Capital Controls Coming
Depositors have been emptying their Greek and Spanish bank accounts, and moving funds to safer places like Germany. This is a trend with a limited lifespan. Either capital starts flowing back into peripheral Eurozone countries, or the slow-motion bank run continues until the Greek and Spanish banks are empty, or the trickle becomes a torrent as everyone heads for the exits at once, thus crashing those countries’ banking systems.
In the second and third scenarios, the result will be capital controls ranging from bank closures, to expropriation of bank accounts, to restrictions on the movement of wealth across borders. Planning for such capital controls is under way; a recent Reuters article noted: “European finance officials have discussed limiting the size of withdrawals from ATM machines, imposing border checks and introducing euro zone capital controls as a worst-case scenario should Athens decide to leave the euro.”
Greece may be spared immediate capital controls as its new government tries to implement the existing austerity plan (it will fail). In the meantime, Spanish 10-year bond yields hover around 7%. Spain probably can’t become competitive through austerity alone, but unlike Greece it’s too big to bail out. So that’s where the next battle between reality and wishful thinking will be fought.
Meanwhile, talking about capital controls risks making them a self-fulfilling prophecy, since holders of Greek, Spanish and Italian bank accounts who read articles like Reuters’ will now have an even more compelling reason to empty those accounts.
It’s not a big leap from a temporary freeze on ATM access to a permanent daily limit on withdrawals. Or from Argentina converting dollar-based accounts into pesos to the US converting IRAs full of gold mining stocks into portfolios of treasury bonds. For investors, this means it is possible to make exactly the right asset allocation decisions and still lose because of government confiscation. This new layer of complexity makes geographic diversification even more crucial.
The Ignorance is Willful
Dr. Michael Burry, a hedge fund manager, made hundreds of millions of dollars betting on the collapse of the housing market, while everyone from the mainstream media to the Fed claimed nobody could have seen the 2008 financial collapse coming. The ignorance, says Dr. Burry, is willful.
The same can be said about the ongoing banking crisis. Moody’s has downgraded the long-term credit ratings of 15 of the biggest European and North American banks: JPMorgan, BNP Paribas, RBC, RBS and UBS. Previously, dozens of Italian and Spanish banks, along with Japan’s Numara and Australia’s Macquarie, were downgraded.
The media has largely ignored this enormously negative bank news, the same way it ignores the way banks value underwater assets. Instead of mark to market accounting, where assets are valued at what they will sell for today, we have ‘mark to fantasy’ accounting: assets are valued at what you hope to get for them in the future. This is an insolvency problem so big that the rules had to be changed to make people think some banks are still solvent.
The same accounting rule changes have taken place in Europe. It is not only the countries going broke, but the banks that hold sour debt that are insolvent. Things there are a bit more desperate; last week, Italy’s Prime Minister Mario Monti warned of the apocalyptic consequences of failure at the next summit of EU leaders, outlining a potential death spiral that could threaten the political and economic future of Europe. Monti’s main concern is the survival of key European banks and not the well being of the people. This is all about preserving the status quo and the power of the banks.
The global financial crisis is really a bank solvency crisis. Moody’s bank credit downgrades are another signpost on the road to perdition. Things are not improving, no matter how much the media underplays the crisis. The “nobody saw this coming” excuse will not work the next time, and there will be a next time.
Tinker Bell is Dead
“If you have seen the stage version of Peter Pan, you know the scene in which the audience is asked to clap if they want Tinker Bell to live. It's time.
Tinker Bell has terminal cancer. The audience can clap all it likes. The audience will find that, after the show is over, their banks have a stack of IOUs on their books that cannot be collected in stable euros.
This is reality. This is not the fantasy of the bailouts.
It is the underlying reality of every Western nation. They have all written IOUs that cannot be repaid. The Eurozone’s politicians found out sooner because there are 18 nations that have made impossible promises, and idiot bankers who made loans to these politicians. They all expect the Germans to bail them out.
Think of Tinker Bell as Angela Merkel with wings. Not too appealing, is it? Not too believable, either.”
North discusses: Voters want a ‘Tinker Bell’ economy (no major cutbacks in government welfare spending, on pain of being voted out); bank runs (if Greece pulls out of the Eurozone and returns to the drachma, Greeks and/or other investors holding drachmas rather than euros will suffer substantial losses) and Germany (if Greece leaves the Eurozone, it will still not repay interest on its debt in euros. It will pay, if at all, in depreciated drachmas, causing the ECB to suffer a loss, and the German central bank’s share of this is 27%).