Sunday, 17 June 2012

In Greece, cash is king

With the Greek elections between the pro-EU New Democracy party and the anti-bailout party Syriza under way, one can`t stop and think about the critical importance of today`s events. The future of the European Union may well rest on the ballets in this small Mediterranean country that accounts for only 2% of the EU combined GDP. No matter the outcome, Greek households and corporations have switched to cash, stuffing the mattresses with euro bills, just in case the economy reverts to the drachma. Greece has become in the last months a cash economy.

Greek bank run
The Greek people will have to choose today between the pro-EU New Democracy Party lead by Antonis Samaras and the anti-bailout radical left Syriza party in what is in effect a referendum on Greece`s appartenance to the European Union. Alexis Tsipras, the 37 year old leader of Syriza has promised Greek voters that he would walk away from the austerity measures and fiscal tightening terms negotiated during the second Greek bailout. Germany, as a creditor nation, views the bailout terms as non-negotiable. The clash between a possible Alexis Tsipras Greek leader and Germany`s Angela Merkel may well translate into a quick Greek exit through the back doors and a reversion to the pre-Euro currency. In this case, Bank of America, an investment bank sees a 50% immediate devaluation of the new currency, capital controls that would restrict the exit of Greek euros, withdrawal restrictions at ATM and an imposed redenomination of all euro assets into drachmas. Put simply, the value of assets denominated in Euro might be halved.
This is why Greek people have started to withdraw their money and savings from banks and park them either in Euro-denominated bonds in offshore accounts or store them in safety boxes or deposit boxes. In effect, Greek households and corporate bank deposits have been shrinking at an alarming rate, in what is a country level bank run. From January 2010 the deposit pool has shrunk from approximately €235 billion to €165 billion, putting additional pressure on a weakened banking sector and drying up one of their traditional sources of bank funding. The deposit base has now reached pre-crisis levels:

 The total deposit stock which includes the government and other euro area deposits has also seen the same sharp fall. Given that deposits are shrinking and that bank capital is getting thinner and thinner, what hope could banks have to provision for their losses in Greek sovereign bonds?

Another source of funding, the inter-bank market has also withered down, because banks have less trust in other banks. Therefore troubled banks have to count on life support credit lines from the European Central Bank and wait to be recapitalised using the latest IMF loan. Until then, Greece is a financial black hole.  

There is no exit
A Greek exit fuelled by the Syriza party would also mean additional pressure on other troubled countries like Spain, Italy, Cyprus and France. Spanish yields are already at the 7% "point-of-no-return" levels at which servicing a close to 100% of GDP public debt becomes burdensome. The €100 billion bank bailout promise provided by the EFSF has yet to be deployed and there are no details regarding the distribution of funds. Italy, which could be next in line has a gargantuan public debt of more than €2 trillion. At this level, not even the EFSF or the ESM are in position to cool off markets in case of a bond run. The debt crisis has tought lavish leaders that the supply of credit is not infinite. Not even when central banks increase the supply of credit using freshly printed money.
But the chances that the EU will willingly accept a Greek exit are slim. Faced with a winning Syriza, unwilling to negotiate any further bailout, the Germany will most probably have to ease out on its demands. The alternative is a rupture within the EU, with indebted countries leaving the Eurozone, reverting to their former currency, subsequently devaluing them and possibly imposing capital restrictions. One thing is certain: both Greece and the Germany have clashed in a policy of brinkmanship which only worked until the situation got serious. Now its time to accept the fact that Greece needs to transfer more political power to the European Union and that Germany needs to be more flashy with its credit card.

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