Thursday, May 17, 2012

The Problem with the Eurozone’s Throw-Greece-from-the-Train Plan Is that its Timing Can’t Be Controlled

There is no democratic deficit in Greece: its people have clearly indicated they want to do two things, clean the slate by defaulting on their debts and staying within the Eurozone.  This is seen as unacceptable in Brussels and Frankfurt, and Greeks are supposed to understand that if they choose the first they will lose the second.

Alas, there is no legal procedure by which Greece can be expelled from the EZ; therefore the strategy has to be one of making retention of the euro so ruinous for Greeks that they will exit on their own volition.  The mechanism is the Target system through which euros are transferred from one national central bank to another.

The idea is this: when funding from the troika is cut off after a default, the Greek government will lack the resources to backstop its banking system.  Moreover, euro transfers via Target will be cut off.  Greek depositors who try to withdraw their funds will be told, sorry, but the cupboard is quite bare.  This will ignite a banking meltdown, and the only way out for Athens will be to redenominate financial liabilities in a new currency they can supply.  Whether they call it a drachma is up to them.

Clever, huh?  The only hitch is that, now that the game plan is becoming clear, rational Greeks are not choosing to wait for an EZ attack before withdrawing their funds from Greek banks and transferring them somewhere, anywhere, else.  There is a gradually accelerating bank run taking place which is likely to reach criticality before a Greek-EZ policy showdown can take place.

There is a broader lesson here.  By threatening to choke the Greek banking system, the EZ implicitly threatens to do the same for Spain or even Italy.  They can say otherwise, but why should depositors in shaky peripheral banks believe them?  Withholding euros from peripheral banking systems is a gun that goes off before it is fired.  Simply brandishing this weapon is causing havoc and speeding the demise of the entire zone.

Better to put the gun away and do what should have been done all along: have the ECB assume the lender of last resort function for all EZ banks, with centralized financing of deposit insurance in particular.  Don’t use the threat of a financial panic as a policy tool.


Garrick Hileman said...

The Greek central bank can physically print its own euros. This would seem to nullify any ECB threat to choke off the Greek banking system:

Shag from Brookline said...

How many Greeks have as a ring-tone "EZ Does It"?

Unknown said...

Great post. This is potentially a big misstep by the Trioka.

Just this morning Zero Hedge reports that a Nationalized Spanish Bank Plummets On News Of Bank Run:
From FT:
Shares in Bankia, the Spanish bank which was part-nationalised last week, plunged by over a quarter on Thursday morning, after a report that customers had withdrawn €1bn from the bank over the past week.
The ECB/EU/IMF have been fairly successful, to date, at kicking the can down the road. Sadly this extra time has not been used to enact effective measures for resolving the underlying problems. Further attempts to buy time should be expected, but as these bank runs accelerate it will become increasingly difficult to stem the tide. Nearly 3 years after the first Greek bailout the Eurozone crisis may finally be approaching the endgame. Despite the enormous costs to a disorderly dissolution, I remain unconvinced that politicians will overcome their differences in some type of “grand bargain.”

Myrtle Blackwood said...

Good post, Peter. Thankyou.

".. have the ECB assume the lender of last resort function for all EZ banks, with centralized financing of deposit insurance in particular. Don’t use the threat of a financial panic as a policy tool."

It is ironic and notable that large global corporations can access an easy bailout but not sovereign nations. How extraordinary!

Unknown said...

And when will that last resort lending ever stops?

I mean, at the end of the day, for the rest of the EZ, there needs to be a game plan by which Greece can stand on its own two feet, trade with others etc without being forever propped.

Any idea on how to bring this about in your ECB-backstops-everything plan?

run75441 said...


Part of the problem for Germany is it needs Greece, Spain, Ireland, Iceland, Portugal on the Euro as it gives the Germans a place to sell their product. Kill the LCC countries and that market begins to shrink

Myrtle Blackwood said...

Frederick Mari: "And when will that last resort lending ever stop?"

It's clear that some big corporate and CEO dominoes need to fall and fail. Debt needs to be forgiven on a large scale. Inducements need to be created for ordinary people, again, to engage in productive forms of lifestyle. (I am not referring to jobs per se but rather to 'productive' employment and productive engagement. Many jobs are simply unproductive).

The 'overproduction' crisis of manufacturing is another issue.