Eurozone: Greece’s capital flight crisis

17th May 2012

Simon Ward, chief economist at Henderson Global Investors, has suggested that the quickening of capital flight may push Greece out of the Euro ahead of next month's elections, rendering current political manoeuvring irrelevant.

His reasoning is that Greek banks could lose access to additional ELA (Emergency Liquidity Assistance), "either because they run out of lower-quality collateral or because the Bundesbank and other "core" central banks place a cap on their Target2 exposure – why, after all, should German tax-payers underwrite high-risk lending serving the function of allowing austerity-resistant Greeks to transform deposits in bust domestic banks into Bunds and other "safe" assets?" 

Target 2 is at its heart, simply a mechanism for making cross-border payments within the Eurozone

A more accessible explanation can be found here: "When money moves from an Italian bank to a German bank, for example, the account of that Italian bank at the Bank of Italy (the Italian central bank) registers a debit and the account of the German bank at the Bundesbank (the German central bank) registers a credit.

However, as Robert Peston points out, recently there has been a striking increase in credits at the Bundesbank and other strong central banks, while corresponding negative balances have appeared in the central banks of weaker economies. What does this mean? Effectively, it means that the weaker Eurozone countries owe huge amounts to the German central bank. Estimates are wide, but the figure may run into hundreds of billions. There is a question over how much of this money would be returned in the event of Greece's exit.

The threat that this poses to the Greek banks is a theme picked up by the Telegraph: "The crisis is replicating the pattern of fixed-exchange ruptures through history. Britain was forced off the Gold Standard in 1931 after pay-cut protests in the navy triggered capital flight. Greek banks have lost 30pc of their deposits since late 2009. The total fell to €171bn in March."

In many ways, this is a rational response by Greek investors, whose deposits will suddenly be worth considerably less on a global scale if they are denominated in drachmas. The most recent comparison is with Argentina . Its currency dropped as much as 70% when it abandoned its peg to the dollar. Although some have argued that the Argentina example suggests Greece would be better off going it alone, the process was undoubtedly painful.

E. Scrooge on the FT site sums up the situation for the Greeks: "It sounds as though there is real fear of a euro exit, and people are withdrawing and hording euros so as not to get stuck with a new Drachma. (This is a ) bank run in the making, everyone trying to hold on to what wealth they have, before the introduction of a new weaker currency with less buying power. Also, a huge lack of confidence in the banks themselves, that euro assets left in Greek banks may end up with a forced Drachma conversion? Not a pretty scenario for citizens and banks in the near future."

Ann Robers dramatically concludes on the same site: "Get your money and assets out of Euro-denominated bonds and accounts. Move your money outside the EU and convert into Dollars (Australian/US/Canadian). Open one or more accounts in Canada, US, or British Virgin Islands in a bank which does not have headquarters in the EU." If ever this was the sentiment to prompt a bank run, this is it.


More on Mindful Money

Portugal should leave the euro

The case for a 'Grexit'

Mervyn King: Eurozone crisis a threat to UK recovery

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