Worrisome Signs

By Marc Chandler

Opinion polls and surveys are finding an increasing number of people expect one or more countries to leave the euro zone. Investors are anxious. What is to be done? What makes this so difficult is that there are so many moving parts and possibilities. The way the question is asked often conditions the answers.

The initial reaction to what happen in the euro zone breaks up is that the new German mark would appreciate. However, that assumes that capital will flow more or less freely, but this seems unlikely to be the case. A break up of the euro zone would likely be coupled with capital controls. Moreover, given the exposure of the BBK through euro zone payment system, Germany would not necessarily be immune.

The dollar, sterling and the yen would seem to benefit from the havoc that is likely to follow a break up of the euro zone, even if capital controls are introduced as third parties would be drawn to these deep liquid markets.

There seems to be a stronger sense that a country, most likely Greece, exits monetary union before the end of next year. Some observers think that exodus of Greece would leave the EMU intact and healthier as the weakest link was removed.

However, the confidence in such a scenario cannot be high. Just as likely, if not more so, pressure would build on another country. Portugal, for example, seems like the second weakest link. Why should it be immune to the same logic and forces that presumably led to Greece’s exit?

One may reasonably worry about a repeat of Lehman. Recall that in the months after Bear Stearns demise, institutions and investors reducing credit lines and exposures, leading many to think that the failure of Lehman would not be the utter catastrophe which it was. In hindsight, this seems to be due to unappreciated and arguably even unfathomable linkages. These must be some risk that Greece is like Lehman and its exit would be more horrendous then appreciated by simply looking at size.

Thus contemplating the impact of a country leaving the euro zone or the end of monetary union itself may be imponderable. Yet there may be some indicators to monitor to see if such an event is more likely.

Appreciating that domestic investors often have an information set not available to foreign investors, we suggest their actions may be more revealing. If domestic investors were afraid of losing the euro and being stuck with a new national currency that would most likely devalue, we asked ourselves, what would they do? Protect their savings by taking it out of the banking system.

The problem is the data is difficult to access and is not particularly timely. Still, it is noteworthy that earlier today the Bank of Italy reported that in households and business pulled money out of Italian banks at the fastest pace in 5 months in October. This decline as 0.6% at an annualized pace. A mere trickle, but some banks, especially the two large ones saw much larger withdrawal of deposits.

Look at Greece for a comparison. Savings withdrawals are accelerating. 8.5 bln euros left in Oct after 5.4 bln euros were removed in Sept. Oct was the biggest monthly outflow since the crisis began in late 2009.Greek savers have taken 25% of their savings out of Greek banks since the end of 2009. This is roughly 60 bln euros, leaving savings accounts with 180 bln euros in total. Time deposits have also been removed and is not captured in these figures. In addition, anecdotal reports suggest the liquidation has continued.

That 180 billion euros may also be compared with Greek bank loans, which total about 250 bln euros. Some bank analysts warn that bad loans, given that next year is likely to be the fifth year of economic contraction and rising unemployment, could be as much as 50 bln euros. This can only intensify the pressure on Greek banks–falling deposits and rising bad loans.

Spain’s two biggest banks reportedly suffered more than a 10% drop in deposits by businesses and institutional investors in Q3 alone. France’s two largest banks have also reported a decline in deposits. The drop in deposits exacerbates the liquidity problems.

Of course, the drop in deposits might not be a sign that domestic investors are preparing for a break up or an exit from the euro zone. Economic hardship, such as rising unemployment, may compel households to draw down their savings.

Yet some reports suggest Swedish and Norwegian banks have been beneficiaries of some of the exodus of savings from the periphery in Europe. In particular, reports emphasize that pension funds and insurers have been particularly drawn to Scandinavian banks. Note too that some companies, such as some German car producers and Siemens, which have banking licenses, may also be depositing funds with the ECB.