Here’s a thought experiment for you. Greece and Spain are bleeding deposits right now. Presumably depositors prefer core country banks (such as German banks) to Greek and Spanish banks. These deposits have been made up for by money from the ECB via the target system. So here’s the experiment: what would happen if, in the extreme, the Greek banks lost all of their deposits to a bank in, say, France and the ECB just kept on doing what it is doing now and made up for the lost deposits at Greek banks through the TARGET system?
As far as Torrnes is concerned, such a run would amount to complete capital flight from the Greek banking system. Greek depositors would now have insulated themselves from the negative monetary effects of a euro exit or a collapse of the Greek banking system. The ECB now bears toe risk that depositors held. Effectively the ECB would have paid out on an implicit deposit insurance scheme. Of course the Greek banks would still have to worry about their loan portfolios, but they don’t have to worry about deposits – effectively the ECB is the sole depositor at Greek banks.
Suppose that the Greek government also announced that it would introduce a new drachma in one year’s time to completely replace the euro as a means of payment and unit of account, and that it would freely float at a greatly depreciated rate. Lenders would now have a big incentive to renegotiate their loans and shorten them down to one year; otherwise when the loan becomes due, the borrower would have to pay the bank back twice as much in drachma. It follows that in one years time Greek banks could simultaneously rollover the old loans into Greek drachma and use the euros that have been repaid to settle their position with the ECB. These loans would in turn form the basis for the new Greek monetary system.
Torrens reckons that the effect on Greece wouldn’t be so bad. The average Greek household both gains and loses – they gain because after one year the drachma value of their euro deposits doubles and they lose because after one year their real wage (measured in euro terms) halves. Moreover, achieving this outcome doesn’t seem so nightmarish either. All it requires is that the ECB plays a supportive role in the transition.
It all seems a bit too easy. So what do you reckon? Has TH lost it?