2012.04.13 - Europe’s Capital Flight Betrays Currency’s Fragility - Bloomberg
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2012.04.13 - Europe’s Capital Flight Betrays Currency’s Fragility - Bloomberg

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13/04/12 15:35Europe’s Capital Flight Betrays Currency’s Fragility - Bloomberg

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Capital flight in the euro zone (selected
countries, cumulative since Feb. 2010)
Source: National central banks. Data for
Italy include balances related to the
issuance of euro banknotes.

Europe’s Capital Flight Betrays Currency’s

Illustration by Bloomberg View

By the Editors Apr 12, 2012 8:00 PM GMT-0300

The euro area’s financial troubles appear to be flaring up
again, as this week’s gyrations in the Spanish bond market
show. In reality, they never went away. And judging from the
flood of money moving across borders in the region,
Europeans are increasingly losing faith that the currency
union will hold together at all.

In recent months, even as markets seemed calm,
sophisticated investors and regular depositors alike have
been pulling euros out of struggling countries and depositing
them in the banks of countries deemed relatively safe. Such
moves indicate increasing concern that a financially strapped

country might dump the euro and leave depositors holding devalued drachma, lira or

The flows are tough to quantify, but they can be estimated by parsing the balance sheets of
euro-area central banks. When money moves from one country to another, the central bank
of the receiving sovereign must lend an offsetting amount to its counterpart in the source
country -- a mechanism that keeps the currency union’s accounts in balance. The Bank of
Spain, for example, ends up owing the Bundesbank when Spanish depositors move their
euros to German banks. By looking at the changes in such cross-border claims, we can

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figure out how much money is leaving which euro nation and where it’s going.

Capital Flight

This analysis suggests that capital flight is happening on a scale unprecedented in the euro
era -- mainly from Spain and Italy to Germany, the Netherlands and Luxembourg (see chart).
In March alone, about 65 billion euros left Spain for other euro- zone countries. In the seven
months through February, the relevant debts of the central banks of Spain and Italy
increased by 155 billion euros and 180 billion euros, respectively. Over the same period, the
central banks of Germany, the Netherlands and Luxembourg saw their corresponding credits
to other euro- area central banks grow by about 360 billion euros.

The seven-month increase is about double the previous 17- month rise, and brings the three
safe-haven countries’ combined loans to other central banks to 789 billion euros, their
highest point on record. In essence, the central banks of the three countries -- and, by proxy,
their taxpayers -- have agreed to make good on about 789 billion euros that were once the
responsibility of Italy, Spain, Greece and others.

The worries about Italy and Spain reflect the inadequacy of Europe’s efforts to stem what has
become a combined banking, sovereign debt and economic crisis. The European Central
Bank’s efforts to prop up bond markets with more than 1 trillion euros in emergency bank
loans have only encouraged Italian and Spanish banks to buy more of their governments’
bonds, tying their fates to those of the afflicted sovereigns. The harsh austerity measures
required by Europe’s new fiscal compact are making things worse by stunting the economic
growth needed to help the countries reduce their debt burdens. Should markets balk at
lending to Italy and Spain, Europe’s bailout fund -- with only about 600 billion euros in spare
capacity -- remains far too small to cover the two countries’ financing needs, which amount to
more than 1 trillion euros over the next five years.

If Europe’s leaders want to stop the rot, they’ll have to change their approach. The least bad
solution, as Bloomberg View has argued, is a combination of overwhelming force and deeper
integration. Together with the European Union and the International Monetary Fund, the ECB
would provide large enough guarantees -- more than 3 trillion euros, by our estimate -- to
erase any doubt that solvent governments such as Italy and Spain can cover their financing
needs and banks can raise capital. If the amount pledged were big enough to tame markets,
it wouldn’t have to be spent.

Fiscal Union

Aside from adopting tougher fiscal rules to get government debts under control, the euro area
should also forge a closer fiscal union to provide some support for struggling countries, much
as federal transfers in the U.S. cushion downturns in individual states. This could help
Greece, Portugal, Ireland, Spain and Italy extract themselves from the downward spiral of
budget cuts and weakening economies.

The idea that Europe’s current incremental approach has the advantage of saving money is
an illusion, and not just because the disintegration of the currency union could trigger a
global financial meltdown. As the capital flight figures demonstrate, the stricken nations of the
euro area are bleeding private money and becoming increasingly dependent on taxpayers. In
all, the debts of struggling banks and sovereigns to official creditors such as the EU, the ECB
and national central banks now exceed 2 trillion euros, much of which would be lost if the
debtor nations dropped out of the currency union.

Hopefully, Europe’s leaders will recognize that it would be a lot cheaper to put up the money

13/04/12 15:35Europe’s Capital Flight Betrays Currency’s Fragility - Bloomberg

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needed to restore confidence in the common currency. If they wait too long, the cost of the
crisis could prove to be more than their taxpayers can bear.

Read more opinion online from Bloomberg View.

Today’s highlights: The View editors on gender inequality at the Masters; Jonathan Alter on
why Paul Ryan’s budget proposal would irk the founders of the Republican Party; Jonathan
Weil on JPMorgan derivatives trader Bruno Iksil’s nicknames; Michael Kinsley on class
warfare and the presidential campaign; Stephen Carter on Mitt Romney and his father’s
portrayal on the program “Mad Men”; Gary Shilling on misplaced optimism in the stock
market; and Rohit Aggarwala on why user fees are preferable to an infrastructure bank.

To contact the Bloomberg View editorial board: view@bloomberg.net.

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