Published on 29 Jan 2012

Euro collapse contingencies at Davos

The sense of frustration amongst the world economic elite at the Eurozone inertia is beginning to crack. International investors are, off the record, confirming to us the remarkable extent of their plans to cope and mitigate a Eurozone collapse.

This is deeply problematic for those running the Eurozone. The understandable experiment with putting the horse of reining in PIIG debts before the rescue cart is running out of time.

A leading European bank has begun to account for euros differentially, by nation state. That is to say, they are differentiating a risk to euros that originate in a potentially defaulting country from that of a euro-cert. They, in effect, have invented the concept of a German, Greek and Irish euro.

Now we accept that government debts from these nations are different. The idea that a bank treats cash differentially, is an incredible development. I understand that this would allow this bank to account for an “internal exchange rate”, within the euro, between a strong country and a weak one. And the bank in question suspects they are not the only one.

In theory each euro note is marked with a letter, showing its country of origin. Euro notes tend to migrate south from Germany Holland, to Spain and Italy (where they are spent). The ECB convincingly rubbishes stories that individuals were accepting or not accepting euros with different letter markings. My information about this bank is about electronic money. It would make sense, if you believed there was any material risk of a country leaving the euro. I believe this is just an accounting contingency so far. But if the banking system generally starts to make contingencies for the notions that not all euros are equal, then this could start to be rather self-fulfilling.

That is just the start. I spoke to the head of one of the most impressive institutional investors in the world. He told me with regret about the lengthening list of Eurozone banks that have been taken off their “approved counterparties list” for derivatives trading. This is the reality right or wrong of the lethargic response. The Eurozone financial system is being slowly cut off from the world, certainly from dollar funding. “No matter” you might say, as these banks have three years of practically free money from the ECB via the LTRO bazooka fired in December.

Let me be clear: this is not a prediction of imminent euro or banking collapse. Far from it. Regulators suggest that these are reasonable contingencies, or insurance against so-called “tail risks”. Another UK financial CEO told me that he had heard of this stuff, but that it wasn’t going to be needed. Saving the euro will cost a horrible €500bn, but not saving it will cost a calamitous €3tr. And they will save it, eventually.

The ECB’s half trillion euros is ample to keep its banks muddling along as the worlds biggest bridging loan. But where exactly is this bridge heading? Very important players in the global financial system are starting to make contingencies that should horrify Frankfurt and Berlin. My real fear is that Frankfurt and Berlin haven’t even had the conversations that I have just had here in Davos.

15 reader comments

  1. Philip Edwards says:

    Faisal,

    While all these weasel words are being turned out by the thousand, can you find time to explain to everybody why it is necessary to pay disabled and poorer citizens LESS to “encourage” them to work while paying bankers and those at Davos MORE to “incentivise” them to work?

    Bit of a dichotomy there, don’t you think?

  2. Saltaire Sam says:

    So when bnks get in trouble, governments rush to the rescue.

    When countries get into trouble, banks hasten to protect themselves.

    Must be good to be a banker. You can’t lose and get paid shedsful of money plus bonuses no matter whether you are succesful or not.

  3. John Dillinger says:

    If these euros are electronic, in what way are the banks “treating cash differently”?

    Essentially all they’re doing is ensuring they know the origin of the euros they hold, presumably as a way to judge how much risk there is that those euros will be withdrawn and so what their exposure to a national bank run would be.

    A saver in Greece might be more likely to demand access to their cash than a saver in Germany, and that’s true no matter if they paid in “Greece euros” or “Spanish euros” (there’s no requirement for them to get back the same “nationality” of euros that they paid in).

  4. LOT says:

    You say at the end of your story: “…Another UK financial CEO told me”. So that European bank you are talking about higher up is a UK bank. Hardly surprising they are making contingency plans and leaking that to journalists given the level of euroskepticism there, isn’t it?

  5. Kes says:

    The Germans understand your point. Merkel has just demanded that the Greeks give up domestic economic management to the EU (along German lines). Anschluss without blood?

    Don’t underestimate Berlin. They need to save the Euro and they will, with a lot of European taxpayers’ money. Also, Greece isn’t the end of it. Portugal is next etc etc.

    1. pierregonzalez says:

      Merkel is fulfilling a 2000 years old German dream: the domination of Europe . Before it has been through wars and occupations , now it is through the economy.
      Before they start taking control of Greece economy through Brussels , why don’t they start by paying the 15 Billions S$ they owe to Greece in concept or war damages . Germany , Italy and Bulgaria were condemned to pay for the destruction of the Greek economy during their occupation from 1940 until 1945 . Italy and Bulgaria did pay ; Germany didn’t .
      They are very used of doing that ; they paid only 17% of their war debts after First World War ( and the last payment was in 2010 ).
      Merkel should also take care because the French are voting soon and one candidate expected to get 25% of the votes is in favor of leaving the Euro and the favorite to win wants to renegotiate the last agreement claiming it is to favorable for the Germans.
      Nowadays in France anti Eurozone feelings are gaining momentum and remember they rejected the Maastrich treaty the first time.

    2. Caliban says:

      “in France anti Eurozone feelings are gaining momentum. . .”

      And much good it will do them against the EU juggernaut. The people of the UK have had anti EU feelings for decades, and they have been successfully ignored by politicians of all parties.

      And that is in the UK where the peoples’ opinion usually counts for something.

      In the EU, where a referendum that results in the “wrong” answer is simply held again, where a treaty rejected by voters is reworded and passed without the tedious business of a referendum, public opinion counts for less than nothing. It is actually regarded as a misguided nuisance to be brushed aside.

      So the French had better get used to their feelings being ignored, just like the rest of us.

  6. pierregonzalez says:

    To create a German , Irish and Greek Euro is music to the ears of Adolf Merkel .
    You are asking if Berlin is listening ? The answer is no !
    Adolf Merkel si in a situation of denial . She believes that if she changes policy it will cost her the next elections . Poor her ; she will lose the next elections and fortunately for the rest of the world all opposition parties including the Greens are in favor of the Eurobonds solution.

  7. Andrew Dundas says:

    From a (temporary) US perspective, there’s something eerily similar about Republican contender/frontrunner Mitt Romney and our David Cameron.
    Both proclaim to understand the troubles of ordinary folk. And to be just ordinary guys. Neither of them is. They are both extremely rich and were born rich. And went to the poshest schools in each country.
    Consequently neither Romney nor his soul-mate Cameron understands that the truly troubling issue currently at Davos is INEQUALITY. That the RICH getting RICHER – what both Romney & Cameron want – is now the BIG ECONOMIC PROBLEM!
    Mario Monte understands what Cameron-Romney can’t. That this forced austerity is deeply divisive and NOT sustainable. Moreover, it’s clear to Monti, and what’s not clear to either Brunhilde Merkel or her right-wing pals, that using the crisis to make a dramatic grab for more inequality just won’t work.
    Nor will that agenda for inequality work in the USA either.
    Expect Romney to lose. Expect Brunhilde to lose next year and for Cameron to be kicked out a year later.

    1. pierregonzalez says:

      Dear Andrew ,
      to add to your post we should remember that German prosperity is based on some kind of deflation fo German workers salary .
      The gap in between workers and directors has never been so big in Germany.
      This has 2 benefits :
      1) to help exports.
      2) to reduce imports
      Both because German products are more competitive.
      No wonder that the socialists and the Geen are leading in voting intentions.

    2. Caliban says:

      Andrew, although inequality is an issue, it is not a major one. The mega rich could be taxed out of existence the effect on the economy would be minuscule.
      The problem is how do you get out of a recession when the government cannot spend (or reduce taxes, which is much the same) to stimulate the economy.
      As Labour are quoting Keynes, he said spend during the bust to keep things going. What they don’t bother to mention was, he also said save during the boom to pay for it. Brown spent during the boom, with predictable outcomes in the bust.
      We can’t even export our way out because our major trading partners are also in the mire.
      My solution is to free up SMEs, you can see it in more detail on my blog – it’s called My Chat With Dave.

  8. pierregonzalez says:

    Hi Caliban
    There is a big difference nowadays ; the French elections. Sarkozy , in spite of the help of his American friends who removed from the race Strauss Khan , will lose ( in case he decides to be candidate ) and the 2 candidates in the best position to be elected are having a completely different approach of the problem , simply because they have to take into consideration what people want .
    The favorite to win will renegotiate the last agreement which has still not be past as a law , so can be withdrawn , because he considers it is a capitulation to favorable to Germany.
    Another who cold finish second and in that case run for the second round is in favor of living the Eurozone ; a very popular argument , simply because it is difficult to prove that France would lose anything by doing it.
    Three months to wait …..

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