The euro exodus from Greece and Spain

Wary depositors have been hauling billions of Euros out of Greek and Spanish banks over the past few weeks.  Since 2009, Greek depositors have withdrawn $4 million a month from that nation’s banks, while Spanish bank customers pulled 31 billion euros from Spanish banks in April alone.

More than any election result, bank runs reflect the mood of the people.  After all, depositors consider bank deposits their property.  The bank is just holding the money for them.  Any bit of nervousness, and it’s run first and ask questions later.  There is no upside to trusting the bank.  If it goes broke, the depositor’s property is gone.  At best, the bank doesn’t fail and the property remains.  There is no compensation for the sleepless nights.

Murray Rothbard explained in Making Economic Sense,

But in what sense is a bank “sound” when one whisper of doom, one faltering of public confidence, should quickly bring the bank down? In what other industry does a mere rumor or hint of doubt swiftly bring down a mighty and seemingly solid firm? What is there about banking that public confidence should play such a decisive and overwhelmingly important role?

Deposit insurance and the Federal Reserve have made banks runs in America a historical relic of the Great Depression.  The result is that bankers can lend increasingly high percentages of deposits with little fear that lines of anxious depositors form at the front door, not matter what the economic environment.   There’s no competitive advantage for a bank to maintain high reserves in the era of deposit insurance.

Systemically important banks are bailed out if their loans don’t work out, while small banks that topple over are seized on Friday evenings, with the deposit liabilities most likely assumed by another bank.  A new sign is put on bank over the weekend and many deposits don’t notice the difference.

Deposit insurance is only as good as the private entity or government that stands behind it.  As Rothbard points out, private and state deposit insurance schemes have not worked because all banks with fractionalized reserves are unsound and susceptible to bank runs, no matter how profitable they may be.  No private system has the monopoly of force required to cover all deposits.

If Greece announced a return to a drachma backed by gold or silver and 100% reserve banking, deposits would come flooding into Greek banks.

Instead, what the bank runs in Europe expose are the unsound nature of those banking systems, the fragility of the euro, and the uncertain viability of the individual fiat currencies that may be forced upon the public.  All of which is a good thing.  These runs provide a natural check on the banks’ ability to inflate.

On the bank run, Rothbard writes,

It is a marvelously effective weapon because (a) it is irresistible, since once it gets going it cannot be stopped, and (b) it serves as a dramatic device for calling everyone’s attention to the inherent unsoundness and insolvency of fractional reserve banking.

According to Wikipedia, deposits are insured in Greece and Spain, but there must be some doubt about the viability of those deposits, the currency, the deposit insurer, and the government itself.

Not wanting to let a good crisis go to waste, European Central Bank President Mario Draghi is urging European leaders to form a “banking union” that would include deposit insurance for depositors and “prevent failed banks from threatening the financial system,” the WSJ reports.  This is code for having the EU bail out systemically important banks,  because individual country finances are not capable of funding these bailouts.

Olli Rehn, the economics head of the European Commission, claims,

We need both a genuine stability culture in the euro zone and its member states, and a much upgraded capacity to contain contagion and reduce borrowing costs for its members. This is the case if we want to avoid a disintegration of the euro zone and instead make the euro survive and succeed.

The money Draghi would like to get his hands on is the European Stability Mechanism, the euro-zone’s permanent rescue funds. Right now these funds can only be used to lend to government, the ECB President would like to use the funds to re-capitalize banks.   In addition to providing euro zone-level deposit insurance, Draghi would also like to centralize banking supervision and regulation.

“The latest EU funding program does not solve the longer term problems of the solvency or funding of the banks, which now remain heavily dependent on the largesse of the central banks. One European economist calls  “a government-sponsored Ponzi scheme where weak banks are supporting weak sovereigns, who in turn are standing behind the banks — a process which can be described as two drowning people clinging to each other for mutual support.”

Bank customers who have decided to take their money and run, are looking out for themselves while leaving the bankers and the bureaucrats to drown.

The euro is a political construct that has the full backing of Europe’s political elite.  If the market was allowed to prevail, the euro and all of Europe’s banks would be history.  Even London bookmaker Ladbrokes has the odds at less than even-money the euro will be gone by the end of 2015.

Allowing the bank runs to continue would bring about a collapse of the banking system throughout Europe, paving the way for sound money. But don’t underestimate government force.  Draghi’s bank union plan can take the fate of euro, temporarily, out of the public’s hands, allowing the inflating to resume and the charade of a united Europe to continue.