Light at the End of a Tunnel or a Coming Train

If you saw a potential train crash coming, would you stand on the tracks in the hopes that the train might stop in time, or get out of the way?  Many Europeans from Greece, Portugal, Spain, and Italy are choosing to get out of the way.  The potential train wreck they foresee is either their country abandoning the euro or a possible break-up of the euro-region.

Regardless, this leads to the possibility of returning to the drachma, escudo, peseta, and lira for these countries.  A return to any or all of these currencies would very likely lead to a large currency devaluation - meaning a $5 bottle of wine could very well cost $10.

Thus these Europeans are protecting their wealth by moving it to other countries they assume will keep a strong currency. By moving their wealth, these Europeans hope to retain its value by retrieving it after the devaluation occurs. From Der Spiegel: Southern European Money Migrating North to Safety

Nowhere, though, has capital flight reached the dimensions that it has in Greece. According to data released on Monday by the European Central Bank, deposits in Greek banks plunged by 17 percent last year. Other countries in crisis have also seen declines, but they have been much smaller. In Ireland, deposits fell by 6 percent, in Spain it was almost 3 percent, and in Italy it was just under 2 percent. By comparison, deposits in Germany in the same time period climbed by 3 percent and, in France, the increase was fully 10 percent.

Yet as deposits leave these countries, the situation leaves their banks with a shortfall in funding.  The graph above illustrates the relative amounts borrowed by European banks from the European Central Bank (ECB).  In July 2010, Portuguese banks required over 25% of Portugal's monthly economic output in loans to continue operating.  And from ~June 2011, the trend for Greece, Spain, and Italian banks has been to borrow more money.

This graph also illustrates why European banks need the ECB's Long Term Refinance Operation (LTRO).  These banks desperately need capital in order function.  Without the ECB loans, everyone would see that these banks are insolvent because they would need to shut down.  Take a look at the growth of loans leading up to the LTRO spike in December 2011 in the graph below.

The growth starts around June 2011 and then spikes in December with the LTRO.  As noted in To the Moon and Back:

What about the Long Term Refinancing Operation (LTRO) by the ECB - didn't it loan out nearly €500 billion in December? As revealed by Hussman Funds in Five Global Risks to Monitor in 2012, the €500 billion is more like €191 billion. (emphasis mine) 

While there was much fanfare last month after the ECB loaned 523 banks 489 billion euros, the actual amount of new funds was a more modest number. This is because two earlier loan programs expired on the same day as the three-year LTRO was held, and banks probably rolled these funds into the three-year operation. The earlier operations included a 3-month loan of 141 billion euros offered in September, and a net 112 billion euros of overnight loans. The ECB also allowed banks to shift 45 billion euros from an October operation into the 3-year LTRO. Of the 489 billion Euros operation, that left about 191 billion euros of fresh loans.

That spike looks about right for that amount.

Yesterday the ECB loaned more than €500 billion to 800 banks in the second installment of the LTRO - meaning Europeans continue to protect their wealth by moving it to safer destinations.  I agree as they would be insane to trust good intentions.  Why risk the light being a train?

The ECB is buying more time for leaders to try and find a solution.  The game of extend and pretend goes on.


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