Are Europeans fit enough to run or just to be tied?

It must be driving the ECB crazy right now and Draghi (ECB head) is probably fit to be tied watching the head-in-the-sand political approach to crisis management.The ECB is in a challenging position at the moment. Deposits have been flowing freely from the risky periphery economies (e.g. Spain and Greece) to the safe core economies (e.g. Germany and France). To keep the process from turning into a run, the ECB uses the target system to reverse the process. In doing so the ECB is essentially providing a melange of lender of last resort lending and deposit insurance. It takes on the risks that the periphery depositors would have faced from a periphery bank failure, while the periphery depositors cash is safe and sound at the core.


In doing so, the ECB has effectively managed to keep what would otherwise have been a run on the periphery banks to what James Haley calls a “jog”. But this raises interesting questions. Like what happens if people start to doubt the integrity of the Euro itself, or if they simply choose to invest the cash outside the euro system in Switzerland, Denmark, the US or UK? In those circumstances, the ECB would not have a “target” option. It would amount to a net capital outflow from Europe. This would have to be matched through a current account surplus – which would come about via two channels: The depreciation of the euro and, more likely, the collapse of domestic demand in the Euro area as bank landing is forced to contract and contract sharply. If that was to happen, then there would genuinely be a role for the IMF to act to provide the financing that would facilitate adjustment. Trouble is that even with all the recent pledges, it is highly unlikely that the Fund could deal with a euro run.


Now, if you think this is all just bollocks, here is a tid bit of worrying news. According to the Financial Times, data from the Bank of Spain on Monday showed Spanish banks’ bad loans rose to 8.72 per cent of their outstanding portfolios in April, the highest since April 1994, highlighting concerns about the country’s financial sector.

Someone has to bear those losses and things are can get worse. The European economy is very close to stalling and Europe is more heavily dependent on its banking system than the U.S.. TH wonders what the data are like for the other periphery banks? Surely, it wont be that bad, … will it?

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