Saturday, August 6, 2011

Greek Bank Run and a Debt Downgrade

Wise Greeks have begun withdrawing their savings and holding them as cash --
In one of the biggest banks in the centre of Athens a clerk is explaining how his savers have been thronging to pull out their cash.

Wary of giving his name, he glances around the marble-floored, wood-panelled foyer before pulling out a slim A4-sized folder. It is about the size of a small safety-deposit box – and those, ever since the financial crisis hit Greece 18 months ago, have become the most sought-after financial products in the country. Worried about whether the banks will stay in business, Greeks have been taking their life savings out of accounts and sticking them in metal slits in basement vaults.

The boxes are so popular that the bank has doubled the rent on them in the past year – and still every day between five and 10 customers request one. This bank ran out of spares months ago. The clerk leans over: "I've been working in a bank for 31 years, and I've never seen a panic like this."
This is the modern version of a bank run.  Greeks are apparently increasingly coming to terms with exactly what the consequences will be of the situation they are facing.  Ultimately, deposit insurance that would repay them in the event of bank failure is funded by the government treasury.  If the government fails AND their bank fails, their deposits will be lost.

Paper money, however, is part of the monetary base -- under a fiat regime, anyway.  Under a gold standard, it is not. As such, its supply cannot be contracted or destroyed by bank failures, while mere bank deposits can.  By holding 'cash,' -- not bank deposits --wise Greeks are are protecting themselves.  Their government has no way to nationalize the ECB or to force it to inflate or to save the financial system, though obviously in its own self interest the remainder of Europe's banks would prefer the Greek system not to fail.  This is a fairly unique juncture.

Our own threatened 'default' of the past few weeks is not analogous, as evidenced by low Treasury interest rates here vs. Greek rates.  Greece is at the end of its rope, while we still have a few more feet to fall.  There is no such threat here and now, but that does not mean there will never be.

S&P has downgraded Treasury debt -- notably on a Friday evening after markets had closed, so that nobody could do anything about it. That was very considerate of them. Whether that will actually raise interest rates remains to be seen. Theoretically, it should, but theoretically, where is an investor to put his money these days?

Whatever happens over the next few days, at some point America's lenders will balk at further funding -- even including the FED.  There will be a choice to make -- nationalization of the FED, or default.  When that day comes, remember this day in Greece.

Forewarned is forearmed.

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