Tango Lesson

The Weekly Standard, December 12, 2011

Casa Rosada, Buenos Aires, August 2011 © Andrew Stuttaford

There are good days and bad days, but even on the good days the abyss is never too far away. The eurozone’s dangerously original mix of innovation, incoherence, and unaccountability makes it difficult to identify a single event that could finally push it over the edge. But, with confidence already shot, there is one obvious contender, a series of old-fashioned bank runs given a brutal new twist by the logic of currency union as cash pours out of the stricken banks and the country (or countries) that hosts them. Unless the European Central Bank could show that it has what it really takes, fear would feed on itself, credit markets would seize up, and that, quite possibly, would be that.

The extra liquidity offered by the Fed and other central banks on November 30 was a sensible precautionary move, but its extent and its timing were clear signs of anxiety that, while the eurozone’s leadership moves from grand plan to grand plan, the building blocks of disaster are falling into place. U.S. institutions are wary about extending short-term funding to many European banks. European banks are wary about lending to each other.

Of all the sickly banks surviving on the Rube Goldberg life support systems now being deployed in the eurozone’s grisly ER, Greece’s are probably (and the implications of that “probably” are appalling) the most vulnerable to the panic that could set everything off. Their country is the closest to default. If Greece goes under, its banks will, without fresh capital, go under too. So what are their depositors doing?

They are not yet running. But they are walking away at an ever quicker pace (deposits have fallen by over 20 percent since January 2010) that can only have accelerated since the moment in early November when Angela Merkel and Nicolas Sarkozy first conceded that a country’s eurozone membership might not be irrevocable after all.

To understand just how bad things could get, the best place to look is Argentina in early 2001. In 1991, just 10 years before, Latin America’s most gorgeously faded republic had decided to turn over its latest new leaf. It linked its peso to the dollar at a 1:1 exchange rate. This peg was backed by reserves held by a currency board. Despite its distinctly permissive, distinctly Argentine, characteristics, it was designed to use external market pressure to force the country into the tough financial discipline that it had found impossible to impose upon itself. Those Greeks who regarded the EU’s single currency as something more than a free lunch supported signing up for the euro for pretty much the same reason.

At first, the Argentine experiment worked well. The economy grew briskly, and foreign lenders were pleased to feed its growth in a manner well beyond the capability of Argentina’s relatively small banking sector. After all, they told themselves, the country had changed its ways, and, thanks to the peg, exchange risk had been hugely reduced. What could go wrong? If you think that sounds a lot like the talk that accompanied the prolonged surge in international lending to Hungary, Latvia, Greece, Ireland, and all the other future catastrophes crowded into the euro’s waiting room (and, subsequently in some cases, the eurozone itself) just a few years later, you’d be quite right.

What could go wrong, did: Deep-seated structural flaws within the local economy, a series of external shocks (starting with the Mexican crisis of 1994), weaker commodity prices, and stresses flowing from the fact that the dollar and the peso were an ill-matched pair all combined to push the country into difficulties made cataclysmic by ultimately unsustainable levels of foreign debt. Private lenders shied away. Private capital fled. Taxpayers hid. Ratings agencies screamed. The cost of borrowing soared. The resemblance to Greece in 2011 is unmistakable. Interestingly, the Argentine storm was gathering strength at the same time as Greece was being accepted, not without controversy, into the eurozone, raising the question what in Hades the EU’s leadership was playing at. The implicit warning for Greece contained in the Argentine disaster was as clear as Cassandra, and just as ignored.

In any event, as the 20th century lurched into the 21st, Buenos Aires previewed Athens. There were differences, of course, not least the fact that Argentina had hung on to its own national currency, but that meant less than it might have done. By the end of the 1990s, 90 percent of Argentina’s public debt was denominated in a foreign currency, marginally better than Greece’s 100 percent (for these purposes the euro is a “foreign” currency everywhere), but not by enough to give any comfort. And it wasn’t just the debt: Wide swaths of the economy had been dollarized.

And so had the banks: According to the IMF, close to 60 percent of the Argentine banking system’s assets and liabilities were denominated in dollars throughout the second half of the 1990s, leaving the banks horribly exposed in the event that the peg broke. Indeed, the potentially enormous cost of breaking the peg was a good part of why it was maintained, a logic similar to that now keeping the embattled PIIGS (Portugal, Italy, Ireland, Greece, and Spain) on the euro’s leash. This should come as no surprise: The stability that such mechanisms can bring largely rests on the absence of any obvious exits. Countries that sign up for them need to be sure that they have what it takes to stay the course. Slinking in on fudged numbers and, ludicrously, expected to maintain some sort of pace with Germany’s Porsche economy, the Greek jalopy stood even less of a chance than had far-better-intentioned Argentina.

Argentine headlines in 2000-01 must have read much like those in Greece today. The country accepted billions in international assistance (from the IMF) in exchange for the imposition of austerity measures that pummeled an already faltering economy. There was a voluntary debt swap (on terms as absurdly expensive as those proposed for Greece earlier this year) that bought time, but no confidence.

Massively widening spreads between peso and dollar debt signaled the market’s fear that the peg was doomed. But, to quote the IMF’s invaluable Lessons from the Crisis in Argentina (approved by one Timothy Geithner), it was “the resumption [in July 2001] of large scale withdrawals from Argentine banks [that was] perhaps the clearest sign of the system’s impending collapse.” Indeed it was.

The banks—and, of course, the country itself—were quite literally running out of the dollars that made up a monetary base already depleted by previous capital flight, and a growing current account deficit. The rules of a currency board (even in its looser Argentine variant) meant that it was not possible simply to print money to fill the gap. This is a problem familiar to those of today’s PIIGS who have to watch the money drain out of their economies, yet are blocked from direct access to the printing press by the European Central Bank. Argentina’s more sinuous treasuries (provincial and then national) tried to meet this challenge by issuing a series of evocatively named quasi-monies (IOUs, basically), but these patacones, porteños, quebrachos, and lecops were harbingers of doom, not a solution.

And when the dominoes of finance finally fall, they fall quickly. To return to the IMF’s grim textbook: “The crisis broke with a run [on] private sector deposits, which fell by more than $3.6 billion (6 percent of the deposit base) during November 28-30.” At that point the game was up. The authorities’ response (notably the introduction of the corralito) should alarm depositors throughout the PIIGS as they mull how their governments might stop precious euros escaping to safe havens abroad in the wake of bank runs at home.

The corralito limited cash withdrawals from individual bank accounts to the equivalent of $250 a week (the dollar value would soon fall sharply). And the response to it should worry those now running the PIIGS. Argentinians took to the streets and reduced the country’s political order to chaos. Depending on how you define the term, Argentina had five presidents in less than a month, but none could change the inevitable. The country defaulted on its debt, the peg was scrapped, the peso tanked, and the corralito was replaced by the corralón, the centerpiece of an even tougher regime. Depositors were allowed to withdraw a little more money than before, but only in heavily depreciated pesos. Term deposits were frozen, and transfers of money out of the country heavily restricted. Not so long after, dollar deposits were switched into pesos, and the ruin of Argentine savers, many of whom lost their jobs as the economy crashed, was complete.

History does not always repeat itself. Maybe those remaining Greek depositors are confident that, however battered their nation’s finances, its guarantee of bank deposits up to some $135,000 will hold up through the toughest times. Maybe they have faith that Greece will stick with the euro. And maybe they trust that, should the walk from Greek banks turn into a run, the European Central Bank will do what it takes to put things right. But if they do have any doubts, they can, for now, easily move their euros to a part of the eurozone—Germany, say—where there is no currency risk and bank deposits are blessed with a guarantor that is, you know, solvent. Thinking like that is how a run on the banks can begin. Paranoid? Well, if you were a depositor with a Greek bank, what would you do?

And, if you were a depositor in an Italian bank, watching all this and aware that money is ebbing away from Italy too, what would you do?

I know what the Argentine advice would be. Run.

And if the Greeks run, and the Italians run, who will be next?