Thursday, April 19, 2012
Get a Prenup
By Adam O’Dell, Editor, Survive & Prosper
Get a prenup!
That’s the advice we suspect George Soros would have given the European Monetary Union, based on his recent remarks at the Institute for New Economic Thinking in Berlin.
Reading through Soros’ critique of the Maastricht Treaty, I just can’t help but compare the European Monetary Union (EMU) to marriage.
Think about it. Do marriage counselors challenge their clients to prepare for the good times or bad times? The bad times, of course. The good times are easy.
Deciding to share a bank account (for married couples) or a currency (for EMU members) is the first (and easiest) step. But they must also prepare in advance for when things go wrong. After all, you don’t want to wait for crap to hit the fan. You want to have the bucket and mop ready for when it does.
And things always go wrong.
Yet, as Soros points out, the EMU made none of the advance preparations it should have. In fact, he highlighted three main shortfalls of the Maastricht Treaty…
First, it failed to establish a political union. This is akin to a couple sharing a bank account, but having no unified system for decision-making. “I’ll do what I want and you do what you want” just doesn’t work if you’re sharing a bank account or a currency.
Second, the EMU doesn’t provide a mechanism for enforcement. So euro members agreed to keep deficits under 3% of GDP, but there were no consequences when they didn’t. There’s nothing that breeds resentment better than one partner following the rules while the other partner breaks them.
Finally, the Maastricht Treaty provides no way out for any member that wants or needs to exit the union.
Basically, they don’t have a prenup.
Just like countless couples who enter marriage with no contingency plan, the EMU must have assumed their “love” and “devotion” for a common currency would always be enough to sustain them.
When the Shine Wears Off…
The EMU’s lack of proactive planning suggests it thought the relationship would always be hunky dory. But this arrangement was always far from ideal. And now European bank customers are acting just like disillusioned married couples, with those on the periphery squirreling away money for life after the euro.
If Greece – or Ireland, Italy, Portugal or Spain – left the euro, they’d revert to a currency worth much less. So anyone holding a bank account in Greece would go to bed with, say, the equivalent of $100,000 in euros and wake up the next day with the equivalent of $70,000 in Greek drachmas.
However, this is a loss they can avoid. All depositors have to do is move their money out of Greek banks and into German banks. That way, if Greece did decide to leave the euro, the depositors’ money is still in euros. And that’s exactly what people in these embattled countries are doing. The magnitude of this money flow is growing every month.
In February 2010, fewer than €50 million crossed borders in the euro zone. By February 2012, that amount ballooned 10-fold to €500 million. Spain and Italy are leading the recent surge in deposit withdraws that started in mid-2011.
There’s a long line of people waiting outside the banks every day just to withdraw money. This smacks of the bank runs from the 1930s when, guess what, people didn’t trust their banks and were eager to get away.
This mass exodus of customer deposits is coming at the worst time for struggling banks. Look at how many bad loans are on the books of Spanish banks…
Spanish banks must back these loans with collateral. As they accumulate more and more bad loans, they should be setting aside more and more collateral. Except, they can’t. They’re bleeding bank deposits. Said collateral is fleeing to safer shores.
And while sovereign bonds are currently allowed as collateral, bond investors are questioning this rationale. After all, everyone now knows that sovereign bonds are anything but “risk free” capital.
We’ll steer clear of the euro for now as the common currency’s union is tenuous (at best)… deteriorating (at worst). As political risk grows in Europe, we’ll keep looking to the dollar as a safe haven currency.
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