I read an article yesterday by Jeff Miller, regarding the European situation. One part grabbed my attention. Banks in Spain and Greece are experiencing record outflows of deposits. Jeff, in his normal bullish way, says that there is a solution coming. He may well be right and I must clarify that I am a regular reader of his articles. I find them both well informed and very useful. Unfortunately, I am bearish on the present global position. I therefore come at the world from an opposite viewpoint to Jeff.
In the EU, there is presently a deposit protection insurance scheme that insures €100,000 of the total deposits of any individual held in any European bank. Any amounts over the €100,000 are at risk. However, spreading your deposits in several banks will mitigate this risk as the schemes will pay €100,000 multiple times if multiple banks fail. The deposit scheme is presently guaranteed by the individual countries' governments (or the programs that they have instituted). Any bank registered in Greece will be guaranteed by the Greek scheme. Any Spanish banks will be guaranteed by the Spanish scheme and so on throughout the 27 EU nations.
It would seem that if people are withdrawing assets from the Spanish and Greek banks they have no faith in the schemes in those countries. This would seem logical, as the finances of the governments of these countries are in poor shape. The solution would therefore be to make the scheme larger and covered by a central EU authority, backed by all nations. Mario Draghi has just suggested that some changes are made to the deposit scheme, to stop bank runs in the periphery nations. He did not specify what should be changed.
Problem over, or maybe not - as usual in Europe, it is not that simple. Let us first take a closer look at the problem. There are 4 things (not 1) that the Europeans fear:
1. That the government goes broke and cannot honor the deposit scheme. In a country that has its own printing press, this is not such a problem. In the Eurozone, where individual countries cannot print their own currency, the problem is worse.
2. Confiscation of assets. Some asset managers in Europe are speculating that European problems are going to get worse. Several of the large banks are planning ways to protect their wealthy clients assets from this confiscation risk. It is presently a popular dinner topic. Although the public debt situation of most European states is desperate, the countries themselves are rich. Unfortunately the riches are in the hands of individuals, not the state. The solution to the problem - confiscate the assets in the name of the state. You will be saving your country by giving up your hard earned wealth. Hugh Hendry of Eclectica Asset Management has been warning of this problem for some time. Many of the South American and African countries have confiscated assets from individuals and companies, in the recent past. Why not Europe?
3. A move back to the pre-euro currencies for the periphery countries (regardless of whether they stay in the European Union or not). In this scenario the deposit insurance is useless. You wake up on a Monday morning to find your account balance in Pesetas or Drachmas. These promptly lose 50% of their value in purchasing power terms.
4. A break up of the Eurozone. This will result in government deposit schemes being converted to the original local currency. This is the same result as in 3 above (assuming that deposits are covered at all).
These 4 fears are the reason for the present runs on Greek and Spanish banks. To be successful, any changes to the deposit protection scheme will have to alleviate all of the 4 problems above. Any move to make the scheme non-country specific will likely slow the flows. This slowing will be temporary, unless all of the above concerns are addressed. The possible solutions are:
1. An EU wide deposit protection scheme joined by all member countries.
2. All individual governments promise to guarantee deposits in euros, in all circumstances. This would mean that there will be no forced exchange of euros for the local pre-euro currency, even if the country were ejected from the Eurozone.
3. An assurance from the ECB that they will guarantee all deposits. They can print euros.
You may be able to think of others, but will they satisfy all of the fears of the average European citizen? In solution 1 above, fears 2, 3 and 4 are not satisfied. In solution 2, fears 1 and 2 are not satisfied. In solution 3, fears 2 and 4 are not satisfied.
There are two other problems with the solutions described above:
1. I cannot see any chance of the UK or any other non periphery country joining a combined scheme. Think of the outcry in Germany if they were to end up securing Greek deposits.
2. The chance of the ECB guaranteeing deposits is nil, in my opinion.
I have no doubt that when a change to the deposit scheme is announced it will provide temporary relief to the markets and reduce deposit flight for a period. I am sure Jeff will highlight it as a solution to the problem. As in all European problems, there is no easy solution. Due to the difficulty, the solution is most likely to be a poor fudge. I expect that any changes to the deposit scheme (if there are any at all) will only have a fleeting effect on capital outflows from Greece and Spain. I cannot presently come up with, nor have I seen, a scheme that will put all fears to rest. It seems likely that this deposit flight problem will continue to fester for some time to come.
On a related point, I read all the time that Greece has made no progress and is doomed. By most forecasters' estimates, Greece has completed a 13-15% internal devaluation. At the outset of the crisis, estimates of the required internal devaluation were 25-30%. I would therefore argue that in the 5 years since Greece entered this crisis, they have achieved half the desired outcome. If the Germans had been required to devalue by 25%, it would undoubtedly have been done more efficiently. As it was not, any comparison is useless. It is easy to argue about all of the things that the Greeks have not done.
What they have done, in their own inimitable style (which we all love to criticize) is devalue 13-15%. All bad things come to an end. The problem for Greece is not that they have not made progress, but that the end is not in sight. The political will to go through the other half of the process is gone. I would not wish that the Greeks have to endure the pain that is required to go through the second half of this transition. However, I think it is a shame that they seem to be abandoning the project at the half way stage.
Nearly all of the European economies have a transition to go through and none have got as far as the Greeks. Spain seems to be giving up at a very early stage in the process. All of this seems to me to be missed in commentary on the Greek situation. Most articles just highlight all of the things that the Greeks have failed to do. The lessons that we learn from Greece are going to be needed in coping with Spain, Italy, Belgium, France, the U.K. and many others. Perhaps congratulating the nations on the progress that they have made, rather than berating them for the things that they have not done, should be one of the lessons.
I am presently reading Manias, Panics and Crashes by Charles Kindleberger. It is a very good read so far, with lots of pearls of wisdom. I would recommend it to you.
Disclosure: Long RWM, RIMM, USD/JPY, Gold and oil futures, Various UK corporate bonds.