We have argued that the German effort to make the Greek election into a referendum on the euro was misguided. Greece made its decision to join more than a decade ago. Opinion polls indicate that this is still the case: Greek people, by an overwhelming majority, want to stay in the EMU.
The memorandum of understanding has been renegotiated already and we are convinced that even if the ND and PASOK are able to put together the next government, the infamous memo will be renegotiated again given the drop in tax revenues and tourist receipts.
The problem with suggesting that Greece can leave the EMU is that this creates a new risk that only complicates effort to address the crisis. This the risk of redenomination. Moreover, it is not limited to Greece. Several observers argue that Spain, arguably more so than Greece, would benefit from leaving the eurozone. Others argue that as soon as one member leaves, it increases the likelihood of a more generalized disintegration of the monetary union.
The redenomination risk is that a country drops out and by the force of law converts the euros in savings and local contracts to a newly introduced currency that will most likely devalue and potentially sharply at that.
How then can there be meaningful EU wide deposit insurance? Can Greek or Spanish saving deposits really be guaranteed in terms of euros? If Greece or Spain were to drop out and reintroduce a new currency and domestic savings would be immediately converted to the new and weaker currency, who would absorb the loss? If the guarantee is only operative if a country remains a member of the EMU, it would seem to lose some of its effectiveness to stem the bleeding of deposits.
In addition, the size of the contingency risk is bigger than one might imagine. Consider that in the U.S. savings deposits are around two-thirds of GDP. In Europe, deposits are somewhat larger than the euro area GDP.
Some observers in the U.S. talk about financial repression being negative real interest rates. That is nothing compared to what sovereigns can do. Redenomination of savings, now that is financial repression. Or as some countries have done in the past, confiscate a percentage of deposits to fund the government's coffers, that is financial repression. A rally in bond prices that force yields below the rate of inflation can hardly be thought of as in the same category.
Perhaps the redenomination risk in the eurozone has always existed. However, until European officials played it up by talking about a country exiting, investors did not have to take it too seriously. Now that it is the subject of board room discussions and cocktail chats, officials appear to have needlessly complicated the necessary policy response to the crisis.
Yesterday's ECB money supply data showed that in April bank deposits were largely stable except in Spain and Portugal, but with the Greek election and the Bankia mess, May looks likely to be worse. Depositors need not only be worried about weak banks and weak sovereigns, but now redenomination risk as well. Cold hard cash may be the practical alternative for many savers and avoiding Europe for institutional investors.
Disclosure: No positions.