Watch deposit flight, not the eurocrats
One way the current crisis could nix Greek euro membership is if the bailout fund - the EFSF - refuses to dole out the relevant billions on a date coinciding with the Greek state having to use said billions to repay its debts.
That is the "political trigger" to euro exit. But market participants are watching something else: the flight of deposits out of Greek banks and into other Euro currencies.
That is because the normal mechanism for making payments across Euro borders, called TARGET2, is seen as the economic trigger for a euro exit.
It works like this. Suppose a Greek wants to send a Spaniard 1,000 euros. Let's call them Louk and Gomez:
- Louk's account at Bank A is docked 1000 euros.
- Bank A signals to the Greek central bank, Bank of Greece, that the payment will go ahead using TARGET2.
- Bank A's reserves at the Bank of Greece are docked 1000 euros.
- Bank of Greece's liability to the Eurosystem of central banks rises 1000 euros.
- The Bank of Spain now has a claim of 1000 euros on the Eurosystem of central banks (as a whole, not merely its Greek counterpart).
- The Bank of Spain creates a reserve of 1000 euros for Gomez's bank, Bank B, in Spain
- Bank B creates 1000 euros in Gomez's bank account
The thing to note here is that both central banks are creating debits and credits with the entire system, not each other. They do not directly face each other. All that happens is that their accounts with the central system, TARGET2, are changed.
Now what if Bank A, in Athens, does not have enough reserves at the Bank of Greece? It borrows from the Bank of Greece, which is in turn borrowing from the ECB.
Now what if the Bank of Greece knows Bank A is in trouble because its deposits are being withdrawn? Still no problem: it can lend to Bank A, borrowing from the ECB, and take very poor collateral, by permission of the ECB, up to a certain limit.
But the sticking point comes on the issue of collateral. The Bank of Greece has permission from the ECB to lend against poor collateral up to a certain amount, set twice a week. If that amount is breached, the ECB must vote to raise it: that vote will be effectively a vote to allow massive capital flight. The moment the limit is not raised, Bank A goes bust, triggering massive capital flight if it has not already started. At that point, the Bank of Greece would have to impose capital controls, and everybody who has euros in a Greek bank account would have to keep them there and see them devalued on euro exit.
There are about 170bn euros of deposits in Greek banks. If these were then devalued by 50% after euro exit, it would probably not crash the euro system. On Greek sovereign debt, the default has already occurred. Until Monday, only 700m euros had fled Greece since the election. But on the first two days of this week, says the FT, outflow exceeded 1.2bn euros.
However, what the markets are looking at right now is contagion to Spain and Italy. Here you have 800bn euros of foreign-owned government bonds, 600bn euros of foreign-owned corporate bonds, and 300bn euros of foreign-owned listed equities (numbers from JP Morgan) - together with E3 trillion of deposits.
What policymakers and market players are worried about right now is if foreign investors see a Greek deposit crisis as a signal to rush for the exits in Italy and Spain.
One way of stopping that, says my market interlocutor, is if the Eurozone authorities would issue pan-European depositor insurance, effectively saying to everybody, everywhere in the zone, that the other members would make good bank deposits in the event of exit, or capital controls etc. It would be another way of imposing fiscal union and therefore a tough one to get through Germany/Holland etc.
The coming weeks, leading to the second Greek election, will see the interplay of opinion polls, depositor behaviour and the European Central Bank's bi-weekly decisions on the Bank of Greece's lending capacity.
The above is a technical explanation why the future of Greece in the euro may not lie in the hands of the electorate as voters: it lies in the hands of the electorate as bank customers.