People are more likely to change their spouses than change their banks. The Greek crisis has tested this adage to the limit. For five years now, Greek banks have endured a “bank jog” of deposits out of the domestic banking system and into mattresses, foreign accounts and even bitcoins. Amazingly, however, some EUR 130 bln in household and business deposits have stayed put. But when Greek banks reopen, who can doubt that the jog will turn into a run, or even a sprint?
If only a quarter of Greek depositors were to decide that keeping cash in institutions liable to be frozen for two weeks at a politician’s whim is not for them, that would mean EUR 32.5 bln heading for the door. Meanwhile, Greek banks have less than EUR 2 bln in cash at hand, according to one report, which raises the question: how can the Greek government conceivably re-open its banks?
There are two possible answers:
1) The Greek government cannot re-open its banks in any normal sense.
Instead, Greece will have to follow the trail blazed by Iceland and Cyprus of enforcing capital controls and limiting withdrawals. In both economies, such bank controls contributed to a subsequent decline in GDP of almost double digit magnitude. Stringent controls on the movement of capital would surely have similar consequences in Greece. Add extreme fiscal tightening—a massive increase in value-added tax, and deep cuts in pension benefits coupled with an increase in retirement age—to the mix, and it is hard to see how the combination of capital controls and tighter fiscal policy could do anything for Greek growth but trigger another collapse, rendering all forecasts for tax receipts and debt reduction invalid. This simple reality helps explain the reluctance of Europe’s policymakers (or at least the economically literate ones, which excludes Francois Hollande) to sign up to a plan that Greece would be utterly incapable of delivering.
2) European policymakers ask the European Central Bank to backstop Greece, providing Greek banks with unlimited funding.
In this scenario, it is likely that between EUR 25 bln and EUR 50 bln would flow straight from the ECB’s printing presses into Greek pockets via Greek bank tellers. Having taken advantage of ECB liquidity to monetise a sizable portion of Greece’s savings, the Greek government would then be free to leave the euro at a greatly reduced cost—hardly a palatable option for Europe’s politicians.
In terms of their career prospects, the first option—in essence “extend and pretend”—is the least risky for the EU’s Eurocrats. Yes, it would condemn Greece to many more years of economic stagnation, just as it would condemn the Eurocrats to more late night meetings in Brussels and Frankfurt over holiday weekends when everyone would rather be at the beach. But it would keep the show on the road for everyone else, and would not cause massive disruption (outside Greece). Conversely, the second option— throwing a lot of good money after bad—risks leaving policymakers with egg on their face should Greece then decide to quit the euro in three to six months time. If Greece were to leave, who would want to be the finance minister that signed off on the last line of credit worth tens of billions of euros?
All of which brings us to the title of this article: “Broken Trust”.
Today, not only is the trust of the Greek people in their domestic financial institutions completely broken—and without trust, it is hard for capitalism to function, because capital gets hoarded instead of being allocated. As we clearly saw over this weekend, the trust between European governments is also severely compromised. In turn, this raises the question: How long will foreign investors retain their trust in the euro as a stable store of value?
Optimists argue that an “extend and pretend” solution that allows the current show to remain on the road is the most likely scenario. Moreover, with few foreign investors overweight eurozone assets, while everyone is overweight the US dollar, such an outcome is likely to prove bullish for the euro in the near term. As a result, the contrarian trade would be to buy the euro and European risk assets on the premise that the Europeans will once again manage to “get it together”.
Against that, the sorry spectacle offered to foreign investors over the past couple of weeks and the continued breakdown in trust should, at the margin, put more pressure on the ECB as the one functioning European institution to get even more involved, and to print money ever more aggressively. All else being equal, over time this should lead the euro lower.
So, perhaps the single most important question for global investors becomes whether the euro’s March low of EUR 1.05 to the US dollar gets taken out. If it does, parity before the year’s end will become a realistic target, with resulting implications for US Federal Reserve policy tightening, the Nikkei’s outperformance, eurozone bond yields, etc.