You know those signs you see homeless people holding in the street? They usually say something like, ‘Will work for food’. Your editor gets the feeling that the depositors in southern European banks are telling the Germans something similar. In this case, the message is more like, ‘Will believe in the euro for more money’.
The European situation has become so complicated that rational people have begun doing the only sensible thing: panicking. Investors were in full freak-out mode on Friday. Aussie stocks fell 2.67% for the day and 5.6% for the week. Over in Facebookland (America), the Dow Jones Industrials have fallen 12 times in 13 trading sessions. It’s the Dow’s worst thirteen session performance since October of 1974, according to the Wall Street Journal.
But you can’t underestimate the motivating effects of a good panic. Depositors in European banks look like they’re in the early stages of a bank run. Things may get a lot worse before they get better.
Last week it was Greek savers taking out over €700 million from the banks in one day. By Friday, we learned that nearly €1 billion had fled Spain’s fourth-largest bank, Bankia. The bank is heavily exposed to the Spanish property market. It was nationalised by the government in the last ten days. Its auditors have refused to sign off on its balance sheet.
Bank of England governor Mervyn King has said it’s irrational to start a bank run, but rational to participate in one. Once you realise that everyone else is asking for their money, you’d be an idiot not to ask for yours too. This is why central banks fear bank runs. They are self-fulfilling psychological panics that can only be prevented by the restoration of confidence in the ability of a bank to meet its obligations to depositors.
Depositors in Spain, Italy, Greece, Ireland and Portugal have no reason to be confident. Banking sectors in those countries are too large to be bailed out by governments. The government can’t guarantee the banks or the depositors. And in the meantime, the only thing keeping inter-bank lending afloat in some European countries is access to funding from the European Central Bank.
As a saver in one of these countries your fear would be crystal clear: the banks will become insolvent and depositors will be destroyed by a devaluation when the exchange rate between the new currency and the euro blows out. Savers are getting their money out of banks while they can.
Our description above assumes that the nations with the most troubled banking sectors will be forced to exit the euro. This would create an exchange rate between the new national currency and the euro. These ‘exchange events’ are always compulsory and never result in an increase in purchasing power.
But we are probably begging the question. Europe’s policy makers are having a great debate right now. Can they save the euro with a new fiscal pact or new pan-European banking regulations where banks are under European control and not, for example, Spanish or Greek control? Or should they even try?
Guaranteeing all bank deposits at the EU level is the best short-term answer, although it wouldn’t be easy. You’d have to decouple troubled banking systems from troubled governments. You’d have to make the banks the problem of the European Central Bank. The ECB can engineer some new Long Term Refinancing Operation or some fake recapitalisation effort. National governments and their budgets will be relieved of the pressure of supporting the banking system.
But all of that is complicated. And in any event, the ECB itself is funded by national governments. How can the PIIGS countries afford to fund the ECB if they can’t afford to bailout their own banks?
Obviously they can’t. What’s really at issue is under what terms the core of Europe is willing to pay for the banking crisis at the periphery. This debate simmers between Berlin and Paris.
In the meantime, European depositors are voting with their feet, and their feet are taking them into line at the bank and right back out the door with cold hard cash. The disappearance of depositor money makes the banks even more reliant on ECB funding. It also brings the moment to its crisis.
So here we are on the doorstep of a crisis again. Can an ECB guarantee on European bank deposits stop a European bank run? Or will capital controls and restrictions on deposits be required? And more importantly, do any of those options actually restore confidence by savers that Europe is headed to an orderly resolution of its financial problems?
Rational discussion of the problem is quickly giving way to irrational action. That’s bad news for Europe. It’s also bad news for investors. And come to think of it, it’s probably not good for Aussie banks that have seen their European funding costs rise.
More than anything this is bad news if you’re the sort of person who believes complex systems can be micromanaged by State committees. This has all the makings of a ‘complexity catastrophe’. We reckon that Europe’s savers are realising that the big problem is not financial, it’s political and even ideological. And there is no solving it with more money. More on that tomorrow…and what the rational response of an Aussie investor to this mess is.
for Markets and Money
From the Archives…
The Physical Gold Market – From the Weak to the Strong
2012-05-18 – Greg Canavan
Why JP Morgan is Playing the Same Old Rigged Game
2012-05-17 – Eric Fry
Why Greece Can’t Afford to Stay in the Euro
2012-05-16 – Dan Denning
A Big Oops at JP Morgan!
2012-05-15 – Dan Amoss
Preparing For China’s Growth Slowdown With The ‘Energy Hub’ Portfolio
2012-04-14 – Dan Denning