there's a silver lining in all this "excess supply" of currency.