European policymakers are still enjoying their famously long, languorous summer holiday. The vacations will end in the coming days, with Germany’s Chancellor Angela Merkel scheduled for a series of meetings with leaders from France, Greece and Italy this month. Meanwhile, at a more rapid pace, Europe is in the midst of a massive run on bank deposits in Greece, Portugal, Spain, Italy and Ireland. While the last out-of-office auto-responses zip across the continent in multiple languages, the bank runs continue to accelerate.
How did we get here? What can we expect next? And, most important, what is the way out?
Europe’s trip down the highway to hell began with an original sin. At the birth of the euro, nations that adopted it and formed the European Monetary Union (EMU) gave up their national currencies. They could no longer “print” money to pay for expenses (despite the longtime use of keystrokes for this purpose, the image of stacked, crisp bills somehow hangs on). The European Central Bank, comparable to the US Federal Reserve, could increase the supply of euros, but individual nations could not.
Like each of the US states, each nation in the EMU became a user, rather than an issuer, of money. But each country kept control of taxing and spending through its own treasury. The design flaw—think major miscalculation here—was the absence of a unifying body that could move resources from country to country in the event of local trouble, as the US government does between states.
The single currency was intended to insure that capital could flow easily across borders. For banks, this meant the ability to buy assets and make loans wherever the euro was used. And did they ever. The Basel Accords, initially set up in 1988 to establish international standards of capital adequacy, ended up allowing banks to self-determine the weight of risky assets on their balance sheets, leaving them without any supervision or regulation in their calculation and pricing. This added more opportunities to take on Wall Street–like risks.
Yet individual nations remained responsible for their own banks. Private “banks without borders” could, and did, run up fabulous debts that were easily several orders of magnitude greater than their host country’s total government spending or taxing. When the winning streak ended, the public had to pick up the tab. To visualize this debacle, picture a US state, any state, having to find the funds to settle a run on Bank of America because it happened to be headquartered there.
Covering the bank losses ballooned national deficits and debt to previously unheard of levels. This is what happened in Ireland, for example, and it is emerging now in Spain, where during the first five months of this year about 163 billion euros left the Spanish banks.
Finally, and key to the current cash exodus, depositors could shift their euros without cost from one bank to another throughout Euroland. Anyone with euros in, for example, a Spanish bank, can simply transfer them to a German bank.