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A World of Trouble if the Spanish Banking Crisis Spreads

Until flaws in the euro are addressed, the crisis is likely to simmer on.

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The heart of the real crisis in the Eurozone is the euro itself. Until the deep flaws in the design of the European Monetary Union (EMU) are addressed, the crisis will simmer on. The EU leadership can do one of two things: either establish a credible and functional federal fiscal authority and allow it to run deficits that are commensurate with the gaps in private sector spending now existing in the zone -- or abandon the currency union altogether.

Right now, the first option would require such an authority to run deficits continuously for many years into the future, which were well in excess of the rules of the Stability and Growth Pact ( an agreement among the 27 member states of the European Union developed in the '90s) . Those harmful rules should be abandoned and a growth strategy with direct job creation programs (especially for youth) prioritized.

Unfortunately, the EU elites are pushing through a new fiscal compact which is an even harsher version of the Pact. Which means that they are not even close to understanding the reality and what is required.

In last Saturday's Financial Times, authors Niall Ferguson and Nouriel Roubini published an  article titled “Is it one minute to midnight in Europe?” They discussed the bank run that has been happening as depositors take their money out of troubled European banks:

On a recent visit to Barcelona, one of us was repeatedly asked if it was safe to leave money in a Spanish bank. This kind of process is potentially explosive. What today is a leisurely 'bank jog' could easily become a sprint for the exits. In the event of a Greek exit, rational people would ask: who is next?

So what is “one minute to midnight” in Europe? A leisurely “bank jog." What is “midnight” in Europe? When the bank jog becomes “a sprint for the exits”?

Ferguson and Roubini report that Greeks have withdrawn more than 700 million euro from their banks in the past month. That's what we might call a "jog." Charles Dallara, managing director of the Institute for International Finance, tells us there was more than 170 billion of euro lender of last resort financing of the Greek banks by the European Central Bank (ECB) through the end of April. Given the fact that Greece’s money supply has contracted by perhaps 50 billion euros, the implied total deposit run might be well in excess of 200 billion euros. In plain English, that sounds more like a sprint toward the exits.

Amazingly, Ferguson and Roubini are being fooled about the extent of the Greek deposit run because they are looking at the money supply data, which actually tells you nothing about the extent of the bank run. Why is that? Because when a Spanish depositor takes his or her money out of a local bank in, say, Barcelona, and re-deposits it down the street with a local German banking subsidiary, it doesn't change the money supply data. Therefore it masks the amount of deposits fleeing the Spanish banking system. The true magnitude of the run can only been understood by closely examining the ECB's so-called "Target 2" payments system (through which the national central banks of member states provide payment and settlement services for intra/euro area transactions) and the ECB's so-called "Emergency Liquidity Assistance" (ELA). Both of these have been growing exponentially.

Just this past week alone, there is Target 2 data reporting a 68.4 billion euro ECB injection of funds into Spain. That is more than half of the now-much discussed 100 billion euro Spain bank bailout. That also sounds like a sprint for the exits.

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