Watch deposit flight, not the eurocrats

 
A worker cleaning a sign for the Bank of Greece

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One way the current crisis could nix Greek euro membership is if the bailout fund - the EFSF - refuses to dole out the relevant billions on a date coinciding with the Greek state having to use said billions to repay its debts.

That is the "political trigger" to euro exit. But market participants are watching something else: the flight of deposits out of Greek banks and into other Euro currencies.

That is because the normal mechanism for making payments across Euro borders, called TARGET2, is seen as the economic trigger for a euro exit.

It works like this. Suppose a Greek wants to send a Spaniard 1,000 euros. Let's call them Louk and Gomez:

  • Louk's account at Bank A is docked 1000 euros.
  • Bank A signals to the Greek central bank, Bank of Greece, that the payment will go ahead using TARGET2.
  • Bank A's reserves at the Bank of Greece are docked 1000 euros.
  • Bank of Greece's liability to the Eurosystem of central banks rises 1000 euros.
  • The Bank of Spain now has a claim of 1000 euros on the Eurosystem of central banks (as a whole, not merely its Greek counterpart).
  • The Bank of Spain creates a reserve of 1000 euros for Gomez's bank, Bank B, in Spain
  • Bank B creates 1000 euros in Gomez's bank account

The thing to note here is that both central banks are creating debits and credits with the entire system, not each other. They do not directly face each other. All that happens is that their accounts with the central system, TARGET2, are changed.

Now what if Bank A, in Athens, does not have enough reserves at the Bank of Greece? It borrows from the Bank of Greece, which is in turn borrowing from the ECB.

Now what if the Bank of Greece knows Bank A is in trouble because its deposits are being withdrawn? Still no problem: it can lend to Bank A, borrowing from the ECB, and take very poor collateral, by permission of the ECB, up to a certain limit.

But the sticking point comes on the issue of collateral. The Bank of Greece has permission from the ECB to lend against poor collateral up to a certain amount, set twice a week. If that amount is breached, the ECB must vote to raise it: that vote will be effectively a vote to allow massive capital flight. The moment the limit is not raised, Bank A goes bust, triggering massive capital flight if it has not already started. At that point, the Bank of Greece would have to impose capital controls, and everybody who has euros in a Greek bank account would have to keep them there and see them devalued on euro exit.

There are about 170bn euros of deposits in Greek banks. If these were then devalued by 50% after euro exit, it would probably not crash the euro system. On Greek sovereign debt, the default has already occurred. Until Monday, only 700m euros had fled Greece since the election. But on the first two days of this week, says the FT, outflow exceeded 1.2bn euros.

However, what the markets are looking at right now is contagion to Spain and Italy. Here you have 800bn euros of foreign-owned government bonds, 600bn euros of foreign-owned corporate bonds, and 300bn euros of foreign-owned listed equities (numbers from JP Morgan) - together with E3 trillion of deposits.

What policymakers and market players are worried about right now is if foreign investors see a Greek deposit crisis as a signal to rush for the exits in Italy and Spain.

One way of stopping that, says my market interlocutor, is if the Eurozone authorities would issue pan-European depositor insurance, effectively saying to everybody, everywhere in the zone, that the other members would make good bank deposits in the event of exit, or capital controls etc. It would be another way of imposing fiscal union and therefore a tough one to get through Germany/Holland etc.

The coming weeks, leading to the second Greek election, will see the interplay of opinion polls, depositor behaviour and the European Central Bank's bi-weekly decisions on the Bank of Greece's lending capacity.

The above is a technical explanation why the future of Greece in the euro may not lie in the hands of the electorate as voters: it lies in the hands of the electorate as bank customers.

 
Paul Mason, Economics editor, Newsnight Article written by Paul Mason Paul Mason Former economics editor, Newsnight

End of an era

After 12 years on Newsnight, Economics editor Paul Mason has moved on to pastures new and this blog is now closed.

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  • rate this
    0

    Comment number 54.

    If fiat currencies are in such danger how come the price of gold has collapsed ?

  • rate this
    0

    Comment number 53.

  • rate this
    0

    Comment number 52.

    I get the feeling that Capitalism is beginning to slowly unravel; and it has an aura of inevitability about it. The Elite's path of 'expansionary austerity' will only lead to [their] despair. It probably explains why the Left has been relatively quiet - they don't need to do anything but wait. Wait until the economic conditions deteriorate even further, until the Centre no longer holds.

  • rate this
    0

    Comment number 51.

    Increased cash withdrawals from Spanish banks reports BBC News.

    Time to get my cash out of Santander I think.

    Is it time to panic and another Northern Rock bank run about to begin in the UK - do I trust the UK Govt deposit protection scheme? No, and judging by the posts on UK money forums there are an awful lot of people out there thinking the same thing.

    Things are speeding up.

  • rate this
    +1

    Comment number 50.

    The Greek central bank can physically print its own euros. This would seem to nullify any ECB threat to choke off the Greek banking system:

    http://www.polycapitalist.com/2012/05/greece-can-physically-print-its-own.html

  • rate this
    0

    Comment number 49.

    Coming weeks, leading to 2cd Greek election, will see interplay of opinion polls, depositor behaviour & European Central Bank's bi-weekly decisions on the Bank of Greece's lending capacity. The above is a technical explanation why the future of Greece in the euro may not lie in the hands of the electorate as voters: it lies in the hands of the electorate as bank customers.

  • rate this
    0

    Comment number 48.

    One way of stopping runs is EZ authorities issue Pan-European Depositor Insurance, effectively saying to everybody IN EZ that other members would make good bank deposits in the event of exit, or capital controls etc. It would be another way of imposing FISCAL UNION & therefore a tough one to get through Germany, Netherlands, etc.

  • rate this
    0

    Comment number 47.

    Sticky point: collateral. Bank of Greece has permission from ECB to lend against poor collateral up to certain amount, set twice a week. If amount is breached, ECB must vote to raise it - effectively a vote to allow massive capital flight. Limit not raised, Bank A goes bust = massive capital flight. Bank of Greece would impose capital controls; euros in a Greek banks would have to stay there...

  • rate this
    0

    Comment number 46.

    EFSF & ESM need action:
    1. backstop national deposit guarantee funds.e,g, an Italian saver would know if Rome's own guarantee scheme ran out of money, there were funds in another kitty.
    2. bailout funds could lend cash directly to govts that were no longer able to issue bonds in the markets.
    BUT bailout funds are not large enough to stem a panic = 740B euros - not even with IMF help.

  • rate this
    0

    Comment number 45.

    To protect govts, ECB would need to take action. It cannot lend to states directly, but it can buy their bonds on secondary market. (Indeed, it has already done so.) It would need to be prepared to buy bonds in limitless quantities. Otherwise, investors might just run anyway & take the ECB's money while it lasted.

  • rate this
    +2

    Comment number 44.

    I am a Greek lawyer resident in London. I spent the morning talking to banks in Greece about ways to move money out fast. Everyone I know is on the phone to their banker asking for a way out. We are fast approaching a point that we will wake up to crowds outside the Greek banks asking for their money. Northern Rock gone large, and no goverment guarantee will settle things this time.

  • rate this
    0

    Comment number 43.

    4 EZ CBs: Germany, Netherlands, Luxembourg & Finland - have positive balances. At the end of April, Bundesbank was owed 644B euros ($1.06 trillion). Sum has been rising - average of 33B euros/month since crisis took a turn for the worse at the end of July/11. Meanwhile, all the peripheral countries have big liabilities; Italy & Spain have the largest.

  • rate this
    0

    Comment number 42.

    Maybe the bbc should post a journalist to observe Activity at De La Rue, would not be surprised to see afew extra truck movements in the coming weeks.

    Getting late in the antipodes. I wonder what Europe I will wake up to tomorrow will be an ongoing sentiment from here on in.

    Goodnight all and good work Paul and good luck everyone (except investment bankrs and eurocrats)

  • rate this
    0

    Comment number 41.

    Flight of deposits out of Greek banks & into other Euro currencies.
    TARGET2 can be seen as the economic trigger for a euro exit. Indeed, there already has been significant capital flight from peripheral economies. The best way of seeing this is by looking at so-called Target 2 imbalances = rough proxy for capital flight.

  • rate this
    0

    Comment number 40.

    China's appetite for gold continues a pace.

    Interesting.... Alternative gold backed currency to the dollar or euro anyone?
    YES PLEASE!!!!!!!
    The chain reaction of capital flight has got to end somewhere?

    A new global reserve currency perhaps.

  • rate this
    0

    Comment number 39.

    Euro Group, Jean-Claude Juncker asked Mario Draghi for tecnical advice. Originally, European Stability Mechanism (ESM) would've been launched July 2012, but was only intended to help out debt-ridden govts, which would have to meet strict requirements in return. But now, I note closed-door discussions about direct aid for banks. Something is changing...

  • rate this
    +1

    Comment number 38.

    Great journalism paul wish there was more of it about.

    Feel stupid now! Of course the financial sentiment will be the determining factor before the politicians are even elected! That's human nature.

    The narrative has switched already as measured by lagarde and co. recent comments. But do they realise how quick it could now move completely out of there hands and their narrative.....

  • rate this
    0

    Comment number 37.

    #28 RedRiot

    look at all those transactions, each one generating a fee
    (Louk might transfer money costing him E1000 in total but that is not what Gomez receives)

    Target2 is system for interbank transfer of liabilities, in this case from the Greek bank owing Louk to the Spanish bank owing Gomez.

    Because the banking system can see the transfer then they can calculate the nett flow.

  • rate this
    +1

    Comment number 36.

    #23 Alfred

    Are you sure you know your facts? Certain financial institutions "assisted" Greece in masking their debts:

    http://ftalphaville.ft.com/blog/2010/02/09/145201/goldmans-trojan-greek-currency-swap/

    It seems a bit rich for financial institutions to then turn round 8-10 years later and cry foul at the "lazy" Greeks.Are creditors completely innocent in cases of poor lending decisions?

  • rate this
    0

    Comment number 35.

    get the popcorn in, its finally happening.

    the greeks authorities can never print new banknotes before the public find out, so of course they will withdraw their euros which will be worth much more than "new drachmas" in a few months. Or they might withdraw their euros and exchange them for dollars, or gold.

    OR its even tighter fiscal integration (aka EUSSR which was the original plan all along)

 

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